Fundamentals Flashcards
The 3 Types of Duties owed by a CFP
1) Duties Owed to Clients (15)
2) Duties Owed to Firms & Subordinates (3)
3) Duties Owed to CFP Board (5)
Duties Owed to Clients (15)
- Fiduciary
- Integrity
- Competence
- Diligence
- Disclose and Manage Conflicts of Interest
- Sound and Objective Professional Judgement
- Professionalism
- Comply with the Law
- Confidentiality and Privacy
- Provide Information to Client
- Duties when Communicating with a Client
- Duties when Representing Compensation Method
- Duties when Recommending, Engaging, and Working with Additional Persons
- Duties when Selecting, Using, and Recommending Technology
- Refrain from Borrowing or Lending Money and Commingling Financial Assets
Duties Owed to Firms & Subordinates (3)
- Reasonable care when supervising
- Comply with Lawful Objectives
- Provide Notice of Public Discipline
Duties Owed to CFP Board
- Felony: at least 1yr prison or $1,000 fine
- Study Tip: Driving offenses, tickets, and misdemeanors not involving alcohol or drugs are not considered relevant misdemeanors. Even 1st time drug/alcohol misdemeanors are not relevant. Tax and financial are almost ALWAYS relevant.
- Report within 30 Calendar days (includes weekends and holidays) after CFP is named, charged, convicted, settled, adversely mentioned in an action, arbitration, or civil event. Must include narrative statement of material facts, outcome, & status.
Financial Advice vs Financial Planning
Financial Advice:
1) Description
2) Pay (how client will)
3) Compensation (how advisor will be)
4) Bankruptcy/Public discipline
5) Conflicts of interest
6) Benefits from Referrals
7) Other material matters
—————————————————
+ Financial Planning:
8) Scope of Engagement
9) Limitations
10) Responsibilities
Sales-Related Compensation
Any economic benefit more than a de minis amount.
- Includes: any bonuses or portions of compensations resulting from a client purchasing/selling/holding financial assets or any referrals.
- NOT include: Soft dollars
Fee-Only vs Fee-Based
Fee-Only: receive no Sales-Related Compensation
Fee-Based: “fee and commision”
Financial Planning
Maximize the client’s potential for meeting life goals
Financial Planning Process (7 Steps)
Acronym: UIADPIM - Uber Is A Drunk Persons Immediate Motor Vehicle
1) Understand circumstances
2) Identify goals
3) Analyze courses of action
4) Develop recommendations
5) Present
6) Implement
7) Monitor & update
Minor Rule Violation
Fine is $2,500 or less
Relevant Misdemeanors
Tax & financial misdemeanors are almost always relevant.
- Not Relevant: driving offenses, tickets, and other misdemeanors not involving alcohol/drugs
Reporting to CFP Board
- Must report within 30 calendar days after CFP is charged, named, convicted, settled, or adversely mentioned in an action, arbitration, or civil event
- Report both initial charge & outcome
Felony
An offense punishable by one year or more in jail or over $1000
4 E’s to become CFP
education, exam, experience & ethics
Proper use of CFP Mark - 6 Nouns
Professional, practitioner, mark, certificate, certification, or exam
Conflict of Interest
- Written consent not required
(unlike with privacy notices & the Brochure Rule that are every 12months)
Candidate Fitness Standards
1) ALWAYS Unacceptable Conduct:
a. Felony for murder or rape
b. Any other violent crime within 5yrs
c. Felony for theft, embezzlement, tax fraud, & other financial crimes
d. Revocation of a financial license, unless revocation is administrative (ex. choosing not to renew by not paying fee required)
2) PRESUMED Unacceptable Conduct:
a. Felony for nonviolent crimes (including perjury) within 5yrs
b. Felony for violent crimes (other than murder & rape) that occurred more than 5yrs ago
c. Revocation or Suspension of a nonfinancial professional license, unless revocation is administrative
d. Two or more bankruptcies
Exceptions To vs Exemptions From Registration with SEC
Exceptions To: need not register
- TABLEs are incidental:
Teachers, Accountants, Brokers, Lawyers, & Engineers whose advisory services are solely incidental
Exemptions From: need not register but meet the definition of “investment advisor”
- VIP’s are SaFE from exemptions
Venture capital, Insurance companies, Private funds < $150M, home State*, Foreign advisors, & securities not on a national Exchange
*advisors whose clients reside in their state of business and who do not provide services to nationally listed securities
*Both Exempt & Exception parties are subject to Anti-Fraud Provisions of the Uniform Securities Act of 1956
The Brochure Rule
Requires annual written disclosure to every client of:
- services provided
- types of investment securities
- interest in securities transactions
- education/background of advisor
*in plain English, summary of ADV Part 2A & 2B
Forms of Discipline
- Suspension: 90 days to 5yrs. CFP remains subject to terms of CFP mark but is not permitted to use mark.
- Revocation: removal of CFP’s right to use marks
Catch-All
- ## Written consent not required for Conflicts of Interest
RIA Registration
<$100M = state
>$110M = SEC
between = choose
SEC vs FINRA
- SEC: government org. designed to protect integrity of stock market. It oversees FINRA. Form ADV.
- FINRA: Separate entity (not part of government) that handles licensing and regulation of broker dealers. Form U-4. (Series 6/7 to sell securities)
Investment Advisor knows his ABC’s!
Advice, Business, Compensation
Form ADV
(generally what each form is concerned with)
- Form ADV, Part 1: investment business
- Form ADV, Part 2: advisor
- Form ADV, Part 3: Form CRS - Customer Relationship Summary
Exceptions to SEC Registration
- Not need to register. Not regulated.
TABLEs: Teachers, Accountants, Brokers, Lawyers, & Engineers
Exemptions from SEC Registration
- Meet definition of investment advisor but not required to register. Subject to regulation.
“VIPs are SaFE from exemptions”
Venture capital, Insurance companies, Private funds under $150M, home State, Foreign advisors, & securities not on a national Exchange
Exceptions to VS Exemptions from SEC Registration
An exception or exemption does not exempt anyone from anti-fraud provisions of Uniform Securities Act of 1956
Brochure Rule
Require written disclosures of:
- conflicts of interest
- advisor education
- advisor investment philosophy
- fees, compensation, and commissions
- material changes provided annually
FINRA
Financial Industry Regulatory Authority
- Requires passing an exam to sell securities. (Ex. Series 6 or 7).
Series 6
License to sell Mutual Funds, UIT’s, variable life insurance, and variable annuities.
- To sell variable life/annuities, must have state insurance
Series 7
License to sell everything except commodities & futures
Accredited Investor must meet 1, or 2, 3 test!
$1M or $200,000 of income if single, or $300,000 of joint income
Opportunity Cost
Highest valued alternative not chosen
3-Panel Approach
The “Big Three” Estate documents
1) Will
2) Durable Power of Attorney for Healthcare
3) Advanced Medical Directives
3 Learning Styles
1) Visual - pictures, charts, and graphs
2) Auditory
3) Kinsthetic - create hands on activities
5 Primary Economic Factors
- Interest Rates – impact on investment returns and purchasing power
- Taxes – impact on redistribution of wealth
- Inflation – impact on cost of goods, services and money
- Inflation – impact on cost of goods, services and money
- Monetary and Fiscal Policy – impact on economic expansion/contraction
Price Elasticity
Measures the change in quantity demanded, relative to changes in price.
- Elastic
- Inelastic
Elastic Demand vs Inelastic Demand
- Elastic Demand: Quantity demanded responds significantly to changes in price. (ex. luxury goods, airplane tickets). Graph is almost horizontal sloping down & to the right
- Inelastic Demand: Quantity demanded changes very little to changes in price. (ex. necessities, gasoline). Graph looks like an “I”
Business Life Cycle
1) Expansion
2) Peak
3) Contraction/Recession
4) Trough
GDP vs GNP
- GCP measures the amount of goods and services in the US, regardless of ownership (Ex. Mexican beer that is made in Texas is included)
- GNP measures the amount of goods and services produced by a country, regardless of where the goods and services are produced (Ex. Ford production in Mexico included)
Recession vs Depression
- Recession: 6 months (2Q’s) consecutive declining GDP
- Depression: 18 months (6Q’s) consecutive declining GDP
Inflation
- Definition: An increase in prices. Loss of purchasing power is the risk inflation impacts.
- Historic Inflation: 3%
- Moderate Inflation: 1-2%
- Inflation Formula:
Inflation = ( (Price level (year x) – Price level (year x – 1)) Price level (year x – 1)
Deflation
Opposite of inflation - when prices are falling
Disinflation
A decline or slowdown in the rate of inflation
CPI vs PPI
- Consumer Price Index: price change in a basket of goods and services at the retail level
- Producer Price Index: price change in the wholesale and manufacturing sector
Economic Indicators (3 types)
1) Leading economic indicators anticipate changes in the economy. (Ex. unemployment, stock prices)
2) Coincident indicators change along with changes in the business cycle. (Ex. employees on payroll, personal income, manufacturing sales)
3) Lagging indicators summarize or “confirm” past performance (Ex. ; interest rates; duration of employment on avg., change in labor cost per unit)
Monetary Policy (Federal Reserve)
The Federal Reserve has the ability to: (REDO)
- Ease Monetary Policy (through increasing money supply and decreasing interest rates.)
- Tighten Monetary Policy (through decreasing money supply and increasing interest rates.)
4 Tools influencing money supply & interest:
1) Reserve Requirement: percentage of deposits a bank must maintain in cash
2) Discount Rate (Fed Funds Rate): the overnight interest rate at which member banks can borrow from the Federal Reserve to meet their reserve requirements
3) Open Market Operations: As the Federal Reserve buys or sells government securities, the money supply is influenced and places pressure on interest rates. As the Federal Reserve buys Treasuries, money supply increases and interest rates decrease.
4) Excess Reserves: monies that a bank holds at the Federal Reserve (or central bank) in excess of the required reserve amount
Fiscal Policy (Congress)
3 tools to influence fiscal policy: (STD)
1. Taxation: Increasing tax rates will reduce money available for spending, thereby increasing interest rates.
2. Spending: Through government spending, Congress can increase the money supply, thereby decreasing interest rates. Alternatively, Congress can cut spending, thereby increasing interest rates.
3. Debt Management: Deficit spending is when Congress spends more than tax revenues that are collected
Yield Curve
Plots current interest rates against the term to maturity
- Normal Yield Curve: concave, sloping upward to the right
- Inverted Yield Curve: convex, sloping downward to the right
4 Types of Account Ownership
1) Individual
2) Joint
3) Trusts
4) Self-directed retirement accts.
Bankruptcy: (1) Debts not discharged in Bankruptcy & (2) Assets Exempt from Creditors
(1) Debts not discharged:
- Students and Government loans.
- 3 years of back taxes.
- Alimony and Child support.
- Monies owed due to malicious acts, drunk driving, criminal fines and penalties, or embezzlement.
(2) Assets Exempt from creditors:
- Homestead
- Life insurance
- Qualified plans
Unemployment Compensation
Maximum number of weeks to receive unemployment is 39 with regular benefits lasting up to 26 weeks. The additional 13 weeks is for periods of high unemployment.
Social Security
Provides old age, survivor and disability benefits (OASDI). Form of “public” insurance funded by payroll taxes on wages earned.
Securities Act of 1934
Established the SEC whose primary function is to regulate securities market
FICO
Fiver factors affecting it:
1) Payment history
2) Amount of debt
3) Length of credit history
4) New credit
5) Type of credit
Goal: score 760 or higher
Consumer Durables & Capital Goods
- Consumer Durables: do not wear out quickly; infrequently purchased
- Capital Goods: phyical assets used by companies for the production of goods
- Consumer durables & capital goods are cyclical in nature and fluctuate directly with the Business Cycle
Interest Rates & Money Supply
- Interest rates are cost to borrow/buy money.
- As money supply becomes scarce, it becomes to borrow money.
- Hence, when money supply decr., then interest incr.
FDIC vs Federal Reserve
- Federal Deposit Insurance Corporation: regulator of state-registered financial institutions designed to instill confidence to the public of the nation’s banking system. FDIC provides deposit insurance up to certain amounts. An independent agency of the US Gov.
- Federal Reserve System: is the Central Bank and Monetary authority in the US. All national banks must be registered with it.
Workers Compensation
Absolute form of liability
Life Cycle Position
- Age: the most important element in financial planning; impacts goals, risk, timing
- Marital status
- Dependents
Emergency Fund
3-6 months of expenses
Federal & State Programs
Federal:
- Special Education
- Social Security Benefits
- Disabled Veteran Benefits
State & Local:
- Residential services
- Transportation services
COBRA
The Consolidated Omnibus Budget Reconciliation Act (COBRA):
Gives workers and their families who lose their health benefits the right to choose to continue group health benefits provided by their group health plan for limited periods of time under certain circumstances such as voluntary or involuntary job loss
2 Primary Financial Statements
1) Balance Statement (Statement of Net Worth or Financial Position)
2) Statement of Cash Flows (Income & Expense Statement)
Balance Sheet
- Lists: assets, liabilities, and net worth (A - L= OE)
- Moment in time
- Assets: a) cash/current, b) invested/LT assets (include EE savings bonds), and c) personal use assets
- Liabilities: a) current b) LT
Balance Sheet - Assets
1) Cash/Cash Equiv/Current Assets:
money market, checking, CD (less than 12month maturity, and any other asset else client can convert within 1yr
2) Invested Assets/LT Assets:
stocks, bonds, EE Savings Bonds, mutual funds, retirement accounts, business ownership, and any other asset maturing greater than 1yr
3) Personal Use Assets:
personal residence, car, furniture, boat, clothing, etc.
Balance Sheet - Liabilities
Liabilities: stated at principal outstanding
1) Current Liabilities: due within 12months. Includes credit cards, taxes, unpaid bills - utilities, cable, cell, etc.
2) LT Liabilities: remaining balance of outstanding debt beyond 12months. Includes loan for house, car, boat, etc.
Statement of Cash Flows
- Lists: income, savings, expenses, and taxes
- Income: salary, interest, dividends, & business income
- Savings: retirement plans, education savings, or other
- Expenses: variable (utilities, charitable, entertainment, etc.) & fixed (mortgage, car payment, student loan, etc.)
Categories of Ratios
1) Liquidity Ratios: measures ability to meet ST or current liabs
2) Debt Ratios: indicates how well one manages his debt
3) Performance Ratios: assesses financial flexibility of client & his progress towards goals
Liquidity Ratios
1) Current Ratio: ability to meet ST obligations.
- Formula: CR = Current Assets/Current Liabs
2) Emergency Fund: 3-6 non-discretionary expenses
- Formula: EF = Current Assets/Non-discretionary Exp (monthly)
Note: if exam gives combined fixed and variable expenses, use the combine fixed and variable as a substitute for non-discretionary exp
Debt Ratios
- Consumer debt payments: should not exceed 20% of NET income
- Housing debt: not exceed 28% of GROSS income
- Housing + all other recurring debts: no more than 36% of GROSS income
1) Housing Debt - 28% Ratio:
Monthly Housing Costs (P+I+T+I)/Monthly Gross Income
• Principal, Interest, Taxes (property), Insurance (homeowners)
2) Housing & All Other Debt - 36% Ratio:
(Monthly Housing Costs (P+I+T+I) + All Other Recurring Debt Pmts)/Monthly Gross Income
Mortgages
- Adjustable Rate Mortgage (ARM):
Appropriate for ST (1-3yr). - 2/6 ARM: interest rate cannot increase more than 2% per year or 6% for term of loan
- Reverse Mortgage:
Homeowner receives monthly payment or a lump sum from a bank while retaining the right to live in the house. Repayment occurs at homeowners death. Appropriate to generate income for elderly – only available 62yr+
Mortgage Calculations (know how to)
1) monthly/annual mortgage payment
2) interest expense deduction
3) refinance with points (point = %)
4) principal reduction
Performance ratios
1) Savings Ratio: benchmark 10-12% of gross income before age 32.
- Formula: SR = Annual Savings (employee + employer)/Annual Gross Income
2) Rate of Return on Investments (ROI): varies depending on age/risk tolerance
- Formula: ROI = (End Investements - Beg Investments - Savings - Gifts Received)/(Avg. Invested Assets)
- Avg Invested Assets = (Beg Investements + End Investments)/2
Expected Family Contribution (EFC)
How much a family should contribute towards their child’s education.
Financial Need
Tuition/Cost of Attendance - EFC = Financial Need
Financial Aid Programs
- Federal Pell Grant: strictly need based. Only for students who have not earned a bachelors/professional degree.
- Stafford Loan:
- Subsidized Stafford is need based.
- Unsubsidized Stafford NOT need based. Primary type of financial aid from the US Dept of Ed - these are student loans. Repayment begins after 6month period Leaving school. - Parent Loans for Undergraduate Students (PLUS): NOT need based.  parents pay for children’s undergraduate studies. Appropriate for parents who can afford a loan, but have not saved for education.
- Grad PLUS loan for Grad Students (GRAD Direct). The graduate student enrolled at least half time. Depends on student credit score. Repayment begins 6month after leaving school
- Federal Perkins Loan Program:
Expired September 30, 2017. Students with low EFC - was need based - Campus-Based Financial Aid: is need based
- Pay as You Earn Repayment (PAYE): available if borrower has high debt to income ratio
- Graduate Repayment: loan paid over 10yrs
Education Savings Plans (Tax-Advantaged)
1) Qualified State Tuition Plans: prepaid tuition, 529s
2) Coverdell Education Savings Accounts
3) Roth IRA
4) Series EE Savings Bonds
5) Uniform Gift to Minor’s Act
Qualified State Tuition Plans
1) Prepaid Tuition: asset of the parent
- Advantage: lock in tuition costs in today’s dollars
- Disadvantages: only earn or return, equal to tuition inflation, child receive scholarship, and may not use - parents only received principle back, not interest too, & only pays cost of tuition – room and board not included
2) 529 Savings Plan: asset of the parent. Qualified education, expenses include tuition, fees, books, supplies, and room & board.
- Advantages: any appreciation is tax-free, contributions can be recognized as pro-rata over 5yr span,
- Disadvantages: 10% penalty on earnings & earnings are included in gross income if not used for qualified education expenses
3) 529 ABLE Accounts: assist persons with disabilities
Coverdell Education Savings Accounts (ESAs)
Contributions limited to $2000 per year per beneficiary. Contributions grow tax free if used for qualified education, expenses. Used for both private elementary & secondary education. Cannot make contributions beyond beneficiary 18th birthday & must be used by 30th birthday. Asset of the parent
Roth IRA
Contributions limited to $6500 per year + $1000 (age 50+). Distribution Rule - 5yr holding period AND one of the following -age 59.5, death, disability, or first-time house purchase ($10,000 limit)
Series EE Savings Bond
Sold at Face Value. $25 min purchase & $10,000 annual max. Only available through Treasury Direct (online). Redeemable after 1yr with 3month interest penalty if redeemed in < 5yr.
Uniform Gift to Minor’s Act (UGMA)
Asset of the child. If the child is less than 19, unearned income may be taxed using parental tax brackets. If 19 or older, then unearned income is taxed at child’s rate.
- Primary risk is that child can use assets for something other than education.
- UGMA: only includes stocks, MF’s, and bonds but not include real estate
American Opportunity Tax Credit
Tax credit consists of:
- Applies to tuition & fees of 4 years of post-secondary education
- $100% of first $2,000 in qualified exp
- 25% of second $2,000 in qualified exp
- Max tax credit per student- $2,500 per yr (based on # of dependent students on family’s tax return)
*Distribution from 529 Plan CAN be claimed in same year as AOTC or LTLC BUT just not for same dollars
*Cannot claim both AOTC & LTLC for same child in same year
Coordination of Benefits
Summary sheet of Education Savings vehicles (2023)
Summary of Qualified Education Expense Definitions
