Fundamentals Flashcards
7 Steps in the Financial Planning Process
Uber Is A Drunk Person’s Immediate Motor Vehicle - UIADPIMV
- Understanding the client’s personal & financial circumstances
- Identifying & selecting goals
- Analyzing the client’s current course of action & potential alternative courses of action
- Developing the financial planning recommendations
- Presenting the financial planning recommendations
- Implementing the financial planning recommendations
- Monitoring progress & updating
Financial Advice
a communication that would reasonably be viewed as a recommendation that the client take or refrain from taking a particular course of action w/ respect to: the development or implementation of a financial plan; purchasing, holding, gifting, or selling financial assets; investment strategies, portfolio composition, or management of financial assets; selection of other persons to provide financial or professional services for the client
exercise of discretionary authority over the client’s financial assets
only Privacy Policy in writing; everything else orally or writing
Financial Planning
a collaborative process that helps maximize a client’s potential for meeting life goals through Financial Advice that integrates relative elements of the client’s personal & financial circumstances
only Material Conflicts of Interest orally OR writing; everything else writing
Money Disorders
rooted in emotion & may be associated w/ money beliefs
include:
compulsive buying disorder
hoarding
gambling disorder
workaholism
financial enabling/financial dependence
5 Stages of Change
- Pre-contemplation
- Contemplation
- Preparation
- Action
- Maintenance
Self-Determination Theory
there are 3 main psychological needs that determine motivation
Competence + Relatedness + Autonomy = Intrinsic Motivation
Money Beliefs
a client’s perceptions about the purpose of money & how it should be used & managed can have a positive or negative impact on their ability to meet their goals
Money Avoidance
tries not to think about money; believes they do not deserve money
Money Worship
buys things in an effort to create happiness
Money Status
needs to keep up the appearance of being successful
Money Vigilance
alert & watchful in financial matters; may have anxiety about financial future
Behavior Finance
investment decisions are impacted by cognitive biases & heuristics
rules of thumb that shorten the decision-making process
Affect Heuristic
judging something as good or bad
Availability Heuristic
relying on knowledge already attained
Anchoring
focusing on a particular reference point even if it is not relevant or pertinent to the issue in question
Herding
mimicking the actions of a larger group
Active Listening
focuses on what the speaker is saying
Reflective Listening
focuses on both the content being said & the feelings being expressed by the speaker
Motivational Interviewing
focuses on overcoming ambivalence to change
Joining
making a connection w/ the client & establishing a trusting relationship
Fiduciary Duty
at all times a CFP professional providing Financial Advice must act as a fiduciary (act in the best interest of the client)
- Duty of Loyalty - client’s interest ahead of planner’s; avoid or disclose, obtain client’s informed consent, manage conflicts of interest
- Duty of Care - skill, prudence & diligence
- Duty to follow client instructions - if reasonable & lawful
Standards of Conduct
- Duties owed to clients
- Financial planning & application of the Practice Standards for the financial planning process
- Practice Standards for the financial planning process
- Duties owed to firms & subordinates
- Duties owed to CFP Board
- Prohibition on circumvention
Compensation Disclosures (Standards A. 12.)
must be provided to client prior to or at time of engagement
oral or in writing if advice does NOT require Financial Planning
written if CFP professional is required to provide Financial Planning in accordance w/ the Practice Standards
must disclose issues related to compensation; specific dollar amount not necessary unless requested by client; sources & calculation of compensation to certificant, certificant’s employer, or a related party is necessary
Fee Only
only be used if no sales-related compensation to certificant or related party
Fee-Based
must clearly state fees & commissions or not fee-only
Sales-related compensation
broadly defined
12b-1 fees, transaction fees, revenue sharing, referral fees
Procedural Rules
Violation of CFP Board’s Procedural Rules will result in one of the following sanctions:
- Private censure
- Public censure
- Suspension (maximum 5 years)
- Revocation
- Temporary bar (respondent not yet a CFP professional)
- Permanent bar (respondent not yet a CFP professional)
*Written notice to certificant’s firm required for public discipline (Standards D.3.)
Code of Ethics
six principles; a CFP professional must:
- Act w/ honesty, integrity, competence, & diligence
- Act in the client’s best interests
- Exercise due care
- Avoid or disclose & manage conflicts of interests
- Maintain the confidentiality & protect the privacy of client information
- Act in a manner that reflects positively on the financial planning profession & CFP certification
Acceptable Nouns (6)
after CFP & CERTIFIED FINANCIAL PLANNER marks:
professional
practitioner
certificant
certification
mark
exam
Notice to CFP Board (Standards E.3.)
CFP professional must report to CFP Board w/in 30 calendar days of BOTH initiation & conclusion:
- charge or conviction of a felony
- charge or conviction of a relevant misdemeanor (including 2nd or more alcohol or drug-related offense)
- conduct mentioned adversely in finding a regulatory action involving failure to comply w/ the laws or rules governing professional services (except minor rule violations)
- suspension or revocation of a professional license
- termination for cause from employment involving allegations of dishonesty, unethical conduct, or compliance failures
- filing for a personal bankruptcy or business bankruptcy in which the CFP professional was a control person
- receipt of notice of a federal tax lien on property owned by the CFP professional
- conduct mentioned adversely in a civil action alleging fraud, theft, misrepresentation, or other dishonest conduct
NOTE: no need to report if timely & accurately reported on Form U4
Sanction for Failure to Timely Report Information
public censure
Sanction Guidelines for Bankruptcies
any personal bankruptcy or business bankruptcy where the CFP professional was a control person is subject to public censure unless the CFP professional can rebut the presumption of inability to responsibly manage financial affairs
Single bankruptcy = certificant may accept public censure w/out hearing or pay hearing fee w/ expedited adjudication
Multiple bankruptcies = follow normal adjudication process
When providing Financial Planning in accordance w/ the Practice Standards, the client must be provided written disclosures including:
existence of any public discipline or any bankruptcy & the web pages of relevant public websites of any government authority, SRO, or professional organization that provides disciplinary history
Monetary Policy
Fed support economic growth, full employment, & price stability
4 Tools:
1. reserve requirements
2. discount rate
3. open market operations
4. interest rate on required balances & excess reserves
MS increases, interest rates decrease
MS decreases, interest rates increase
Fiscal Policy
Congress seeks to support economic growth, full employment, price stability (same as Fed)
3 Tools:
1. taxation
2. spending
3. debt management
Demand Curve
downward sloping (top left to bottom right)
at lower prices people demand more
higher prices, people demand less
Supply Curve
upward sloping (bottom left to top right)
producer’s willingness to supply more at higher prices
at lower prices = less incentive for a producer to supply goods
Equilibrium Price
point of intersection of supply & demand curves
at that price the quantity supplied equals the quantity demanded
Change in Quantity Demanded
movement along demand curve = price change
price drops, people buy more
Change in Demand
shift in demand curve
change in preferences, income, tax policy, etc
Change in Quantity Supplied
movement along supply curve = price change
price drops, producers supply less
Change in Supply
shift in supply curve
change in technology, competition, etc
Substitutes
products w/ similar purpose; replaceable (coffee/tea)
increase in price of one good increases demand for the other good
Complements
products consumed jointly (peanut butter & jelly)
increase in price of one good decreases demand for other
Inelastic Demand
large percentage change in price results in smaller percentage change in quantity demanded
examples = necessities (gasoline, pharmaceuticals)
Elastic Demand
small percentage change in price results in larger percentage change in quantity demanded
Examples = luxury goods (expensive cars)
Unit Elastic
percentage change in price leads to the same percentage change in quantity demanded
Gross Domestic Product GDP
value of total output w/in a country regardless of asset ownership over a period of time
4 Main Areas:
1. consumer spending
2. government spending
3. business investing
4. net imports/exports
Gross National Product GNP
value of total output by the citizens of a country regardless of where the production takes place
Early Expansion
expectations low inflation, current low interest rates
unemployment decreases as companies increase production
monetary/fiscal policy actions support recovery
stock market/housing market typically strong
Mid-Expansion
Fed manages inflation
consumer demand increasing but increasing supply helps maintain price levels
firms may expand capacity
little interest rate movement
unemployment continues to decrease
consumer sentiment/spending is high
yield curve likely upward sloping to indicate interest rates will rise in the future (normal yield curve)
Late-Expansion
price levels increase
interest rates increase (reflect higher inflation expectations)
unemployment at lowest level
GDP is highest at peak
Recession
decline in GDP 2 or more consecutive quarters (depression = at least 6 quarters negative GDP consecutive)
stock market & housing decline
unemployment rises
consumer spending is less
Fed will try to stimulate economy by reducing interest rates
yield curve may be inverted (downward sloping) to reflect expectation of lower rates
recession bottoms out at trough
economic forces at work to move into expansion
Inflation
an increase in general price levels of goods & services
greatest risk w/ unexpected inflation is loss in purchasing power
Business Cycle & Tip
Expansion
Peak
Contraction
Trough
*focus on unemployment; if high then probably in the trough
focus on the heard, if 3/4 are moving then expansion or contraction, if 3/4 at highs/lows then peak or trough
inflation
interest rates
unemployment
GDP
*unemployment moves in opposite direction of other 3
Disinflation
slowdown in rate of inflation
Deflation
decrease in price levels (opposite of inflation)
Stagflation
occurs when inflation & unemployment are both high during a period of slow or stagnant economic growth
Consumer Price Index CPI
measures the overall price level for a basket of consumer goods & services
Producer Price Index PPI
measures price level changes for materials used at the producer (or manufacturing) level
GDP Deflator
ratio of nominal GDP to Real GDP & shows the change in the value of output that results from inflation
Income Statement
lists income & expenses over a period of time
Balance Sheet
lists assets, liabilities & net worth
snapshot in time
Net Worth (Equity) Formula
NW = Assets - Liabilities
Cash & cash equivalents
used to determine emergency fund & current ratios
important consideration for individuals w/ disability policies w/ longer elimination periods (3-6 months)
Current Assets
expected to turn over in one year
cash, checking accounts, money market, short term CDs
Current Liabilities
due w/in 1 year
credit card balances, short term loans, etc
Current Ratio
= Current Assets / Current Liabilities
ratio should be greater than 1.0
Savings Rate
= Annual Savings / Annual Gross Income
should be at least 10% if retirement is the only goal; add to the rate to accommodate retirement & other goals; 20-25% if started saving later in life
*include both EE & ER contributions
Housing Mortgages
up to $750k for mortgages after 12/15/17
up to $1,000,000 mortgages on or before 12/15/17
in acquisition debt can be considered for qualified residence interest itemized deduction
Emergency Fund Ratio
= Current Assets / Monthly Non-Discretionary Expenses
ratio gives # of months covered
if one family income 3-6 months
2 family incomes only 3 months necessary
Debt/Housing Ratios
principal plus interest plus taxes plus insurance (PITI) = Housing Cost (HC)
HC1 no greater than 28% of GROSS income (HR1)
HC + all other recurring debt payments (HC2) no greater than 36% of GROSS income (HR2)
consumer debt payments are added to housing costs in determining HR2
Nondiscretionary cash flows
generally include all income statement expenses other than savings, entertainment, & income & payroll taxes (in the event of job loss)
costs or expenses that would continue in the event of a job loss
Outpacing Inflation
Equities are the only asset class that can be expected to consistently outpace inflation & taxes
Historically real estate & precious metals have also been decent hedges against inflation
Life Cycle Approach
general tool for financial planning that profiles a client based on person’s age & stage
most useful when planner only has partial information
FDIC Insurance
applies only to deposit accounts (checking, savings, money market deposit accounts, CDs)
does NOT apply to stocks, bonds, mutual funds, insurance products, annuities, or cryptocurrency
FDIC only covers U.S. dollar deposits that are payable in the U.S.; does not cover stocks, bonds, mutual funds (including money funds), or cryptocurrency
money market deposit accounts ARE covered
per category/type of ownership
w/in an insured institution: $250k insurance for all single accounts combined, $250k for interest in all joint accounts combined, $250k total for certain retirement accounts depending on investment options used (Traditional, Roth, SEP, SIMPLE IRAs), $250k as beneficiary of trust account (max 5 beneficiaries = $1,250,000 max per grantor in aggregate for all types of trusts)
Chapter 7 Bankruptcy
Liquidation
debtor gets a discharge from all but non-dischargeable debts
Non-dischargeable debts (no forgiveness, cannot be eliminated through bankruptcy) = Student Loans (unless meets “undue hardship” exception), Back taxes (past 3 years), Alimony & child support, Debts from “bad acts” such as fraud or misappropriation etc
debtor turns all non exempt assets over to trustee for liquidation
PROTECTED ASSETS:
1. IRAs - $1,512,350 as indexed
2. IRA rollovers - unlimited (if not commingled w/ regular IRA contributions)
3. Qualified plans - unlimited
4. Inherited IRAs = NOT PROTECTED
5. Pensions
6. Life Insurance
7. Annuities
Chapter 11 Bankruptcy
generally for business reorganization
Chapter 13 Bankruptcy
adjustment of debts for individuals (means tested-repayment period is 36-60 months)
debtor keeps some non-exempt assets
Workers’ Compensation vs Unemployment
Workers Comp:
- laws place absolute liability on employer
- benefits NOT taxable
Unemployment:
- compensation funded by employer payroll tax
- benefits TAXABLE
Low occurrence, Low Loss
retain
High occurrence, Low loss
retain
use risk reduction measures
Low occurrence, High loss
Insurance
High occurrence, High loss
avoid this risk
modify behavior
Peril
cause of a financial loss (fire, theft, collision, hurricane)
Hazard
condition that increases the likelihood that a peril will occur
Physical Hazard
storing gasoline too close to an open flame (may cause a fire)
Moral Hazard
dishonesty
example = an insured files a fraudulent claim
Morale Hazard
carelessness
insured does not take proper precautions to protect an asset because the asset is insured
Life Insurance
loss of lifetime income d/t early death
12-16 times gross pay
Needs Approach & Human Life Value Method may be used to determine insurance coverage
Health Insurance
Loss of income & increased costs d/t unforeseen accidents or illnesses
an appropriate plan for your health care needs
ACA (health care reform) has removed lifetime limits on major medical policies
Disability Insurance
Loss of income & increased costs d/t unforeseen accidents or illnesses
60-70% of gross pay; should cover sickness & accident
should be guaranteed renewable or non-cancellable
Long-Term Care
increased costs of custodial care for elderly
daily (or monthly) benefits at least average cost of an appropriate facility
benefits should be inflation adjusted; benefit period at least 36-60 months
Homeowners Insurance
property losses
less than or equal to full replacement cost value on both dwelling & content; coverage for both should be open perils
homeowner w/ standard HO3, 4, or 6 policy should endorse personal property for open perils & replacement value; HO15 is a rider that adds open perils coverage for personal property
Automobile Insurance
property losses
less than or equal to full FMV for collision & comprehensive
liability coverage is a necessity
Personal Liability Insurance
costs that arise from negligence or other acts for which the insured is held legally responsible
minimum $1M personal liability policy (PLUP umbrella!)
may need to increase underlying liability coverages on homeowners/auto policies to satisfy PLUP issuer
529 Plans
Saving for College (Before College)
pre-paid tuition plan, savings plan
generally parent asset for financial aid purposes
unused funds from account open at least 15 years can be incrementally rolled to Roth IRA for beneficiary as current year contribution (lifetime max $35k)
NO PHASE-OUT FOR CONTRIBUTION ELIGIBILITY
Coverdell
Saving for College (Before College)
contribution limit $2,000/year per beneficiary
funds must be used by age 30
NO contributions past 18th birthday
owner may change beneficiary
use for college, secondary, or primary education
generally parent asset for financial aid purposes
HIGH PHASE-OUT FOR CONTRIBUTION ELIGIBILITY
Traditional IRA & Roth IRA - College
Saving for College (Before College)
10% penalty waived on non-qualified distributions used for education
HIGH PHASE-OUT FOR ELIGIBILITY
EE or I Bond - College
Saving for College (Before College)
purchased in parents name (at least 24 years old at time of purchase)
no income tax on interest if used for qualified education expenses
must be redeemed in same year expenses are incurred
may convert into 529 plan or coverdell
LOWER PHASE-OUT FOR ELIGIBILITY
UGMA, UTMA - College
Saving for College (Before College)
custodial assets
unearned income may be subject to kiddie tax (children under 19 or a full time student under age 24)
considered asset of child
UTMA may include real estate
Grants - College
Paying for College (During College)
Pell, FSEOG
Undergraduate only
Need based
Loans - College
Paying for College (During College)
Stafford (subsidized)
Undergraduate
Need based
Stafford - College
Paying for College (During College)
unsubsidized
graduate or undergraduate
NOT need based
PLUS - College
Paying for College (During College)
Parent Loans for Undergraduate Students
Undergraduate only NOT need based
Student PLUS loans available for graduate students
American Opportunity Tax Credit AOTC
1st 4 years of post-secondary education
100% of first $2,000
25% of next $2,000 of qualified education expenses
maximum annual credit = $2,500 per student
Lifetime Learning Credit LLC
20% of up to $10,000 qualified expenses
(lesser of $10,000 or qualified expenses)
per family credit
maximum credit = $2,000 per year
AOTC & LLC QuickTip
cannot use both AOTC & LLC for expenses incurred by the same person in the same year
Securities Act of 1933
requires full disclosure about new security issues
registration statement must be filed w/ SEC
one portion is the prospectus
Securities Exchange Act of 1934
regulates secondary market
established SEC as agency in charge of regulating securities laws, exchanges, & their members, brokers & dealers
Investment Company Act of 1940
defines/regulates investment companies
3 types = open-end, closed-end, UIT
Investment Advisers Act of 1940
Defines an investment adviser:
ABC - provides Advice/Analysis, is in Business of providing the advice/analyses, & receives Compensation for providing the advice/analyses
assets < $100M = register w/ state
assets > $110M = register w/ SEC
assets b/t $100M & $110M = choose state or SEC registration
EXCLUSIONS:
Lawyers, Accountants, Teachers, Engineers (LATE) as well as broker/dealers, U.S. Government securities dealers, banks, & publishers of bona fide newspapers
EXCEPTION:
foreign advisors w/ fewer than 15 clients in last 12 months & do NOT hold themselves out to the public as an investment advisor
Series 6
Investment Company Products/Variable Contracts representative
sell MFs & variable insurance products (must hold insurance license to sell insurance products)
Series 7
General Securities Representative
sell general securities (stocks, bonds, options)
excludes commodities & futures
FINRA (Financial Industry Regulatory Authority)
an independent regulator of securities firms conducting business in the United States
primary goal = protect investors by maintaining fairness in the U.S. capital markets
persons register w/ FINRA using Form U-4
Sole Proprietor
unlimited liability
1 participant
individual level, Form 1040 Schedule C
income is self-employment income
General Partnership
unlimited liability
more than 1 participant, no maximum
flow-through, Form 1065
income (reported on schedule K-1) = self-employment income
NOTE: 2017 TCJA permits flow through entities to claim a 20% deduction against qualifying business income (QBI)
Limited Partnership
General partner = unlimited liability; Limited partner = limited liability
at least one general partner & 1 limited partner, no maximum
flow-through, Form 1065
income (reported on schedule K-1) = self-employment income for the general partner; may or may not be for limited partners
NOTE: 2017 TCJA permits flow through entities to claim a 20% deduction against qualifying business income (QBI)
Limited Liability Partnership LLP
limited liability
more than 1 participant, no maximum
flow-through, Form 1065
income could be self-employment or ordinary reported on schedule K-1
NOTE: 2017 TCJA permits flow through entities to claim a 20% deduction against qualifying business income (QBI)
Family Limited Partnership FLP
limited liability for limited partners, unlimited liability for general partner (though GP often retains small % ownership such as 1%)
more than 1 participant, no maximum
taxed as partnership, entity form 1065, schedule K-1s issued to general & limited partners
purpose is to transfer assets to younger generations using annual exclusions & valuation discounts for minority interest & lack of marketability
FLPs if properly structured work extremely well for estate planning
Limited Liability Company LLC
limited liability
1 or more members
can be taxed as sole proprietorship (Form 1040 schedule C), partnership (Form 1065), corporation (Form 1120), or S-corporation (Form 1120S)
income could be self-employment, W-2 income & ordinary income, W-2 income
NOTE: partnerships (in addition to LLCs) may also be taxed as another type of entity by filing Form 8832 - Entity Classification Election
NOTE: 2017 TCJA permits flow through entities to claim a 20% deduction against qualifying business income (QBI)
S-Corporation
limited liability
no more than 100 shareholders
flow-through, Form 1120S
owners’ income flows through on Schedule K-1
employee’s income is reported on W-2
owner employees receive both Schedule K-1 & W-2
NOTE: 2017 TCJA permits flow through entities to claim a 20% deduction against qualifying business income (QBI)
Corporation (C-Corp)
limited liability
no restrictions on # of participants
entity level - corporation pays tax; Form 1120
income (reported on W-2 & Form 1099-div)
could be W-2 income & dividend income
Business Entities QuickTip
LLCs have several advantages over S-corporations
LLCs can specially allocate income & deductions
S-corporations must allocate on pro rata ownership basis
S-corporations limited to 100 owners
no maximum # of LLC members
S-corporations have limitations on ownership (only U.S. citizens/residents may be shareholders; partnerships & corporations may NOT be shareholders
LLCs do NOT have these restrictions
Future Value
the future dollar amount to which a known sum today will increase, compounded at a defined interest rate over a specific period of time
FV involves a process called compounding
Present Value
the current dollar value of a future sum discounted at a defined interest rate over a specific period of time
PV involves a process called discounting
Annuities
annuity = series of equal cash flows that occur consecutively
ordinary = deferred annuity; annuity due = immediate annuity
ordinary annuity payments = end of each period
annuity due payments = beginning of each period
annuity dues generally used for retirement funding & education funding; one needs money on the first day of retirement or college, NOT at the end of the month
ordinary annuities used for debt repayments (car loans, mortgages, bank loans, student loans, credit cards) because interest is charged from day one but is paid in arrears
Rule of 72
useful estimation tool (time to double) so long as interest rate is in 6-9% range; example interest 9%, 72/9 = 8 years to double
outside of 6-9% range it will produce errors
