Financial Planning at Different Ages - Essay Example

Financial Planning at Different Ages Introduction The average life expectancy for people residing in United Kingdom is 80.75 years, as per the last census conducted in 2011. Reportedly, the population is also ageing. Living standards and family health have largely improved from that about 50 years back. Despite such advancements, it is to be realised that ailments and contingencies can arise at any time. Also, retirement shall come to one and all and proper financial management can alone assure a relaxed and rich retirement (Matterson, 2008). Hence, financial planning is essential at all stages of working life in order to ensure a strong foundation and realistic goal setting enables a strong lifestyle, spending pattern and good and healthy asset attainment. The paper starts with identification of financial planning and highlights the importance of such financial planning during an individual’s life cycle. Different stages of an individual’s life are examined and depending on financial needs, suggestions towards suitable financial products are made. The paper concludes that based on spending needs, risk bearing capacity and returns desired of an individual, financial planning at every stage of human life is pivotal. What is Financial Planning? Financial planning is an activity of individuals or businesses to progressively and cumulatively design and accomplish a financial goal within a circumstantial set. Such circumstances include debt elimination and preparation for retirement. Such financial planning calls for budgeting and proper arrangement of personal finances into spending and savings (Greenwood, 2002). Here, future income is segregated into different expenses, like, household expenses and investments like, savings and purchase of property. Financial planning can also be referred to as investment planning and focuses on purchase of estates, risk management, education and retirement planning at different stages of human life cycle. The study of risk management here helps to decide on an investment option that an individual should pick for different stages of human life cycle and also, allows one to make informed decision about maintaining a proper balance between long-term and short-term as well as low risk and high risk investments, such that adequate liquidity position is maintained in the individual’s investment horizon (Kotlikoff, 2008). Figure: Market risk and Expected Return on Specific Investments The figure above shows that risk and return bear a direct relationship. High risk is associated with higher returns. The figure also highlights popular investment options along the risk-return matrix. The risk return matrix here helps to understand the financial products that attach high risk, as well as those with low risks, associated with investment pattern (Toten, 2006). The corresponding rewards, in terms of rate of return, are then obtained. It is to be noted that individuals have different risk bearing capacities at different stages of life. Also, their level of return desired determines the level of risk that they must undertake. Young people prefer high returns and have high risk bearing capacities. Older people have low risk desire and hence, end up investing in lower return and more secure products, like, government bonds. Why is Financial Planning Important? Financial planning is a lifelong process, which involves setting firm base and realistic goals for the future and also, preparing for it well in advance. The way finance has been managed determines a person’s lifestyle, amount of assets owned, pattern of asset ownership and also, the spending pattern (Hallman and Rosenbloom, 2003). Back in 1950s, people were unaware of the importance of saving and were left with little or no money, during times of requirement. Since then, people in U.K. have been reducing their marginal propensity to consume and realized that saving is also essential to manage different goals of life. The investment portfolio of an investor should also hold a good mix of liquid and long-term investments and this should allow for proper decision making between fixed term investments and cash investments. This is necessary to harbour a proper balance between liquid savings and high return long-term savings. Hence, we realise the importance of financial planning for very individual. Financial Planning During the Life Cycle With rise in life expectancy, it has become increasingly important for people to plan well for their future and forthcoming retirement period. In general, one can expect to work for about 45 years and another 25 years can go into retirement, on an average. Planning for a comfortable retirement is essential in order to ensure that after retirement, people have enough money to spend on contingencies, like, medical expenditure and also, regular living expenses, like, rent, food and leisure. It is also likely for individuals to be in urgent need of money at any stage of life, other than retirement. Proper financial planning ensures that such contingency requirements are comfortably met and the individual is financially secure and stable. Such planning needs to be done at the very onset of work life of the individual. The following paragraphs outline a stage by stage analysis of financial planning at different ages of an individual’s life cycle, depending on his needs and requirements (Leung, 2007). An effective financial plan takes into account a person’s age and his goals in life. British people have not been doing very well in managing their finances and most of them are living without heaters in winters or by eating reconstituted meat for sustenance with state pension of £97.50 per week (Charupat, Huang and Milevsky, 2012). Age of 20s A person entering or within the age group of 20 has just landed in work life and is brimming with ideas to spend large and plan big for himself. This is the time when one bags a proper job and a stable salary. People should ideally spend on repayment of debts and managing living expenses with such money. Remaining savings should be ideally put in high risk–high return investments because people of this age are willing to take risks and have a long time period in hand (Corrigan and Matterson, 2010). Despite so, this age demands a part of the investment to be made in long-term, stable securities, like, the tax free ISA (Individual Savings Account). This might appear to be a small start, but it can go a long way to build a safer future with regular savings. Such account also incorporates a sound savings habit among young individuals. The ISA also allows huge flexibility in money access. This age group does not generally enable a lot of savings, as financial expenses run high due to investment in hedonistic expenses and holidays. Threat to life is the least and hence, investing in insurance products is also not advisable (Mulcare, 2008). The age group of 30s As one approaches the age group of 30s, an individual bears more expenses. The salary bar also rises high and people are more or less settled with their lifestyle. Savings in this age should be directed towards repayments of outgoings and debts and planning for certain long-term investments. Individuals should also enter into pensions schemes of their company, as soon as possible. This period is largely occupied with larger financial commitments, stemming from marriage, family planning and buying of property (Shaw, 2013). These are financial challenges of the 30s. However, care needs to be put in to manage ‘rainy day’ savings as well. The age group of 30s has the highest amount of spending associated with it, including marriage, desire to own a house, children’s education and purchases related to lifestyle assets. Pension planning, at this age, involve serious savings in the tax structure. Such management makes sure that financial outgoings are well-managed and a good balance is maintained between future savings and present needs. One also needs to secure that the habit of saving regularly is inculcated well, in early years of money management. Regular and small investments in the share market, say, in form of Systematic Investment Plans (SIP), are ways and means to save in risk-oriented investment options, so that higher returns can be gained in the longer run. Along with the ISA, there are other avenues where people can put their money for the long-term. Investing in unit linked insurance schemes and life insurance options is a good choice for having money allocated within share markets and these assure high returns along with surety of financial security against contingencies for the entire family (Ibbotson, et al., 2006). The investor in his 30s is not as risk averse as the older people and should look at benefitting from higher returns from such market linked investment options. Here, the old adage that shares shall outperform the investment returns against savings bank account returns holds true. It is more essential to spend within a budget than seeking proper financial advice. Limited spending secures good money to be invested in savings. The need for insurance also becomes more apparent and desired for the family breadwinner to support and manage one’s family. The 40s group This is the time when, for many, serious saving patterns emerge. People in their 40s and 50s tend to realize that old age and retirement are approaching and hence, they plan to save accordingly. The strategy here is to keep on building upon the ISA and since earnings in this period are very high, it is suggested that a large sum is allocated for pension funds because this is the crucial time for retirement planning. At this age, most debts are usually paid off and more real money is available to individuals. For liquid money needs, savings should be split between cash ISAs and long-term savings ISAs (West, 2013). This age also entails responsibility of costs associated with marriages of off-springs and need for a split of savings between cash investments and locked-in sums. Government bonds and fixed deposits associate a smaller amount of interest, but provide higher assurance, in terms of returns, while shares of companies, warrants and debentures link a higher rate of return and risk, with lower security of assured returns (Finney, 2010). The age of 60 and beyond As one approaches retirement, it should be made sure that the risk towards the share market volatility and capital degradation through stock market and such high risk instruments are reduced (Lachance, 2012). This is essential because an individual might lose out on stock market volatility, which might be difficult to regain in a short time and remain locked in for longer time than desired. Nonetheless, retirement does not really mean that the financial planning process stops right on the day an individual retires (Harrosen, 2005). Financial planning is a continuous process and a retired individual is yet to plan the investment of his returns and maintain a proper liquidity in the investment portfolio. The ISA interests continue to come and so does interest on other risk bearing instruments. Spending is low within this age group as most large financial investments and debt obligations have been met with (Hyde, 2010). Huge financial expenses can come only in terms of health and security needs. Conclusion After the financial crisis, it is evident that people have started spending less and saving more. Also, their spending patterns have further declined due to large unemployment. Hence, financial planning has become more important in the given economic scenario. With such limited spending, people have also realised the importance of savings. Savings can be done in myriad ways and making the choice is rather difficult for people (Mayer and Levy, 2003). Each one needs to provide some direction to life and with help of strong personal financial planning, such goals can be defined more realistically. Such financial goals also depend on availability of adequate finance. Even so, certain assumptions are inherent while planning one’s finances. People assume that they shall live long and that inflation shall be consistent within the economy. Within this set up, it is also feared that the ageing population of U.K. shall put greater stress on pension funds and social service schemes, which calls for a greater need to plan in advance. Reference list Charupat, N., Huang, H. and Milevsky, M. A., 2012. Strategic Financial Planning Over the Lifecycle: A Conceptual Approach to Personal Risk Management. Cambridge: Cambridge University Press. Corrigan, J. and Matterson, W., 2010. A Holistic Framework for Lifecycle Financial Planning. [pdf] Institute of Actuaries of Australia. Available at: [Accessed 3 February 2014]. Finney, M. J., 2010. Wealth Management Planning: The UK Tax Principles. New Jersey: John Wiley & Sons. Greenwood, R. P., 2002. Handbook of Financial Planning and Control. Aldershot: Gower Publishing Ltd. Hallman, G. V. and Rosenbloom, J. S., 2003. Personal Financial Planning. New York: McGraw Hill Professional. Harrosen, D., 2005. Personal Financial Planning: Theory and Practice. New Jersey: Prentice Hall. Hyde, D., 2010. How to plan for a richer retirement. [online] Available at: < http://www.thisismoney.co.uk/money/pensions/article-1695053/How-to-plan-for-a-richer-retirement.html> [Accessed 3 February 2014]. Ibbotson, R., Milevsky, M., Chen, P. and Zhu, K., 2006, Human Capital, Asset Allocation, and Life Insurance, Financial Analysts Journal, 62(1). Kotlikoff, L., 2008. Economics’ approach to Financial planning. Journal of Financial Planning, 21(5), pp. 5-10. Lachance, M., 2012. Optimal onset and exhaustion of retirement savings in a life-cycle model. Journal of Pension Economics and Finance. 11(1), 21-52. Leung, S. F., 2007. The existence, uniqueness, and optimality of the terminal wealth depletion time in life-cycle models of saving under certain life-cycle and borrowing constraint. Journal of Economic Theory, 134, pp. 470-493. Matterson, W., 2008. Risk in Retirement: Impact of the market downturn and implications for retirees and product providers, Milliman research report. Mayer, R. H. and Levy, D. R., 2003. Financial Planning for High Net Worth Individuals. Washington: Beard Books. Mulcare, M., 2008, The Personal CFO: An Alternative Model for Financial Advice. Institute of Actuaries of Australia. Shaw, E., 2013. Investing in a green and pleasant future. [online] Available at: < http://www.express.co.uk/finance/personalfinance/436398/Investing-in-a-green-and-pleasant-future> [Accessed 3 February 2014]. Toten, M., 2006. Financial Planning. New South Wales: Career FAQs. West, R. M., 2013. Seven ages of Isas: a plan for each stage of your life. [online] Available at: [Accessed 3 February 2014]. Read More