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Financial planning and informed choices - Coggle Diagram
Financial planning and informed choices
6.1 Financial budgeting within a life cycle
Over their lifetime, people have a number of aspirations and life events to plan and
to finance. As a result, they may have several plans at the same time, but on different
timescales.
6.1.1 Regular short-term plans
A short-term plan might run over just one year – for example, it might be a plan to
have enough money available every year to take a summer holiday. Alternatively, it
might be a monthly or even weekly plan, for instance to have enough money from
the monthly or weekly income to pay the bills over that period. Short-term plans were
covered in Unit 1 so we will not be considering them here; nevertheless, it is
important to remember, when discussing
medium-term and long-term plans, that the
short-term plans are still there and must be
achieved. The result of the short-term plan
partly determines the success of the longerterm ones; if someone overspends in the
short term, then they have no savings to put
by to finance the medium-term want or
aspiration.
6.1.2 Medium-term plans
These plans can be achieved after a few years, for instance someone saving up for a
car might put money aside over three years and then the plan has been achieved.
But it is most likely that the person will then start saving up for something else and
so there will be a new medium-term plan; or this might even begin before the end of
the first plan and so there will be some overlap. People use medium-term plans for
different wants at different stages of their life cycle. For example, when they are
young, they might be saving up to do a college course or go to university; in middle
age they might be saving up to build an extension on their house; in late middle age
they may be saving for a holiday
6.1.3 Long-term plans
These plans span a longer period of years. Two good examples are buying a home
and paying back a mortgage, and saving for retirement. A normal mortgage period
is 25 years and borrowers have to meet the repayment obligation every month. This
obligation affects their short-term and medium-term plans since the mortgage
payment leaves them with less money to save or to spend on something else. This
plan spans their young adulthood up to early or late middle age.
6.2 Making informed choices
There are many different products on the market to fulfil people’s many and various
financial needs, and choosing the right product for the right situation can be a
complex task. In order to make an informed choice, a person should look carefully
at their wants and aspirations, at their position on the risk / reward spectrum and at
the risk / reward spectrum of the product
6.2.1 Wants and aspirations
A customer needs to consider why and to what extent they want to buy a financial
product: in other words, they need to think carefully about their wants and
aspirations
6.2.2 The risk / reward spectrum of the customer
The products chosen by any individual depend partly on their risk profile. This in
turn depends partly on their personality, their financial situation and their age – it
may vary according to the stage they have reached in the life cycle (see below). It
can also differ according to the nature of a life event – for example, someone who
needs money quickly in an emergency is less likely to consider the risks of borrowing
the funds
6.2.3 The risk / reward spectrum of the product
A prospective customer needs to make two main decisions concerning the product
group and the product brand; both involve a consideration of risk. The first is the
risk associated with a particular type of product and the second is the risk profile of
a specific brand.
6.3 Matching a solution to the circumstances
To summarise what has already been said, the most important factor when someone
is choosing a financial product is to match the product to its intended purpose and
to the characteristics of the person buying it. This means that the product should fit
well into the person’s financial plan and be suitable in terms of:
◆ the intended purpose – for example, achieving an aspiration or paying for a life
event;
◆ the timescale – medium term or long term;
◆ affordability – that is, taking into account the person’s income and other
expenses;
• Consider the strength of their want or aspiration.
• Think about the benefit they will derive from fulfilling it.
• Look at their own risk profile according to their financial circumstances.
• Consider the risk profile of the product they are intending to buy.
• Consider the risk profile of the provider that is selling it.
• Find out the charges and any penalties, how flexible it is, and the terms
and conditions.
• Consider the extent to which it fits in with their own values.
◆ attitude to risk and the risk profile of the product and the brand;
◆ how the product fits into the overall product mix.
6.4 Product mix
This unit has identified and analysed various product groups that relate to mediumterm and long-term financial requirements:
◆ saving and investment;
◆ borrowing; and
◆ insurance.
These product groups are not necessarily mutually exclusive as many people buy
products from all groups at the same time. In other words, it is perfectly possible
for someone to be repaying a loan, paying premiums on an insurance policy to
protect the payments on that loan, and saving at the same time
6.4.1 Savings and investments only
People save and invest in the medium and long term either because they are aiming
to spend the money eventually on a particular item or life event, or because they
want to provide for their own or their children’s future. The amount someone saves
depends on several factors:
◆ Their income – there is a strong relationship between income and savings.
Someone on a low income is unlikely to be able to save.
◆ The amount of current consumption (spending) in their short-term plan – since
saving means giving up current consumption, the more people consume in the
short term, the less they can save for the longer term.
◆ The necessity of saving – someone who is desperate to buy an expensive item
and cannot access a loan is forced to save up for it over a number of years.
6.4.2 Borrowing only
People borrow in the medium and long term to finance an item of expenditure that
is too large for them to afford now or because it would take too long to save up for
it and they want to have it now. The amount someone borrows depends on several
factors:
◆ Their income – this determines the amount they are able to repay over a given
period and it also determines the amount a provider is willing to lend them.
◆ Their other expenditure, especially the mandatory and necessary items – the
more someone spends on other items, the less they can afford to borrow.
◆ The time period of the loan – the longer the period, the more they can borrow
and repay.