Book 1: General Financial Planning, Conduct, and Regulations Flashcards
DEFINE: FINANCIAL PLANNING
A collaborative process that helps maximize a client’s potential for meeting life goals through financial advice that integrates relevant elements of the client’s personal and financial circumstances
WHAT IS FINANCIAL ADVICE
A communication that based on its content, context, and presentation would be reasonably viewed as a recommendation for the client to take or refrain from taking a particular action in regards to:
- development or implementation of a financial plan
- value of or advisability of investing in, purchasing, holding or gifting financial assets
- investment policies or strategies, makeup of portfolio, management of financial assets or other financial matters
- selection or retention of other persons to provide financial or professional advice to the client
WHAT IS NOT FINANCIAL ADVICE?
A communication based on context, content, or presentation that would not be reasonably viewed as a recommendation
A response to directed orders
If a reasonable CFP pro would not view it as Financial Advice:
- marketing materials
- general financial education
- general financial communications
FINANCIAL ADVICE IS OBJECTIVE RATHER THAN SUBJECTIVE
The more customized a planner’s recommendation to a client’s situation the more likely its advice
Making services available, marketing materials, general education or general communciations are not consdiered Financial Advice
3 QUESTIONS TO DETERMINE IF FINANCIAL PLANNING IS OCCURRING
- Has the planner agreed to provide Financial Planning?
- Does the client have a reasonable reason to believe the planner will or has provided Financial Planning
- Does the advice provided require integragtion of relevant elements of the client’s personal and financial situation in order to determine clien’t best interest.
RELEVANT ELEMENTS OF FINANCIAL PLANNING
Elements that are incorporated into the financial planning process depending on client’s situation:
- Delevoping client goals
- Managing assets and liabilities
- Managing cash flow
- Indentifying and managing risks
- Identifiying and managing the financial effect of health considerations
- Providing for educational needs
- Achieving financial security
- Preserving or increasing wealth
- Identifying tax considerations
- Preparing for retirement
- Pursung philanthropic interests
- Addressing estate and legacy matters
INTEGRATION FACTORS FOR FINANCIAL PLANNING
Integration Factors are variables that help determine whether Financial Advice requires Financial Planning.
- The amount of Relevant Elements incorporated
- The portion and amount of the Client’s Financial assets that the Financial Advice may impact
- Length of time the client’s personal and finacial circumstances could be impacted by the Advice
- The impact the Advice will have to the client’s overall level of risk
- The barriers to modifying the actions taken to implementing the Advice ie. surrender charges, tax implications
FINANCIAL PLANNING VS ADVICE ONLY
Financial Planning and assoicated Practice Standards required in situations where depth and breadth of integration factors are significant
If after determing Financial Advce requires planning and client doesn’t want to do planning then a Planner can do any of the following:
- Provide the requested services after informing the client how FP would benefit and that their decision not to do planning may limit the advice given
- Not enter into the engagement
- Limit the scope to services that do not require FP
- Terminate the engagement
REQUIRED INFORMATION TO PROVIDE WHEN INITIATING FINANCIAL PLANNING
Required to provide the following written docuatments prior to or at the start of the engagement
- A descriprtion of services and products to be provided by the CFP Pro
- How the Client will pay for the products and services and additional types of costs they could incur
- How CFP Pro is compensated
- Location of relevant info and websites for the CFP Pro re. regulatory and personal history
- Disclosure of any info about CFP Pro or their firm that is material to the decision by the client to work with the CFP Pro
- Disclosures of conflicts of interest
- Polices regarding protection and handling of nonpublic personal info
- Info required under the engagement and in response to reasonable client requests
SEVEN STEP FINANCIAL PLANNING PROCESS
- UNDERSTAND CLIENTS PERSONAL AND FINANCIAL CIRCUMSTANCES
- Financial status - assets/liabilities, estate plan, goals, risk, health, attitudes and beliefs
- Life cycle phase:
- Accumulation - 20-45+ starting off with increasing wealth as gets older, higher risk tolerance
- Conservation/Protection - 45+ to preceding retirement - higher net worth and cash flow, more risk adverse
- Distribution/Gifting - person realizes can spend monies, usually starts off trying to conserve/protect asset
- IDENTIFY AND SELECT GOALS
- Requires collaboration with client and planner - use open ended questions so client provides the details
- Should encourage prioritize goals as may not have sufficient assets to fund it all; should discuss with client if goals are unrealistic
- Come up with reasonable assumptions
- ANALYZE CLIENT’S CURRENT COURSE OF ACTION AND POTENTIAL ALTERNATIVES
- Review current course to gauge pros and cons and potential alternative courses and gauge to see which course provides best chance to maximize potential to meet goals
- This step helps for planner to gauge strengths and weaknesses
- DEVELOP THE PLAN AND RECOMMENDATIONS
- Recommendations should be client specific and in line with client’s situation
- Pros and Cons of each recommendation should be stated - how do the recommendations maximize goal potential, anticiapted impacts of recommendations, how the recommendations fit in with client’s situation
- PRESENTING THE FINANCIAL PLANNING RECOMMENDATIONS
- Plan should address: goals, assumptions, observations and findings, alternatives, recommendations
- Communicate recommendations and get feedback
- Revise recommendations as needed based on feedback
- IMPLEMENTING THE FINANCIAL PLAN
- FP is responsible for implementation unless excluded from Scope of Engagement
- What things need to be done to accomplish implementation
- MONITOR PROGRESS AND UPDATE
- Monitor progress towards goals, review client results, update recommendations on a recurring basis to account for changes in situation
- Economic/Market conditions may also dictate when plan is modified
PERSONAL FINANCIAL STATEMENTS:
STATEMENT OF FINANCIAL POSITION
Also known as balance sheet or neet worth statement
Provides a snapshot as of a given date
- Assets and liabilities should be listed at FMV
- Assets - Liabilities = Net Worth
- Footnotes used to describe details of assets and liabilities
- Specific labels used to identify ownership:
- S1, S2 individaul ownership
- JT - joint with rights of survivorship
- CP - community property
- TC - tenants in common
- TE - tenants by entirety
- Categories of Assets:
- Cash and equivalents - maturites of less than 1 year
- Investments (invested assets)
- Personal use assets (residence, furniture and autos
- Assets should be listed in order of liquidity - most liquid to least liquid
- Categories of Liabilities:
- Current Liabilities - due in less than one year
- Long-term Liabilities - due in one year or more
PERSONAL FINANCIAL STATEMENTS:
STATEMENT OF CASH FLOWS
Also known as a Cash Flow Statement
Indicates a covered time period ie. Jan 1 2021 to March 31 2021
Inflows - Outflows = Net Cash Flow (or Savings Level)
- Inflow types:
- Gross salaries; Interest and Dividends regardless if reinvested; Gross rental income; tax refunds due; realized cap gains; Alimony or child support received; Trust income; Inheritances; Gifts
- Outflows: Savings and investments (by item); fixed outflows non-discretionary (mortgage, loans); fixed outflows discretionary (subscription fees); variable outflows nondiscretionary (food and medical expenses); variable outflows discretionary (vacations and entertainment)
- Footnotes should be used to explain details of income and expenses if needed
ANALYSIS OF FINANCIAL STATEMENTS:
CURRENT RATIO
CURRENT RATIO: Examines relationship between a client’s curent assets and current liabilities
Current Assets: assets that can be converted to cash within one year (cash and equivalent, accounts receivable, and inventory for businesses)
Current Liabilities: due within one year (accounts payable, current debts - annualized credit card and loan payments, taxes)
Formula: Current assets divided by current liabilities
Indicates ability of client to meet short term obligations (due within a year) ie. credit cards, mortgages, loans
Ratios of 1> indicates client can pay off existing short-term liabilities with liquid assets - ideal betweeen 1.0 and 2.0
ANALYSIS OF FINANCIAL STATEMENTS: OTHER RATIOS
CONSUMER DEBT RATIO:
Non Housing Monthly Debt Payments divided by Monthly Net Income = ≤ 20%
HOUSING RATIO:
All Monthly Non-Discretionary Housing Costs ÷ Monthly Gross Income ≤ 28%
DEBT TO INCOME RATIO (Total Debt Ratio):
All Monthly Debt Payments and Housing Costs ÷ Monthly Gross Income ≤ 36%
STATEMENT OF CASH FLOWS MISC
Statement of cash flows should be analyzed using a month-to-month comparison calculting each outflow as a percentage of total income.
- Goal is to develop a predictive model for each expenditure
Emergency Fund:
- Should be 3 to 6 months worth of non-discretionary cash flows - 3 months if two working spouses 6 months if single or only one income
CASH FLOW MANAGEMENT - BUDGETING
BUDGETING:
- Requires planning for the expected, recurring, and unexpected
- Process of projecting, monitoring, adjusting and controlling future income and expenditures
- Preparing a Budget steps:
- Collect records for last 12 months (bank statements, check registers, credit card statements
- Track expenses by category and by month over 12 mo period to see trends
- Calculate each category as a percentage of gross income
- Note discretionary spending as this area will be used for any shortfalls by reducing spending here
- Project budget for next 12 months using last 12 as a template . Account for any changes ie. new purchases, loans
- Client should compare each month’s actual to projected budget to identify and adjust excess spending early in budget year
CASH FLOW MANAGEMENT - SAVINGS STRATEGIES
- Automatic investments to investment accounts
- 401k and employer plan contributions through payroll dedcutions
- Paying off credit card balances
FINANCING STRATEGIES - DEBT
Debt is appropriate when matched properly with the economic life of the asset and the ability to repay.
Debt should be analyzed in terms of cost (acquisition fees, interest rate, prepayment penalties) and estimated useful life of the asset.
Debt should not be used to fund a lifestyle that cannot be afforded
Cash flow analsysis will help planner determine tendencies
If high consumder debt balances should utilize a payment strategy:
Snowball Technique
- Focus on smaller balances first
- Redirect payments from other debt to target debt to pay down faster
- This provides encouragement as client sees debt paid down
Avalanche Techniques
- Prioritize highest interest rate first
- Saves in interest but slower progress paying down debt
HOME MORTGAGE TYPES
FIXED RATE:
- Level interest for length of loan
- Fixed payment amortization schedule
- Shorter the term, higher the monthly payment if interest rate is same
ADJUSTABLE RATE (ARM):
- Interest rate changes usually in relation to an index, this impacts payments up or down accordingly
- Initial rate and payment can change monthly, quarterly, year, 3 years, 5 years
- Rate caps limit how much rate can change
- Negative Amortization is when monthly payments are not enough to cover interest due - unpaid interest is added to principal
FHA (FEDERAL HOUSING ADMINISTRATION)
- Guaranteed by Federal Govt
- Low down, and sometimes lower rates since loan is guaranteed
- Mortgage Insurance requirement:
- used to protect lenders from loss on defaults
- FHA reqs require mortgage insurance for borrowers putting down less than 20%
VA (VETERANS ADMINISTRATION)
- For US veterans only
- No down, no mortgage insurance
- Same payment guarantee as FHA loans
INTEREST ONLY:
- Only interest is paid for a specific amount of time (5-10 years)
- Keeps mortgage payments to a minimu, principal remains unchanged
- Suitable for homeowners with shaort time horizon for ownership and those with sizable liquid assets
- If housing prices fall home may not be worth as much as mortgage and can be difficult to refi
REVERSE MORTGAGE
- Technicall this is a Home Equity Mortgage Conversion (HECM)
- Lender pays homeowner an income stream secured by equity in the home
- Amount of payments based on FMV of home and age of borrower
- Borrowers must be 62 plus with home free from debt
- Homeowner retains title but incurs an increasing amount of debt with each payment received fromt he lender
- Repayment required if homeowner dies, sells home, or a preset loan period ends, or owner no longer lives in home (uusally 6-12 months)
HOME EQUITY LOANS/LINES OF CREDIT (SECOND MORTGAGE)
- Second mortgages allow home owner to use equity in the propertyu to provide money for home improvements and other purchases
- Borrower receives lump sum in amount of the loan
- HELOC brorower is given aa set amount of credit they can borrow
- Home equity loan interest is only deductible if loan used for buying building or substantially improving a home
MORTGAGE SELECTION ISSUES
LENGTH OF OWNERSHIP
- If shorter term ARM might be better as initial interest rate usually less than fixed rate mortgage
- ARM rates can reset annually usuall with a 2/6 cap (2%max per yr /6% lifetime cap so in long run can be more expensive than fixed rate
- Clients considering an ARM in order to quialify for a higher loan amount should be counseled by planner
- Lower initial rate means less income needed to qualify
- Usually a poor plan that leads to inability to pay and eventual foreclosure
CLIENT’S CASH FLOW AND DISPOSABLE INCOME
CLIENT’S RISK TOLERANCE (FIXED VS VARIABLE PAYMENT)
PAY POINTS TO REDUCE RATE OR NOT
SAVINGS DUE TO MORTGAGGE SELECTION - A SHORTER TERM USUALLY MEANS LOWER RATE
- Benefits of shorter term is earlier repayment of debt and slightly lower interest rate
- Many 30yr terms are taken mainly as its the only way to qualify for the loan - if no prepayment penalty can shorten loan by paying more ie pay a 30yr mortgage in 15 years.
BUYING VS RENTING CASH FLOW CONSIDERATIONS
EFFECT ON CASH FLOW WHEN BUYING:
- Mortgage payments
- Down payment, closing costs, mortgage insurance, property taxes and insurance, maintenance, operating expenses
- Mortgage interest deductible for primary and second residence/improvement. Maximum loan amount cannot exceed 750k
- Type of mortgage (variable, fixed, balloon) can impact cash flow
EFFECT ON CASH FLOW RENTING:
- Cost is fixed, no long-term commtitment
- No property tax associated with renting
- Minimal maintenance and repair costs
- Cost of insurance for renter substantially less compared to homeowner
- Savings toward home purchase
RENTING GENERALLY BENEFICIAL IF CLIENTS WILL NOT BE IN THE HOME OVER 5 YEARS. IF LONGER OCCUPANCY THEN OWNING WILL LIKELY BE MORE ADVANTAGEOUS
TWO MAJOR ADVANTAGES TO OWNING:
- Tax deduction (mortage interest and property taxes)
- Buildup of equity
FEDERAL DEPOSIT INSURANCE CORPORATION INSURANCE (FDIC)
FDIC insurance covers dposits that are payable in the US - does not cover deposits payable overseas.
Covers:
- All types of deposit accts: savings, checking, CDs, and Cashiers checks, money orders, officers checks, and outstanding drafts
- Certified checks, letters of credit, and traverlers checks for which an insured instituion is liable for are also covered when exchanged for a money or equivalent or if charged against a deposit account
Not Covered:
- Securities, funds and similar not covered
- T bills (notes, bonds) purchased by an insured depository instition on a customers behalf not covered - ie. bank picks up for client acct
Any person or entity can have FDIC insurance on a deposit - does not have to be a citzen or resident
Creditors and Shareholders of a failed bank/savings association not covered by FDIC insurance
Deposits in different qualified instituions/or chartered separately covered separately - different institutions not branches of the same
- Max Coverage $250,000 per insured ownership type
- Accrued interest is included in calculations
- Deposits held in different ownerships are separately covered even if at same institution
Single Ownership Accounts - an account owned by one person
- Includes accounts in owners name, FBO by agents/custodians/conservators/guardians
- All single ownership accts are added together for insurance coverage purposes
- If Single Owner later gives access to account to another account is treated as a Joint Acct
UTMA accounts for the same minor added up to calculate insured amount
Joint Ownership Accounts - an account owned by two or more individuals
- Joint Ownership Accounts at same institution are added up for coverage limit
- Joint Ownership accts are insured as a separate covered acct only if:
- all co-owners are persons (not entities)
- all co-owners must have same right of withdrawal as the other owners
- if different limits or rules then its not considered a joint account, if a coowner is restricted to a specified dollar amount then the amounts are considered as individual ownership acct for insurance coverage rules
- all coowners have signed a deposit account signature card except for if acct is a CD or similar OR if acct is maintained by an agent, nominee, guardian, custodian or conservator as long as the actual deposit is jointly owned
Community Property laws do not impact insurance coverage. In community property states an account in the name of one spouse will be insured as an individual ownership acct. A joint acct is insured as a joint acct.
An account that is held in two or more names that doesn’t qualify as a joint account owners/entities share treated as individual ownership accts and amount is aggregated to all other individual owned accts in that institution
Business Accts
- Funds deposited by corporation, partnership, unincorporated association are insured separately from personal accts of stockholders, partners, members
- To qualify the entity must be engaged in an independent activity (means that the entity is opearted for some other purpose than to increase deposit insurance)
- Sole proprietor owned accts are treated as individual funds of the person who is the slole proprietor and aggregated with other individual owned accts
Retirement Accounts - covers total amts across IRAs held at single institution as long as its in bank investment products and not securites
Revocable Trusts
- In general 250k coverage for each owner per, each beneficiary up to 1250000 per revocable trust
- If assets are less than or equal to 1250000 its assumed each owner/beneficiary covered to 250k
- If assets are more than 1250000 and there are more than 5 beneficiaries the coverage is the greater of 1250000 or the aggregate of all beneficiaries proportional interest up to 250k.
Irrevocable Trusts
- Covered for 250k of the combined interests of the contigent beneficiaries
- Additional up to 250k per beneficiary may apply based on actuarial value
- doesnt apply if beneficiarys interest is contingent
- doesn apply if bneficiary interest is subject to the possiblity that the trustee may divert assets from the beneficiary
CREDIT UNIONS
Are non-profit institutions owned by members with a common association (ie. firefighteers)
National Credit Union Share Insurance Fund (NCUSIF), backed by full faith and credit of US govt
- Insures accts of all federal and most state chartered CUs up to 250k
INVESTMENT BANKS
A broker-dealer that underwrites new issues
Functions include:
- advising corporations on how to raise long term capital
- raising capital for issuers by distributing new securities
- buying securities fr issuers and reselling them to the public
- distributing large blocks of stock to the public and institutions
- helping issuers to comply with securities laws
