Personal Financial
Management
Semester 2 2008 – 2009
Gareth Myles g.d.myles@ex.ac.uk
Paul Collier p.a.collier@ex.ac.uk
Lecture Notes
These slides are available at:
www.people.ex.ac.uk/gdmyles/GDM.html
Course Textbook
G. Callaghan “Personal Finance”
Wiley
Secondary Textbook
T. W. McRae “Managing Your Own Finances”
Thomson Learning
PFM Classes
The class teachers are Zhiren Mao and
Humaira Asad
 There are six groups
 Each group meets once every two weeks
 Groups/times are displayed on notices
 Exercises are found on the web page

Reading
Callaghan:
 McRae:

Chapter 1
Chapter 1
Why manage?
 Increasing

self-dependence
Student tuition fees and loans
 “Tories
plan to keep student fees” (Link)
More students declare bankruptcy
Three times more students wrote off student loans
by declaring themselves bankrupt in 2003 than in
2002. 899 filed for bankruptcy last year, compared
with 276 in 2002, 249 in 2001, 97 in 1998 and
eight in 1992. A number are thought to have taken
advantage of a loophole in government legislation
allowing student loan debts to be cancelled out by
bankruptcy. (Link)
Why manage?

Increasing self-dependence

Health care


“Two-tier NHS care for pregnant women ready to
pay £4,000” (Link)
Private pensions
“New bond threat to pensions” (Link)
 “Pension reform: what other countries do” (Link)

The State Pension
% of Average Earnings
State Pension as % of Average Earnings
25
20
15
10
5
0
1973 1978 1983 1988 1993 1998 2003 2008
Year
Why Manage?

Financial risks
Property prices continue to fall
House price inflation in England and Wales
dropped sharply in December, according to
the Land Registry. Average prices fell by
0.4% in December. The December fall was
the first decline recorded by the Land
Registry since August 2005. It said the
latest data was "a clear indication of a
weakening market". The average house
price was £184,469 in December. (Link)
Why Manage?

Increasing financial complexity

Range of products
Mortgages (discount, fixed, interest only)
 Insurance (car, house, life, travel)
 Pensions (defined contribution, defined benefit)


Exposure to products
Student loans
 Credit cards
 Legislation: sellers’ packs (Link)
 Choice: saving for children (Link)

Why Manage?

The current financial crisis has shown



The implication is uncertainty about the future



The vulnerability of the financial system
The extent of risk
When will economic growth return?
How will the economy be organized in the future?
Financial planning must take this into account
Lecture Topics
Week 1: Introduction
 Week 2: Risk and Return
 Week 3: Financial Assets
 Week 4: Personal Taxation
 Week 5: Capital Gains and Estate Duty

Lecture Topics
Week 6: Insurance
 Week 7: Interest and Interest Rates
 Week 8: Purchasing Real Assets
 Week 9: Pensions and Annuities
 Week 10: Revision Lecture

Style

Partly practical


Partly analytical


E.g. What kinds of mortgages are
available?
E.g. How do you calculate the payments?
Intention

To allow evaluation, comparison and
selection
The Need for Planning
Example 1: Housing
 A “standard” 1930s threebed semi-detached
house in Exeter costs
£200,000
 This is 8 times average
earnings (£24908 in
2007: Data)
The Need for Planning
The interest payments on a 100%
mortgage would be £10,000 per year
 Most mortgage lenders would not lend
more that 4 times income
 This is only half what is required
 How can this be affordable?

The Need for Planning
Example 2: Pensions
 USS, the pension scheme for university
employees, pays a pension of 50% of final
salary plus a lump-sum of 150% of final salary.
 A professor earning £60,000 would receive a
pension of £30,000 (protected against
inflation) plus a tax-free lump-sum of £90,000.
 How much would you need to save to obtain
this with a private pension?
The Need for Planning





Assume inflation/length of life cancel out
Assume a 5% interest rate. Then £30,000 per
year requires savings of £600,000. With the
lump-sum, total required is £690,000
With a 4% interest rate, £840,000 is required
Even with 7%, the sum is £520,000
Can this be accumulated?
The Need for Planning
Example 3: Life-Cycle Earnings
 Most career paths have earnings that
increase over time
 The typical earnings profile is shown in
Figure 1
 The typical pattern of savings is shown in
Figure 2
The Need for Planning
Income
Enter
work
Retire
Figure 1: Income
Age
The Need for Planning
Saving
Enter
work
Age
Retire
Figure 2: Saving = Income - Expenditure
Earnings Profiles
Year
1
3
4
Salary
28010 28849
8
11
29716 34448 37642
15
17
42367
45166
University Lecturer
House
Officer
Senior House
Officer
Registrar
Qualified
Consultant
19703
24587-34477
27483-41733 28845-72882 67113-90838
NHS Hospital Medical Staff
Year
1
3
5
7
Salary 18264 21645 22992 24501
9
11
13
25848 26688 27669
Police Officer
15
28905
The Need for Planning
The need for planning is to produce a
smooth flow of consumption
 This requires borrowing early in life,
saving in mid-life and planned dissaving in retirement
 This process should be planned and
managed

The Need for Planning
Example 3: Costs and Rewards
 Consider the annual cost of a maintaining a
typical standard of living for a family of four





Mortgage
Utilities
Cars
TOTAL
15,000
4,000
3,000
39,000
Food
Holidays
Other Items
7,000
5,000
5,000
To support this expenditure requires a pre-tax
income of about £60,000
The Need for Planning

For some additional
items



Education
Leisure
15,000
5,000
The required pre-tax
income is now £90,000
 And this does not include
pension contributions
 How does this compare
with salaries?
Salaries in the UK

Teacher
 General Manager
 Junior Civil Servant
 Accountant (non-partner)
 Solicitor
 Professor
 MP
 Accountant (partner)
 Doctor (GP)
 Doctor (Consultant)
 Judge/Senior Civil Servant
£30,000
£30,000
£35,000
£40,000
£40,000
£50,000 +
£60,000
£65,000 +
£80,000 +
£80,000 +
£120,000
Observe
How few achieve the required £60,000
 And very few £90,000
 Conclusion


To meet such aspirations requires planning:
career choice
 expenditure
 investment

Financial Plan
Short-term
Example 1: To provide finance for
university
Aim:
to graduate with only student loan
outstanding
Expenditures: fees, accommodation,
books, leisure
Income: loan, work, savings
Options: summer work, reduce leisure
costs
Financial Plan
Medium Term
Example 2: To provide finance for house
purchase
Aim: To purchase in fifth year of employment
 Expenditures: Rent, food, car, utilities
 Income: Work
 Options: Reduce holidays, sell car

2007
2008
2009
2010
2011
Salary
25000
26000
27000
30000
31000
After Tax
17500
18200
18900
21000
21700
7000
7200
7400
8500
Income
Expenditure
Rent
Mortgage
10000
Food
4000
4050
4100
4150
4200
Car
1500
1700
1800
1800
1900
Utilities
800
840
900
940
1000
Clothes
500
550
600
600
600
Holidays
2000
2100
2200
2300
3250
Sundries
500
500
500
500
500
16300
16940
17500
18790
21450
Savings
1200
1260
1400
2210
250
Total Saving
1200
2460
3860
6070
320
Total
House Deposit
6000
Financial Plan

Long-Term Plan
Objectives: To enjoy at least two holidays a
year, detached house, run two cars (<3),
finance children through university
 Requirements: Evaluation of costs,
borrowing possibilities
 Choices: Career options to make this
achievable

Financial Plan

Very Long-Term Plan
Objective: To retire at 55
 Requirements: Sufficient savings

Pension rights
 Potential lifespan


Choices: Career options, investment
choices