Book 1: General Financial Planning, Conduct, and Regulations

Question 1

DEFINE: FINANCIAL PLANNING

Answer 1

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

Question 2

WHAT IS FINANCIAL ADVICE

Answer 2

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

Question 3

WHAT IS NOT FINANCIAL ADVICE?

Answer 3

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

Question 4

FINANCIAL ADVICE IS OBJECTIVE RATHER THAN SUBJECTIVE

Answer 4

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

Question 5

3 QUESTIONS TO DETERMINE IF FINANCIAL PLANNING IS OCCURRING

Answer 5

1. Has the planner agreed to provide Financial Planning?
2. Does the client have a reasonable reason to believe the planner will or has provided Financial Planning
3. 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.

Question 6

RELEVANT ELEMENTS OF FINANCIAL PLANNING

Answer 6

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

Question 7

INTEGRATION FACTORS FOR FINANCIAL PLANNING

Answer 7

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

Question 8

FINANCIAL PLANNING VS ADVICE ONLY

Answer 8

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

Question 9

REQUIRED INFORMATION TO PROVIDE WHEN INITIATING FINANCIAL PLANNING

Answer 9

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

Question 10

SEVEN STEP FINANCIAL PLANNING PROCESS

Answer 10

1. UNDERSTAND CLIENTS PERSONAL AND FINANCIAL CIRCUMSTANCES
   
   1. Financial status - assets/liabilities, estate plan, goals, risk, health, attitudes and beliefs
   2. Life cycle phase:
      
      1. Accumulation - 20-45+ starting off with increasing wealth as gets older, higher risk tolerance
      2. Conservation/Protection - 45+ to preceding retirement - higher net worth and cash flow, more risk adverse
      3. Distribution/Gifting - person realizes can spend monies, usually starts off trying to conserve/protect asset
2. IDENTIFY AND SELECT GOALS
   
   1. Requires collaboration with client and planner - use open ended questions so client provides the details
   2. Should encourage prioritize goals as may not have sufficient assets to fund it all; should discuss with client if goals are unrealistic
   3. Come up with reasonable assumptions
3. ANALYZE CLIENT’S CURRENT COURSE OF ACTION AND POTENTIAL ALTERNATIVES
   
   1. 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
   2. This step helps for planner to gauge strengths and weaknesses
4. DEVELOP THE PLAN AND RECOMMENDATIONS
   
   1. Recommendations should be client specific and in line with client’s situation
   2. 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
5. PRESENTING THE FINANCIAL PLANNING RECOMMENDATIONS
   
   1. Plan should address: goals, assumptions, observations and findings, alternatives, recommendations
   2. Communicate recommendations and get feedback
   3. Revise recommendations as needed based on feedback
6. IMPLEMENTING THE FINANCIAL PLAN
   
   1. FP is responsible for implementation unless excluded from Scope of Engagement
   2. What things need to be done to accomplish implementation
7. MONITOR PROGRESS AND UPDATE
   
   1. Monitor progress towards goals, review client results, update recommendations on a recurring basis to account for changes in situation
   2. Economic/Market conditions may also dictate when plan is modified

Question 11

PERSONAL FINANCIAL STATEMENTS:

STATEMENT OF FINANCIAL POSITION

Answer 11

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

Question 12

PERSONAL FINANCIAL STATEMENTS:

STATEMENT OF CASH FLOWS

Answer 12

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

Question 13

ANALYSIS OF FINANCIAL STATEMENTS:

CURRENT RATIO

Answer 13

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

Question 14

ANALYSIS OF FINANCIAL STATEMENTS: OTHER RATIOS

Answer 14

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%

Question 15

STATEMENT OF CASH FLOWS MISC

Answer 15

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

Question 16

CASH FLOW MANAGEMENT - BUDGETING

Answer 16

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

Question 17

CASH FLOW MANAGEMENT - SAVINGS STRATEGIES

Answer 17

• Automatic investments to investment accounts
• 401k and employer plan contributions through payroll dedcutions
• Paying off credit card balances

Question 18

FINANCING STRATEGIES - DEBT

Answer 18

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

Question 19

HOME MORTGAGE TYPES

Answer 19

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

Question 20

MORTGAGE SELECTION ISSUES

Answer 20

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.

Question 21

BUYING VS RENTING CASH FLOW CONSIDERATIONS

Answer 21

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

Question 22

FEDERAL DEPOSIT INSURANCE CORPORATION INSURANCE (FDIC)

Answer 22

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

Question 23

CREDIT UNIONS

Answer 23

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

Question 24

INVESTMENT BANKS

Answer 24

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

Question 25

BROKERAGE COMPANIES

Answer 25

Licensed financial institutions that specialize in the business of effecting securities transactions

Usually receive compensation for advice and assistance - commisions on buy/sell orders executed

Usually offers money market accounts in which clients can place monies while waiting to invest mones in securities

Question 26

INSURANCE COMPANIES

Answer 26

Provides asset and income protection against insurable risks through risk sharing and risk transfer

Generally regulated by states:

• keep insureres solvent
• safeguard policyholders against substandard practices
• ensure coverage is available to all individuals
• maintain competition

Federal Regulation:

• COBRA, HIPAA< ACA, Gramm_Leach-Bliley, Dodd-Frank

Federal taxation based on the product

Question 27

MUTUAL FUND COMPANIES

Answer 27

Mutual fund companies raise money by selling shares to the public and investing the monies in a diversified portfolio of securities

• also known as open-end investment comapnies and constantly issue and redeem shares according to investor instructions
• investments professionally managed, securites sold and bought at managers discretion
• investors provided with prospectus detailing portfolio objectives, costs, and features

Question 28

TRUST COMPANIES

Answer 28

Act as a Trustee, Fiduciary, or Agent for clients

Offer investment management and estate planning services

Administers trust funds and estates

Regulated by state laws

Question 29

AMERICAN OPPTY TAX CREDIT (AOTC)

Answer 29

AOTC credits 100% of the first $2000 of qualified expenses paid in the tax year plus 25% of the next $2000

Max credit per year is $2500 per student if there are $4000 in qualifying expenses

Requirements:

• use for qualified tuition, enrollment fees, related expenses and expenses for text books and course materials incurred and paid in the first four years of post secondary education for the taxpayer, spouse, or dependent
• excludes room and board
• must be at least 1/2 time student

Credit subject to phaseout in 2021:

• Married filing joint $160k-180k
• All others: $80k-$90k

Up to 40% of the eligible AOTC credit is refundable. Those who owe no tax can still get up to $1000 of the credit for ea eligible student as cash back. ie. if a taxpayer ownes no taxes and is eligible to take the maximum AOTC of $2500 they will receive a refund of $1000 (40% of $2500)

Question 30

LIFETIME LEARNING CREDIT

Answer 30

Benefits:

provides annual reimbursement for qualified tuition and related expenses per family up to $2000 per year

must spend $10k in expenses to qualify for full amount of credit; based on a 20% factor of the qualified expenses

Requirements:

• tax credit available for tuition and enrollement fees for under graduate, graduate, or professional degree programs
• does not require enrollement in a degree program or 1/2 time enrollement
• can be claimed for an unlimted number of years
• subject to annual phaseout based on MAGI for 2021:
  
  • married/jt $160k-$180k
  • single $80k-$90k
  • married filing separately not available

Question 31

COORDINATION OF AOTC AND LIFETIME LEARNING CREDITS