Debt Recycling

Case Study

You are a financial planner who is required to present a Statement of Advice to the following clients, Franca and Carlos Pound who are 58 years and 60 years respectively.

Case Study Debt Recycling This is an open book assessment activity. You are required to read this assessment and answer all 4 questions that follow. Please type your answers in the spaces provided. Estimated time for completion of this assessment activity: 2 hours Case Study You are a financial planner who is required to present a Statement of Advice to the following clients, Franca and Carlos Pound who are 58 years and 60 years respectively. About their family Franca and Carlos have 3 children; Bianca, Peter and Tania who are 31, 29 and 27 respectively. Tania, the youngest child still lives at home with Carlos and Franca and doesn't pay any board. She has recently completed post graduate studies in psychology and has been saving up for a deposit on her first house with her parent's blessing. Tania plans to purchase her first home in the near future, as long as she can find the right house. She will move out of the family home once this has been achieved. Carlos and Franca's other two children are both financially independent and have left the "family nest". Bianca, the oldest child is married to Mathew and is also 5 months pregnant with their first child (and Franca and Carlos's first grandchild). Bianca is a secondary school teacher and Mathew (her husband) is in IT support. Peter, the middle child works as a manager of a restaurant, and is single. Their financial situation Franca works part-time earning $53,000 before tax as a speech pathologist and Carlos works as a construction project manager earning $98,000 before tax. They estimate at the moment they are able to save approximately $2,900 per month since their eldest two children left home. They believe once Tania leaves home this cashflow saving amount will increase to $3,700 per month. They anticipate this will occur within the next 12 months. Franca and Carlos own their own home in joint names. They believe their home is worth conservatively $625,000. They still have a mortgage of $67,000 with NAB. The loan is a principal and interest loan, with a variable interest rate of 5%. They own some direct shares in joint names which they purchased via various initial public offerings and de-mutualisations (e.g. AMP) over the past 20 years. The shares they own are CBA, Qantas, AMP, and Telstra. Combined, the shares are worth $75,000 based on current market values. The gross unrealised capital gain across all shareholdings (if the shares were to be sold) is approximately $46,000. The break-up of their direct shares is below:Today's Market Value Purchase Value CBA $30,500 $4,500 Qantas $7,500 $5,500 AMP $22,600 $5,500 Telstra $14,400 $13,500 Franca and Carlos want to retire when Carlos reaches age 65 - in 5 years' time. They currently have their superannuateon monies in XYZ Superannuateon and ABC Superannuateon. Their balances are as follows: Carlos - $421,500 (XYZ Superannuateon Fund) Franca - $348,400 (ABC Superannuateon Funds) Based on the risk profile they have completed in your pre-appointment pack you sent them prior to your first appointment, Carlos and Franca have indicated they are 'moderately conservative' investors with respect to their superannuateon monies. The five different risk profiles are provided below for your convenience. Indicative Growth assets Income assets |Description Investor in portfolio in portfolio Risk Profile Conservative 0% - 25% 75% - 100% You are a conservative investor who does not wish to take any investment risk. Your priorities are the safeguarding of your investment capital. You are prepared to sacrifice higher returns for peace of mind. Moderately 10% - 30% 70% - 90% You are a moderately conservative investor who is prepared to Conservative accept a small amount of risk. Your priority remains the preservation of capital over the medium to long term. You may have some understanding of investment markets; however you cannot afford to take any chances with your capital. Balanced 25% - 50% 50% - 75% You are a balanced investor with some understanding of investment market behaviour and can accept some short term risk to your capital. You do not wish to see all of your capital eroded by tax and inflation and are prepared to take a small short term. risk in order to gain longer term capital growth. Assertive 45% - 65% 35% - 55% You are an assertive investor who understands the movement of investment markets. You are most interested in maximising long term capital growth, although you do not wish to make unbalanced investment decisions. You are happy to sacrifice short term safety in order to maximise long term capital growth. Aggressive 75% - 100% 0% - 25% You are an aggressive investor. You are prepared to sacrifice your investment capital in pursuit of the highest long term capital growth investment. You are most interested in reducing your taxable income and have an understanding of the behaviour of investment markets.Required Carlos and Franca are interested in growing their wealth possibilities as much as possible prior to retirement. Whilst 5 years of working might have been their target initially, you have subsequently provided them with a few home truths about how much capital they would require at retirement to meet their required income needs (estimated at $75,000 net of tax in today's dollars). This realisation from Carlos and Franca has led them to consider working for at least 7 more years, rather than their initial 1m estimate. Carlos and Franca also are considering gearing as a means to accelerate their wealth creation possibilities over the next 7 years whilst they continue to work and have surplus cash flow. As a responsible nancial adviser, you have explained all the risks of gearing to Carlos and Franca. You have made them re-examine their risk profile after your explanation of the risks, coupled with the reality they will be underfunded in retirement the way they are going at the moment. Carlos and Franca have indicated to you they are comfortable borrowing up to $75,000 to invest in Australian equities (shares) despite their risk profile demonstrating they are \"moderately conservative investors\". They are also attracted to the tax benets of gearing. Obviously, you have explained to Carlos and Franca that they need to have a high (aggressive) risk prole in order to borrow money and invest that money into 100% growth assets. They agree there is a contradiction to some extent in being a moderate conservative investor when it comes to their super, but at the same time wanting you to facilitate a gearing strategy for them (as explained above) without touching their super. You explain to Carlos and Franca that you will need to document this strategy via a Statement of Advice. a} Carlos and Franca would like to use their existing $75,000jointly held shares as security for a M margin loan. Even though the lender will allow a 70% LVR, Carlos and Franca would like a more conservative LVR and would only like to gear at a level of 40%. Calculate the total amount of their investments which will include their own capital of $75,000 and a loan provided by a margin lender which is geared at 40%. Please show all your workings. b} Explain to Carlos and Franca how adopting a conservative gearing ratio of 40% will provide protection in a downward market. c} Explain to Carlos and Franca the difference between a home equity loan to borrow money in order to purchase 550,000 MW investments, compared to a margin lending strategy for this purpose. What benets would a home equity loan have over a margin loan? d} Explain how debt recycling could work in regard to Carlos and Franca's current situation