Personal Finance and Investments

Introduction

OBJECTIVE

The objective of this chapter is to provide an understanding of:

1. The functions and operation of financial systems.

2. The nature of personal financial planning.

3. The nature of investment risk.

People save and invest for various purposes: for holidays, home improvements, cars, deposits for house purchase, children’s education, old age, and general security. Some of these are shortterm objectives and others long term.

The single biggest long-term objective is usually the provision of a retirement income. The time horizon of the investment will influence the nature of the investment. Savings for a holiday are unlikely to be put into a risky investment such as shares. Saving for a pension is unlikely to be in low return investments such as bank or building society accounts. The largest investment item for many people is their pension fund.

At an annuity rate of 8% per annum (p.a.), a pension of £20,000 a year requires a pension fund of £250,000.Whether a pension is being provided by an employer or being funded by the employee, a substantial sum of money needs to be accumulated. So successful investing is vital. The need to invest for retirement is becoming increasingly important as governments progressively back away from promising adequate state pensions.

In Europe and North America, as well as elsewhere in the world, the proportion of retired people in the population is rapidly increasing.This is often called the demographic time bomb. In the United Kingdom (UK), for children born in 1901, the average life expectancy was 45 for males and 49 for females (Harrison 2005).Those born in 2002 had average life expectancies of 76 for males and 81 for females. Life expectancy is steadily increasing, and with it the average period of life in retirement.

The result is a rising ratio of pensioners to workers. It is often seen to be unrealistic to expect those of working age to pay the increasingly high taxes needed to pay good pensions to members of the retired population. One answer is to encourage people to provide for their own pensions by accumulating pension funds during their working lives (another approach is to raise the retirement age).

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