Topic 7

• Flexibility in financial planning

  • Financial plans must have some built-in flexibility so that they can deal with unforeseen events and changes in personal circumstances
• People make plans for their life and factor these into their financial budgets
• Life does not always work out as people expect and much of what happens is not planned
• Some people do not make any medium-term or long-term plans, preferring to make provision for the short term and leave the rest to take care of itself
• Ways the progress of someone's life cycle might differ from what they had expected

  • The events they have planned might happen but not at the expected time
  • The events they have planned might happen but not quite in the way they expected
  • The events they have planned might not happen at all
  • Events that they have not planned might happen
• Anthony


  • Assumed he would marry and have a family, but his fiancée broke off the engagement. He used money from an endowment to start a successful business instead
• Barbara


  • Always wanted to join the RAF as a pilot, but was unable to as women were not accepted at the time. She became a teacher instead, and recently won money on the Lottery to fund a world cruise
• Deborah and Alastair


  • Have been paying into a pension plan for over 40 years, but have just learned that their pension pots are likely to be severely reduced due to losses on the fund's investments
• It is not possible to draw up a separate budget for every possible combination of events that might happen during a lifetime
• Flexibility in financial planning


  Being willing and able to change priorities when major negative events occur
• Bojing


  • Had to close down his bookshop business due to competition, and had to sell personal property to pay business debts. He and his wife have had to reduce their expenditure considerably and set new priorities
• Saving for a 'rainy day'


  Saving money for an emergency - something unexpected that might happen and require money
• Long-term financial plans are less flexible than shorter-term ones
• Non-flexible savings and investments


  • Fixed-term bonds, life insurance policies, personal pension funds
• Non-flexible loan products


  • Hire purchase, fixed-interest mortgages
• Considering health and healthcare insurance

  Need to think about flexibility and whether it will continue to meet changing needs. Private healthcare insurance is expensive and needs to be factored into the budget
• Brett and Caroline


  • Researching private health insurance options and choosing a policy that fits their budget, while considering that premiums may rise in the future
• Limited liability


  If a business is a limited company, the liability of the business for debt is limited to the amount of money that can be raised by selling the business assets. If the business is not a limited company, the owners can be required to use their personal possessions to pay business debts
• Small businesses often have to use personal savings to finance the business, leaving less money to finance their lifestyle
• 'What if' calculations


  Using a spreadsheet function to set out a table of calculations and change one variable to see the effect on the final results
• Variables that change frequently and affect outcomes, suitable for 'what if' exercises

  • Interest rates
  • Inflation rates
  • Tax rates
  • Income levels
  • Expenditure levels
• Impact of interest rate changes

  Increases are a problem for loan repayments but good for savers. Decreases are the opposite
• When analysing markets, a range of assumptions are made about the rationality of economic agents involved in the transactions
• The Wealth of Nations was written

  1776
• Rational


  (in classical economic theory) economic agents are able to consider the outcome of their choices and recognise the net benefits of each one
• Rational agents will select the choice which presents the highest benefits
• Consumers act rationally by


  Maximising their utility
• Producers act rationally by


  Selling goods/services in a way that maximises their profits
• Workers act rationally by


  Balancing welfare at work with consideration of both pay and benefits
• Governments act rationally by


  Placing the interests of the people they serve first in order to maximise their welfare
• Rationality in classical economic theory is a flawed assumption as people usually don't act rationally
• Marginal utility


  The additional utility (satisfaction) gained from the consumption of an additional product
• If you add up marginal utility for each unit you get total utility
• The effect will be on the final results 'if' certain changes happen
• Variables that change frequently and affect outcomes, which lend themselves well to the use of a 'what if' exercise

  • Interest rates
  • Rate of inflation
  • Exchange rates
  • Benefits
• Interest rates


  1. Bank of England decides to make changes in its Bank rate

  2. Providers' interest rates may not change immediately and by the same amount as the change in Bank rate, but in time they will usually go up or down to reflect the change

  3. Individual providers can also change rates on particular products according to the amount of risk they are facing
• Increase in interest rates


  Problem for anyone repaying a loan with a variable rate of interest because their repayments will increase
• Increase in interest rates


  Good news for savers because they will earn a better return on their deposits
• Decrease in interest rates

  Opposite effects to an increase in interest rates
• Not even economists can predict what interest rates will do in the future as it depends on the convergence of many economic factors, but both borrowers and savers need to be aware of interest rate risk and to plan accordingly