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Lecture Personal financial planning – Chapter 18: Capital needs analysis

Lecture Personal financial planning – Chapter 18: Capital needs analysis. The goals of this chapter are: Understand the role of capital needs in PFP integration, appreciate how risk can alter the capital needs calculation, observe the advantages of a total portfolio management approach, . | Lecture Personal financial planning Chapter 18 Capital needs analysis Chapter 18 Capital Needs Analysis 1 Chapter Goals Understand the role of capital needs in PFP integration. Appreciate how risk can alter the capital needs calculation. Observe the advantages of a Total Portfolio Management approach. Apply a retirement needs analysis. Appreciate how a retirement needs calculation forces choices. Perform an insurance needs analysis. 2 Overview Financial integration Using all assets and liabilities all cash flows all household activities all future plans to arrive at decisions. Three principal ways of making integrated financial decisions Simple capital needs analysis. Capital needs analysis incorporating risk. Full integration Total Portfolio Management. 3 Simple Capital Needs Analysis Capital needs analysis takes into account all current and projected income and expenses and assets and liabilities over our life cycle. The approach taken for retirement is to estimate retirement living expenses and compare them with revenues available. The difference shortfall is typically made up through additional savings. 4 Simple Capital Needs Analysis cont. We compute the lump sum needed at retirement to provide cash thereafter that will meet living needs. This retirement lump sum is funded through implementation of a yearly savings figure. We need to employ a full life cycle approach in connection with the yearly savings figure to determine whether we will be able to generate that yearly savings. If the savings are not sufficient we then determine what adjustments have to be made. Life insurance analysis is another major use of capital needs analysis. 5 Capital Needs Analysis Risk-Adjusted Virtually all projections are subject to risk such as disappointing investment returns longer than average life cycles and a higher than projected inflation rates. Two methods that are commonly used to adjust for risk are as follows Method 1 Be more conservative in our simple capital needs