Discussion Paper: Statement of Advice
- Reasons for Advice
My clients, Harry and Sally are seeking financial advice on various issues such as sorting out superannuation from various funds into a single fund, advice on investment options, mortgage clearance, income protection, insuring Mario’s education, and advice on how to save for a holiday trip. Harry has accumulated three funds as a result of changes in his career and has not yet exercised superannuation to date. He does not wish to acquire a new fund but is seeking advice which of his existing funds would be most suitable for him to consolidate all his funds into. He considers himself as being a balanced investor and would wish to align his superannuation funds based on his preferences to risk and return. Also, Harry and Sally would like to pay off their mortgage swiftly but without draining their existing cash flow into their mortgage and losing access to funds. Therefore, they would live advice on how to go about this. They also have a problem with securing their income even in the event of illness or injury so that they can secure their income in case such an event occurs. Harry and Sally would also like to send their son, Mario, to a private school when he turns 13 and as such, they would like advice on how to save for their son’s education. Finally, Harry and Sally would like to visit Sally’s parents in Ireland during Christmas this year and would wish to get advice on how to save for this particular holiday plan.
- What is included in our advice
Harry Truman and Sally Truman, at this time have asked us to provide advice on various issues based on your goals and objectives outlined in the first section above. In particular, upon discussion your goals and preferences, we interpret your advice needs to be in following areas:
- Sorting out Harry’s superannuation into a single fund among his three funds based n his preferences to risk and return.
- Harry and Sally paying off their mortgage quickly without draining their existing cash flow and losing their access to funds
- Harry and Sally securing their income in the event of illness or injury
- Harry and Sally saving for their son’s education (Mario is currently 2 years and they would wish to send him to a private school when he turns 13)
- Harry and Sally saving for their holiday plan for Christmas their year
No other financial planning advice needs have been addressed in this Statement of Advice (SoA). This means that we have not considered your need(s) for the following:
- Life insurance
- Total and Permanent Disability (TPD)
- Trauma insurance
- Obtaining a new superannuation
By not receiving advice on these matters, these potential risks may exist:
By not considering taking a life insurance, TPD, and trauma insurance plans, they may be vulnerable to risks such not leaving enough money for each other or to their son, Mario, in the event of death, traumatic illness, or total and permanent disablement.
Should you change your mind and wish to receive advice in these areas please let us know. Please be aware that by not receiving advice on these matters, you may not have appropriate strategies in place to assist you in achieving your goals in these areas.
The strategies in this document are for discussion purposes only and are not intended for you to act on without further advice.
- Limited information warning
If the information you have provided is incomplete or incorrect, you risk making a financial commitment that may not be appropriate to your circumstances. We have based this advice on your personal objectives and circumstances we recorded in your fact find and which you confirmed for us. These objectives and circumstances are summarized in this SoA. If any information has been overlooked or misinterpreted, please let us know because it may affect whether our advice is appropriate to your circumstances. Please consider how our advice may impact your total circumstances if there are areas of information that you have not given us.
- Where to find more information
This advice is based on and incorporates information from the documents listed below and the documents should be read in conjunction with this advice. These documents have been provided to you, either previously or with this advice, but if you require further copies they are available free of charge by contacting us.
|Financial Services and Credit Guide (FSCG)||V1.1||01 July 2016|
- Your personal and financial position
- My clients are both employed. Harry is an architect while Sally is a call center manager.
- Harry has an annual income of $105,000 while Sally has an annual income of $110,000.
- They both have superannuation based on the personal incomes.
- They have an estimated annual surplus of $1,000 ($12,000 annual surplus), which is computed after deducting all living expenses, debt repayments, and mortgage but does not include paying back principal debt like the $5,000 owing to the credit card (they store in a bank account for holiday plans).
- They have a home loan (Eastpac) of $600,000 (mortgage) which they are repaying by making monthly payments of $3,111, $5,000 owing to credit card, which they are paying $60 per month, and $7,000 HECS-HELP debt.
- Harry has 3 superannuation funds, namely: Argon Super having a balance of $20,000, Trek Super with a balance of $40,000, and Bianci Super with a balance of $30,000. Sally has a superannuation of $100,000 that is invested in about 70% growth, with no insurance available.
- There current employers all my clients’ salary sacrifice but none of them has previously contributed towards the salary sacrifice.
- None of my clients have lost super funds.
- Their current lifestyle expenditure (with the exclusion of mortgage) will continue until their respective life expectancies (82 years for Harry and 85 years for Sally).
- They both have private health cover but no life insurance, TPD, trauma, and income insurance protection policies.
- As regards non-income generating assets, they have a joint principal residence ($1,000,000), home contents ($100,000), and one motor vehicle ($20,000). However, they do not have any investment property assets.
- They also have cash/fixed interest assets of $10,000 in an Eastpac account having an interest rate of 0.001%.
- They do not have any managed investments.
Net worth = (Total assets – Total liabilities)
Superannuation = ($90,000 + $100,000) = $190,000
Principal residence = $1,000,000
Home contents = $$100,000
Motor vehicle = $20,000
Cash/fixed interest assets = $10,000
Total assets = $(190,000 + 1,000,000 + 100,000 + 20,000 + 10,000) = $1,320,000
Mortgage = $600,000
Credit card owing = $5,000
HECS-HELP debt owing = $7,000
Total liabilities = $(600,000 + 5,000 + 7,000) = $612,000
Net worth = $(1,320,000 – 612,000) = $708,000
- Risk Profile
- In terms of risk profile, the investment objective of both Harry and Sally is to maximize the growth of their investments both individually and jointly.
- If their investments were to decline in value by 20% in one year, Harry would remain invested and follow the recommended strategy while Sally would increase the amount invested if possible because the market have become cheaper. However, they would jointly remain invested and follow the recommended strategy if their joint investments were to decline in value by 20% in one year.
- Sally is very willing to experience volatility to generate higher returns. He understands that to generate higher returns there is a risk fluctuation of his investments in the short term. Nonetheless, he believes that there would be a low risk of capital in the long term. On the other hand, Harry will be somewhat comfortable, assuming there will be a limit to volatility. Jointly, they will be very willing to experience volatility to generate higher returns since they understand that to generate higher returns there is a risk fluctuation of his investments in the short term. Nonetheless, they believe that there would be a low risk of capital in the long term.
- As regards their attitude towards investment losses, Harry would be very uncomfortable if he did not recover any significant losses within a 1-2-year time frame. On the other hand, even though her investment suffered significant losses over a 2-year period and she still believed in her long-term strategy, Sally would remain fully confident of a recovery in performance. Jointly, Harry and Sally would be very uncomfortable if they did not recover any significant losses within a 1-2-year time frame.
- For Harry, his preferred strategy for managing investment risk is to have a diversified investment portfolio across a range of asset classes in order to minimize the risk. As for Sally, she prefers not to reduce investment risk as she believes it results in higher returns in the long run. Jointly, they prefer to have a diversified investment portfolio across a range of asset classes in order to minimize the risk.
- In the past, Sally would describe her investment decisions as being good since she has been rewarded for making investments that can fluctuate value. On the other hand, Harry cannot gauge his past investment decisions since he is first time investor, his past investments being only his superannuation. However, they jointly describe their investment decisions based on Sally’s perspective as being pretty good.
- Based on Sally’s understanding of the investment market, she is an experienced investor and constantly keeps up to date with the investment market. She has had exposure to various asset classes and she is fully aware of the risks involved to gain higher returns. On the other hand, Harry awareness of financial market is limited to information passed on by his financial planner or broker. He relies on the professionals to keep him up to date. Jointly, they adopt Harry’s awareness of the investment market.
- Sally has a high willingness to risk short term losses for the prospect of higher longer term results while Harry has moderate willingness for the same. Jointly, they have a moderate willingness for the same.
- Both Harry and Sally have never borrowed money for other investment reasons (like investment property, holiday home, margin loan, and share portfolio among others) other than their own home.
- The score obtained based on the risk profile information provided by Harry and Sally revealed that individually, Harry is a balanced investor (70% growth), being willing to consider assets with higher volatility in the short term like property and equities to attain capital growth in the medium or longer term. A balanced investor’s investment risk consists of a large share of growth assets. On the other hand, Sally is an aggressive investor (100% growth), with her main objective being capital growth. she is prepared to compromise her portfolio balance to pursue greater long-term returns. However, their combined/joint score revealed that they are moderate investors (85% growth) and are ready to accept increased volatility in the short to long term, their primary concern being accumulation of growth assets in the long term.
- Strategy discussion
Financial strategies considered
I would recommend the following to Harry and Sally:
- Setting up and income protection (IP) insurance plan that would enable them to safeguard their income in the event of illness or injury that would force one or both of them to stay away from work for a period of over 4 months.
- Setting up a managed investment scheme to save for Mario’s education. Since Mario is currently 2 years and they wish to enroll him to a private school when he turns 13; therefore, they have to invest in the managed investment scheme for 11 years in order to generate the money. They would like Mario to go to Scots College, where they are projected to pay $30,000 from years 7 (2027) to year 12 (2032), implying that they would require a total of $210,000 to suffice for his education.
- Setting up holiday savings account in order to save money for their holiday trip to Ireland during this year’s Christmas holiday that will cost them $25,000.
- Financial strategy option 1: Income protection insurance policy
The objective of Harry and Sally is to set up an income protection plan that would safeguard their income in the event of illness or injury that may force one of them or both of them to stay away from work. Since both of them have 4 months’ worth of available holiday and sick leave. The major goal of income protection is to cover the income of the insured person’s in the event of temporary absence from work because of illness or injury, in which case, the insurer will be obliged to pay my both Harry and Sally 75% of their overall monthly income; thereby, safeguarding their monthly income.
- How it works
Once an income protection is set up correctly, the plan would payout if one is rendered unable to perform his duties for any medical reason. The cover takes into account all kinds of professions including own occupation. After choosing a deferred period, the cover will begin accumulating benefits as if on has just begun a new job where payments are made at the end of the month. For instance, since both Harry band Sally both have 4 months’ worth available holiday and sick leave, they would set their deferred period as 2 months and they will receive their initial payment after 4 months.
- Benefits if this strategy
- It is an effective form of income replacement since a monthly benefit of 75% of the insured’s income will be paid for illness or injuries sustained both at home and at work. Therefore, Mr. Owen will be financially secure in case he contracts an infection or is injured to a point that he cannot report to work.
- It covers both partial and total and permanent disability. Therefore, unlike PTD, Mr. Owen will still be covered even if he contracts an illness or injury that does not qualify as total and permanent disability.
- Mr. Owen may realize cost and tax reductions if he takes the insurance plan through superannuation.
- Outcomes of the strategy
- Harry and Sally will be able to safeguard their incomes in the event of illness of injury that forces once of them to temporarily stay away from work. Since the insurance plan will pay 75% of their overall incomes, it then implies that Harry will earn [75% x $105,000] = $78,750 while Sally will earn [75% x $110,000] = $82,500 annually.
- The income for both Harry and Sally will al so be tax-free.
- Risks you need to consider
- The policy will become invalid if Harry and Owen are incapacitated for other reasons other than injuries and illness.
- The IP policy changes when the policyholder changes his/her occupation. Therefore, their IP plans will change if any of them changes his occupation.
- Financial strategy option 2: Holiday plan
The aim of this strategy is to ensure that Harry and Sally save about of $25,000 for their holiday plans. They intend visiting Sally’s family and introducing Mario to them since they haven’t meet. Since Harry and Sally often kept their monthly surplus in a bank account for holiday purposes, I would recommend them to withdraw $4000 from their low interest earning Eastpac account and add it to this amount then make monthly contributions of $700 to this amount from for a period of 18 months. This will enable them to earn their projected amount of money for the holiday.
We can assume that Harry and Sally were saving $940 for holiday from the $1000 monthly surplus after paying $60 towards their credit card debt. Therefore, since it is July, we can assume that they have saved for 6 months.
[6 x 940] = $5,640
[$5,640 + $4,000] = $9,640 (which will act as the base amount for their savings)
- How it works
A bank savings account often generates interest to any amount of money saved. Assuming Harry and Sally deposit the money in holiday account that earn an interest of 3.05%, the money saved will earn a considerable interest at the end of 18 months when they will be going for holiday. The net future value of the savings after 18 months will be as shown in the figure below.
Figure 1: Projected returns from the holiday savings of Harry and Sally
- Benefits of strategy
- It is the most effective and secure short-term investment for Harry and Sally given the fact that they have to go for the holiday in 18 months’ time. Within this time, Harry and Sally will have earned a total of $22,999.35, which will still be within the margin of their projected $25,000 holiday expenditure.
- Their savings will also be secure since bank savings are often insured by the government. Therefore, Harry, Sally, and Mario will be guaranteed of getting their money when their planned time for the holiday comes.
- Risks you need to consider
- The money deposited in a savings account is highly liquid, implying that if need be, Harry and Sally may choose to withdraw the money; thereby, ruining his holiday plans.
- The returns will be affected by inflation; therefore, if there is a high inflation rate, Harry and Sally may not achieve their investment target.
- Financial strategy option 3: Setting up a managed investment scheme for Mario’s education savings
The aim of this plan is to ensure that Harry and Sally earn enough money to cater for Mario’s educational needs at Scots College. They wish to take Mario to high school (Scots College) at age 13 for a period of 6 years from 2027 to 2032, with a projected cost of $30,000, which will be about $180,000 for the 6 years. Given the fact that Mario is currently 2 years and they would like him to join Scots College at age 13, it implies that they have a duration of 11 years to save for his educational needs. Therefore, this particular managed investment scheme should be able to generate roughly $180,000 within a duration of 11 years. After using $4,000 for holiday savings, the Eastpac account now has $6,000. Harry and Sally will be forced to seek for a salary sacrifice of %2,000 in order to add to this amount so they can have a base amount of $8,000 for the managed funds. The future value calculations for the returns from the managed funds are shown in figures 2 and 3 below.
- How it works
A managed investment scheme or managed funds is an investment in which people contribute cash in order to earn interest in the scheme. The money is contributed by various investors and is then pooled together in a common enterprise. This scheme is them managed by an external operator. The external operator pools together the money and then invests it in shares, some form of asset, or even in other business operations as long as it can earn a profit. The external operator is often a professional fund manager. As such, the investors to the scheme are relieved of any obligation in the daily operation of the investment.
- Benefits of the strategy
- Harry and Sally will not have to manage their investment since it will be managed by a professional fund manager. As such, they will have enough time to do other things.
- Given the fact that the investment will be managed by a professional fund manager, it is more likely that it will be a success since the fund manager has adequate skills and experience regarding the investment option he choice; thereby, increasing the likelihood of the investment generating profits.
- Since managed investment schemes are usually run by funds pooled from many investors, they will enable Harry and Sally to diversify their investment, a factor that will lower their market volatility.
- Managed funds also have a low investment requirements that will allow Harry and Sally to make regular contributions to their investment.
- Outcomes of the strategy
Harry and Sally will be able to save enough money to cater for their son’s educational needs based on the computations below using compound interest calculator available at: http://www.thecalculatorsite.com/finance/calculators/compoundinterestcalculator.php
Figure 2: Returns from the Managed Investment Scheme for Mario's Education for the first 2 years
Figure 3:Returns from the Managed Investment Scheme for Mario's Education for the last 9 years
From figure 1 above, Harry and Sally will have to withdraw invest the $10,000 in their Eastpac account in a managed fund since the Eastpac account has a very low interest of 0.001%. Assuming that the managed fund generates an interest of 6.5% per annum, it will generate a total of $180,663.60 at the end of the 11-year period. After investing $10,000, Harry and Sally should make a monthly contribution of $850 for the whole period. This strategy will enable Harry and Sally to effective save for their son’s educational needs.
- Risks you need to consider
- Harry and Sally will have to incur additional costs resulting from the fees paid to the professional fund manager running their investment.
- If the schemes investments underperform, Harry and Sally may suffer losses that may derail their plan of achieving $180,000 at the end of 11 years to cater for their son’s education.
- Harry and Sally do not have control over their investment and will have to hand over full control of their investment to a stranger who may not know the significance of their investment.
- Financial strategy option 4: Sorting out Harry’s superannuation
The aim of this strategy is to sort out Harry’s three supers into a single super that is more beneficial that the rest. Harry has a total of three supers, namely: Argon Super having a balance of $20,000 (70/30), Trek Super having a balance of $40,000 (10/90), and Bianci Super having a balance of $30,000 (30/70). Therefore, his overall supers have $90,000. Based on Harry’s risk profile, he is a balanced investor (70% growth) and as such, we can eliminate the Trek Super which has a 90% growth. Therefore, the remaining supers are Argon and Bianci Supers. Looking at the two, Trek Super has a 1 year return of 11% and a 2-year return of 6.8% while Bianci Super has a 1 year return of 8.4 and a 2-year return of 9.5%. Therefore, given the fact that Harry has a moderate willingness to short term losses for the prospect of higher long term returns, I would recommend consolidating all his supers in the Bianci Super.
- Financial strategy option 5: Credit card debt repayment and mortgage payment
The aim of this strategy is to fasten the Harry’s and Sally’s credit card loan repayment as well as their mortgage payments. Currently, the two are paying $50 per month for the credit card debt of $5,000 and $3,111 monthly for their $600,000 mortgage. However, they are not in a financial position to fasten these payments as these would drain their cash flow, making them lose their access to money.
- Other important information
- Forward illustrations
Any forward illustrations are intended as a guide only. They are purely estimates, not guaranteed, and may vary with changing circumstances.
Tax implications of our advice
Under the Tax Agent Services Act 2009, AMP Financial Planning is authorized by the Tax Practitioners Board to provide tax (financial) advice services on matters that are directly related to the nature of the financial planning advice provided to you. We will not consider any other tax matters in our advice to you. Where tax implications are discussed they are incidental to our recommendations and only included as an illustration to help you decide whether to implement our advice.
- Interest rate for the computation of returns on managed funds = 6.5% per annum
- Interest rate for the computation of returns on savings in holiday savings account = 4.2% per annum.
- Harry and Sally have to withdraw their savings in the Eastpac account ($10,000) since it has a minimal interest rate (0.001%) and split up this money so that they can use it as base amounts for both the holiday saving account and managed fund.
- Harry and Sally were saving $940 for holiday from the $1000 monthly surplus after paying $60 towards their credit card debt. Therefore, since it is July, we can assume that they have saved for 6 months.
- The cost of my advice
During our meeting, we agreed the cost of my advice was as set out below. Financial planning fees paid directly. The table in this section shows initial advice costs. It also shows where any of these amounts are received by AMP Financial Planning (AMPFP) and the proportion that AMPFP then passes on to our firm. All amounts in the table that follow include GST where applicable.
- How I am paid
For details regarding how I am paid, please refer to our Financial Services Guide/Financial Services and Credit Guide.
- How am I paid?
I am an employee of The Practice and receive a salary and/or bonus from AMP Financial Planning.
- Other benefits
In addition to the fees and commissions we may receive for our advice and services, we may also receive other benefits such as financial, marketing and training assistance from AMP Financial Services Limited. These benefits may be considered to influence the service we give you or the products we recommend to you.
For further information regarding other benefits, associations and relationships, please refer to our Financial Services Guide/Financial Services and Credit Guide.