Chapter 5

Personal Financial Planning and Investments

Answers to Think It Over (p.132)

1

The minimum cost for a two-week US trip is:

Cost of air tickets = $6,000
Accommodation expenses = $800 13 nights = $10,400
Total cost = $6,000 + $10,400 = $16,400
As the trip requires at least $16,400, $8,000 is not enough for the trip.
2

Any reasonable answer

Income: I would save part of my income for the trip.

Savings: I would invest part of my savings to generate additional returns.

Investment: I would evaluate different investment choices and choose the one which can
provide my required rate of return at a reasonable level of risk.
Consumption: I would reduce my consumption (e.g., cut unnecessary expenses) so that I can
save more money for the trip.
(Or any reasonable answer)
4

Any reasonable answer

Check Your Progress

Q1

Based on the life cycle concept, the first life stage is young single. In fact, as soon as a
person gets his first full-time job, some financial planning should be considered so that proper
consumption behaviour and saving habits can be established.

Q2 Step 1 Understand your own needs

Step 2 Determine goals and gather data
Step 3 Analyse your financial situation
Step 4 Develop a financial plan
Step 5 Implement the plan
Step 6 Monitor the plan
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Q3

Without financial planning, an individual may make serious financial mistakes such as
overspending and misuse of consumer credit.

Q4

(a) If both the husband and wife are employed, the couple may start saving for retirement
and planning their investments. If only one of them works, they should take out
insurance to protect their earning ability against any possible financial burden due to
death and disability.
(b) It is important to maintain their preferred lifestyle with a stable retirement income. They
also need to have enough money for medical expenses. Another priority at this stage is
estate planning. The objective of estate planning is effectively distributing their wealth
with minimum taxation.
(c) As the birth of children greatly increases a familys financial burden, the need for
financial protection is stronger and insurance cover is a must. The couple should also
plan for their childrens educational expenses. They may also save for major purchases
and retirement.
(d) The major financial planning objective for young singles is to create and accumulate
wealth. Since they need to support their parents and families financially, they should also
take out insurance protection against the possible financial burden that may result due to
their own death and disability. They may also save for a home and retirement.
(e) The couples first priority is saving for retirement. As their children have grown up and
become financially independent, the need for insurance which provides financial
protection to the children and the non-working spouse gradually decreases.

Q5

This is because individuals usually have different needs, priorities and objectives at different
life stages. The characteristics of various life stages have a strong effect on financial planning
decisions.

Q6

When preparing a budget, an individual has to keep track of his income and expenses. This
allows the individual to evaluate his financial situation. In addition, budgeting helps him
identify his goals and understand his financial needs. With this information, the individual
can develop a financial plan and know how to allocate resources to achieve the goals set out
in the plan.

Q7

By preparing a budget, an individual can determine whether cash outflows will exceed cash
inflows so that any shortage can be forecast.

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Q8

Q9

Two factors affecting the choice of MPF funds:

1

The risk-return trade-off: In general, the higher the likelihood of large potential returns,
the higher the risk, and the greater the chance of incurring losses.

Investment horizon: Other things being equal, the longer the investment horizon (i.e., the
farther away from retirement), the more risk one can afford to take.

Two advantages of MPF funds:

1

MPF funds allow employees to save for their retirement through gradual savings in longterm investment plans according to their risk tolerance level.

Within the MPF scheme chosen by the employer, employees can make their own
investment choices and enjoy potential investment returns.

Answers to Discussion Questions (p.144)

1

The most expensive life goals for a married couple are providing for their childrens private
school/university education and maintaining a comfortable lifestyle after retirement. For
example, it may cost the couple more than HK$2 million to send one child to study at a
private US university (tuition fees plus accommodation expenses). More costs will be
involved if the child goes to an international high school in Hong Kong before studying
abroad.

He can start investing now and saving money for Susies college education.

With personal financial planning, John can develop a financial plan based on his financial
situation. This helps him prioritise his goals and needs with his limited financial resources. If
the plan is implemented properly, John can steadily accumulate wealth. This helps him
establish financial security, better meet his financial goals and maintain his living standard
when his income level is low (after retirement).

Considering his financial situation, John should evaluate if his daughter's dream is
achievable. As interest rates are low, it is not likely that John can gain enough money to pay
for his daughter's overseas education by saving alone. Instead, he should invest in high-return
financial products. On the other hand, he may ask Susie to set a more realistic goal (e.g.,
studying in Hong Kong instead of studying in US). This is an important step in the financial

NSS BAFS: Basics of Personal Financial Management

Pearson Education Asia Limited 2009
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planning process.

Assessment
MCQ
1
2
3
4
5
6
7
8
9
10
11
12

B
C
B
A
C
B
D
D
A
A
C
D

As the relevant income of the employee was less than $5,000 in that month, he is not
required to contribute to the scheme. However, his employer is still required to make a
contribution ($3,000 5% = $150).

Short Questions
13

Due to unexpected changes in personal and external situations, an individual may need to
revise his financial plan. For example, if an individual suffers a salary cut, he may reduce
consumption. If the government raises the tax rate, an individual should save a larger portion
of his income for tax payments.

14

The six financial planning needs are: consumption, taxation, insurance, investment,
retirement, and estate planning.

15

Step 1
Step 2
Step 3
Step 4
Step 5
Step 6

16

Life stages: Young single, just married, married with young children, married with older

Understanding your own needs

Determining goals and gathering data
Analysing your financial situation
Developing a financial plan
Implementing the plan
Monitoring the plan

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children, pre-retirement, and retirement.

17

Factors which should be considered:

1

The choice of financial products depends on the investment horizon, which in turn
depends on an individuals investment objectives. If the money is needed in a short period
of time, short-term financial products are more appropriate. If the money will not be used
for decades, long-term financial products are more suitable.

Investors should also consider their risk tolerance level. For example, if an investor is not
willing to take risks, he should choose low-risk financial products for his portfolio. If he
does not mind taking risks, he may choose high-risk financial products which have higher
potential returns.Ifheiswillingtoacceptanacceptablelevelofrisk,hemay If he is willing to
accept an acceptable level of risk, he may choose financial products with different riskreturn trade-offs.

18

In the childhood stage, an individual normally does not have any income or wealth to save or
invest. Therefore the childhood stage is normally excluded in financial planning.

19

In choosing a financial product, we have to consider the investment horizon and our risk
tolerance levels. The investment horizon depends on ones investment objectives. If a large
amount of money is needed in a short period of time, we should invest in short-term financial
products which have high potential returns (e.g., stocks). If we have a lot of time for investing
such as saving for retirement, we may choose a government bond or an equity mutual fund.
If our risk tolerance levels are low, we should choose a low-risk financial product. As the
return of a government bond is guaranteed, it is suitable for risk averse investors. If we are
willing to assume an acceptable level of risk, we may choose an equity mutual fund in which
the risk is diversified. If we are willing to take high risks, we may choose a stock which has a
high potential return. However, we may suffer a sharp loss if the stock price drops
significantly.

20

Financial planning helps us deal with daily needs. Most of us (not only rich people) need
financial planning in areas such as consumption and retirement. For example, we may invest
and save money for our home mortgage payments. Couples may save money for their
children's education. Employees may choose proper investment vehicles for their retirement.
To achieve our financial goals, we should do financial planning.

Case Analysis
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21

(a) By investing in mutual funds, small investors can invest in a wide variety of stocks
which are not correlated. The risks of different stocks will cancel each other out. This
allows small investors to buy a number of stocks while reducing the risk of their
investment.
(b) Buying a single stock is riskier. As the return totally depends on the price of one stock,
an investor may suffer a great loss if the stock price drops significantly. When an
investor buys mutual funds, he actually invests in different kinds of stocks which are not
correlated. The risk of the investment is diversified. Therefore buying mutual funds is
less risky.
(c) Peter should consider his investment horizon and risk tolerance level when he chooses
financial products. The investment horizon depends on Peter's investment objective.
Peter's goal is to save for his $150,000 wedding expenses in two years. If he invests in a
mutual fund:
(1 0.01) 24 1

0.01

FVA = $5,000

= $5,000 26.97
= $134,850
If he invests in the stock of the telecommunication firm:
(1 0.02) 24 1

0.01

FVA = $5,000

= $5,000 30.42
= $152,100
As investing in the stock of the telecommunication firm can generate $152,100 in two
years, which can cover Peters wedding expenses, he should choose this option.
However, Peter should also evaluate his risk tolerance level. As investing in a single
stock is risky, he should consider other choices. He may invest in other mutual funds that
provide higher returns. He may also consider saving more per month. For example, if he
can save $6,000 per month by investing in a mutual fund, he will have $161,820 ($6,000
26.97) in two years. This can cover his wedding expenses.
22

(a) Paul: $20,000 5% = $1,000

Jonathan: $12,000 5% = $600
(b) Paul should choose a high-risk product for his MPF funds because he has a long
investment horizon. He has several decades of working left before retirement. As he has

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a stable income, his risk tolerance level is high. He can afford high-risk products.
(c)

The return on Plan A after three years: $60,000 (1 + 20%)2 + $60,000 (1 + 20%)1 +
3
$60,000 or $60,000 [ (1 0.2) 1 ] = $218,400

0.2

The return on Plan B after three years: $30,000 (1 + 8%)2 + $30,000 (1 + 8%)1 +
3
$30,000 or $30,000 [ (1 0.08) 1 ] = $97,392

0.08

As the return on Plan A is higher than $200,000, Paul should choose Plan A.
(d)

Since Jonathan will retire soon, he should choose the low-risk plan. As the standard
deviation of Plan B is lower, Plan B is more suitable for him.

NSS BAFS: Basics of Personal Financial Management

Pearson Education Asia Limited 2009
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