General Principles, Conduct and Psychology Flashcards
Fiduciary Duties
Duty of Loyalty
Duty of Care
Duty to Follow Client instructions
Duty of Care
Must act with care, skill prudence and diligence in light of clients goals, risk tolerance, objectives, and financial and personal circumstances
Duty of Loyalty
Place client’s interests above self and firm
Avoid conflicts of interest or disclose ones that can not be avoided
Act in clients best interest even if a conflict of interest occurs
Duty to Follow Clients Instructions
A CFP must comply with terms of a client engagement and follow all directions of the client that are reasonable and lawful
Financial Advice vs. Financial Planning
Financial Planning is more specific and individually tailored (this is where fiduciary duties apply)
Financial Advice is more like financial education
Code of Ethics
- Act with honesty, integrity, competence and diligence
- Act in the clients best interest.
- Exercise due care
- Avoid and disclose conflicts of interest
- Maintain confidentiality and privacy
- Act in a manner that reflects well on the professional and CFP board
Financial Planning Process
Urkel’s In A Divebar Playing Iron Maiden
U-Understand the clients circumstances
I- Identify and select goals
A- Analyz current course of action and alternatives
D- Develop the fiancnail plan rec.
P- Present the recommendations
I- Implement Recommendations
M- Monitor Progress and Updating
Conduct Deemed Unacceptable penalty
Individual is permanently barred from becoming a CFP
Conduct presummed to be unacceptable and other adverse conduct consequenses
Bans an individual from being certified unless the individual petitions the Disciplinary and Ethics Commission (DEC) and DEC grants petition or permits the individual to reapply for certification later
Examples of Conduct Deemed Unacceptable
- Felony conviction for financially based crimes i.e. theft, embezzlement, tax fraud
- Revocation of financial professional license unless for administrative purposes
- Felony conviction for murder or rape
- Felony conviction for any other violent crime in the last 5 years
Examples of Conduct Presumed Unacceptable
- 2 or more personal or business bankruptcies
- Revocation of non-financial professional license except for administrative purposes
- Suspension of financial professional licenses except for administrative purposes
Felony conviction of a non-violent crime in the last 5 years
Felony conviction of a violent crime more then 5 years ago
Examples of other adverse conduct
Customer Complaints
Arbitration and other civil proceedings
Felony conviction for non-violent crimes more then 5 years ago
Misdemeanor convictions
Employer investigation and termination
CFP Board Counsel
Has the authority to investigate and file a complaint against a respondent for alleged violations of the code of ethics and standards of conduct
Disciplinary and Ethics Committee (DEC)
Composed of CFP Professionals and members of the public. The DEC has the authority to issue a final order that finds facts, determines whether a violation has occurred and where appropriate imposes discipline in the form of a sanctions
Hearing Panel
Conduct the hearing and consists of at least 3 persons. Most of the hearing panel must be CFP professionals and a majority must be DEC members. A DEC member must serve as the chair of the hearing panel
CFP Board Hearing Process
- Complaint made
-Either make a settlement (end) or respond within 30 days - After responding you can either pay fees and fine within 30 days (end) or go to a hearing
- Hearing documents, written statements due within 45 days of complain. Witness list due within 30 days
- Notice of hearing no less then 30 days before hearing
- Hearing in front of panel
-Hearing panel recommendations
-DEC reviews recommendations
-DEC Final order
-Appeals to board of directors within 30 days of final order
DEC Forms of Discipline
Private Censure- Unpublished letter from DEC
Public letter of admonition
Suspension- 90 days to 5 years
Revocation
Business Phases
Expansion- Increasing GDP and Decreasing Unemployment rate
Contraction- Decreasing GDP and Increasing unemployment rate
Business Cycle- Two points
Peak- Very high GDP and very low unemployment
Trough- very low GDP (typically negative) and very high unemployment
Recession
Two Consecutive quarters of negative GDP growth
Not every contraction is a recession but every recession in a contraction
Expansion- Early
Activity rebounds, credit begins to grow, profits grow rapidly
Policy still stimulative
Inventories low sales improving
Expansion- Mid
Growth peaking, credit growth strong, profit growth peaks.
Policy neutral
Inventories and sales growth reach equalibrium
Expansion - Late
Growth moderating, credit begins to tighten, earnings under pressure.
Policy is contractionary
Inventory grows, sales fall
Contractionary period
Falling activities, credit dries up, profits decline,
Policies Ease
Inventory and sales fall
Inflation during Business Cycle
Inflation low between early and mid cycle high during late cycle
Gross Domestic Product
Market Value of the goods and services produced by labor and property in the United States
- Looked at on a quarterly basis
- indicates the pace of growth
Determines under and over performance in sectors
Can be used to compare different nations economies
GDP- Includes and Excludes
Includes - Market value of all goods and services in the economy
Income of forgeigners working in the US
Profits if foreign companies earned in the US.
EXCLUDES- Imports, inflation, transactions where money changes hands but no new goods or services produced. Income for US citizens working abroad, US companies profits earned abroad
GDP Formula
GDP= C+I+G+(X-M)
C-Consumer spending
I- Investments made by Industry
G- Government Spending
X- Exports
M-Imports
(X-M) is also called NE- Net Exports
Price Elasticity
Measuring the quantity demanded of a good in response to changes in that goods price
Elastic Demand
Demand responds greatly to price change (consumer Discretionary
Inelastic Demand
Demand responds little to price changes (gasoline)
Supply and Demand:
Substitutes and Complements
Substitutes- Increases in price of one thing will increase in demand of another. (increases in gas price causes increase in electric vehicle demand
Complements- decrease in price of one item will increase demand of another (when peanut butter goes on sale demand for jelly will go up)
Marginal Utility
Additional benefit received from the consumption of an additional unit of a good
as rate increases marginal utility from additional units will decrease, known as diminishing marginal utility
Fiscal Policy
Congress sets fiscal policy: done through taxation, expenditures and debt management and how each influences the economy
Fiscal Policy: Taxation
Increases in tax rate reduce disposable income and slow down the economy
decreases in tax rate increase disposable income and stimulate the economy
Fiscal Policy: Government Spending
Increased government spending promotes growth and recovery
Once economy is functioning, government support will be eliminated or reduced
Monetary Policy
This is the control over the money supply and influences lending rates. Used to slow down or stimulate the economy
Controlled by the Federal Reserve Bank (aka the Fed)
The Federal Reserve Bank Mandates
Long term economic growth (GDP), maintain price levels as measured by inflation (CPI), maintain full employment based on long term unemployment rates.
4.3% unemployment
2.0% inflation
2.0% GDP growth
The Federal Reserve Bank Tools
Discount Rate- The rate at which banks borrow from the government
Reserve Requirements- The percentage of deposits that must be help in reserve
Open Market- the Fed buys and sells securities in the open market
Monetary Policy: Contrationary (tightening)
Raise discount rates
Raise the reserve requirements
Sell securities
Monetary Policy: Expansionary (Easing)
Decrease discount rate
Decrease reserve requirements
Buy securities from the open market
Heuristic
Anything that is used to reduce cognitive load in decision making
- allows biases to cloud objectivity
- good for short term goals and approximations
these are rules of thumb, educated guesses and trial and error decision making strategies
Anchoring
Where an investor sets a value at, the initial point of information (typically their buy price)
Prospect Theory
People suffer more greatly from losses than they benefit from equal gains
Recency Bias
Investors focus more on the most current events leading to faulty predictions that “this is always how it will always be”
Overconfidence
Overestimating their knowledge under estimate risks and exaggerate their ability to control events and predict outcomes
Factors leading to overconfidence: Choice, task familiarity, active involvement, past success, information (confirmation) bias
The disposition Effect
People seek pride and avoid regret
Sell winners too quickly (confirms correct choice)
Holds losers too long (avoid confirming incorrect choice)
Considering the Past
House money effect - take more risk
Snakebite effect- take less risk
Break-even-itis - Take more risk
Mental Accounting
The assumption that simply investing in enough unrelated assets will reduce risk sufficiently to make a profit
Home Bias
Concentration of stocks in your home country or your employer stock
Herd Mentality
We find comfort in numbers or in groups
Optimism
Leads to exuberance and market bubbles
Financial Statements
Balance sheets and statements of cashflow
Balance sheet (and formula)
Snap shot at 1 specific moment
Reported in fair market value
Show financial position
measures assets, liabilities and shareholder equity
Networth = Assets - Liabilities
Start with cash balance and ends with retained earnings
Cash flow
Reported over a period of time
used to show cash movement
Measures increases and decreases in cash
Starts with net income ends with cash balance
Financial Ratio Types
Liquidity Ratio- used to determine the ability to meet short term obligations
Activity Ratios- use to determine the relative efficiency of financial management
Profitability Ratios- Used to measure relative profitability
Debt Ratios- used to determine the ability to meet long term obligations
Liquidity Ratios
- Current Ratio
- Quick Ratio
- Working Capital
Current Ratio= Current assets / Current Liabilities
Quick Ratio= (Current Assets - inventory) / Current Liabilities
Working capital = Current Assets - Current Liabilities
Activity Ratios
- Inventory Turnover
- Days to sell Inventory
- Account Receivable turnover
- Receivable Collection Period
Inventory turnover = Cost of goods sold / Average inventory
Days to sell inventory = 365 / Inventory turnover
Accounts Receivable turnover = sales / average account receivable
Receivable collect period = 365/account receivable turnover
Profitability Ratios
- Gross Profit Margin
- Operating Profit Margin
- Return on Asset
- Return on Equity
-Gross Profit Margin = Gross profits/ Sales
-Operating Profit Margin= Operation Income/ Revenue
-Return on Assets = Net income / Total Assets
-Return on equity = Net income/Equity
Debt Ratios
- Debt to Equity
- Times Interest Earned
- Debt Ratio
Debt to equity = Total debt / Total shareholder equity
Times interest earned = (earnings before interest + taxes)/ Interest payable
Debt Ratio - Total debt/ Total assets
Emergency Funds (and emergency fund ratio)
Single Income- 6 months
Dual (equal-ish) income - 3-6 months
Prevents selling stocks in a down market
Assists during a job loss or unforeseen expenses
Emergency fund ratio = monetary assets / monthly living expenses
Chapter 7 Bankruptcy
Purpose- Liquidation
Who- Individual or business
Eligibility - Below certain income limits
Unsecured debts are eliminated secured debts are sold to pay off
Doesn’t stop a foreclosure but delays it
Takes 4-6 months
Stays on credit report for 10 years
Chapter 13 Bankruptcy
Purpose- Repay debt
Who- Individuals only
Debt must be below a certain limit
Secured and unsecured debts are paid back over time with a repayment plan
Can stop a foreclosure
Takes 3-5 years
Stays on credit report for 7 years
Chapter 11 Bankruptcy
Purpose- to reorganize debt
Who- Businesses (or individuals who exceed chapter 11 limits)
No Eligibility requirements
Unsecured debts are reorganized, secured debts are restructured and both are paid back over time
Can stop a foreclosure
Takes 6 months - 2 years
Stays on credit report for 10 years
Credit Score make-up
Payment History - 35%
Amount Owed - 30%
Length of Credit History - 15%
New Credit - 10%
Credit Mix - 10%
Mortgage Ratios:
Housing Ratio (front end ratio)
PITI/Gross household income
Pass= less than or equal to 28%
Mortgage Ratios:
Total Debt Ratio (Back end Ratio)
(PITI + monthly consumer debt)/ Monthly Gross income
Pass = less then or equal to 36%
Mortgage Ratios:
Consumer debt ratio
non-housing consumer debt/ Net income
Pass = less than or equal to 20%
VA Mortgages
No Down Payment
No Insurance
2.3-3.6% funding fees (waived if disabled)
USDA Mortgages
No Down Payment
No Insurance
1% fee upfront
.35% annual fee
FHA Mortgage
3.5-20% down payment
needs insurance if under 20% for either 11 years or the life of the loan (if less than 11 years)
No Funding Fees
Conventional Mortgage
3-20% down payment
Insurance needed if under 20% down payment
No funding fees
Education Funding (3 steps)
1) College cost from today to day 1 of college
2) Total cost of college (use begin mode)
3) Amount to cover total cost (either as payments or lump sum)
529 Maximum Contributions
$17,000 per year from an individual
$85,000 from an individual when using 5-year front loading plan
$170,000- from a couple using gift splitting and the 5 year front loading plan
529 Tax Treatment
Post Tax Contributions
Tax deferred growth
Tax free distributions when used for qualifying educational expenses
529 Qualified Expenses
- Tuition, fees, books, computer and related equipment, supplies and special needs
Room and Board for minimum half time students
up to $10,000 to repay student loans
Up to $10,000 in tuition for k-12 school
Coverdale ESA Age limit
Contributions must be made before beneficiary turns 18
Account must be deleted or beneficiary changed by the time the original beneficiary reaches age 30
EE and I Bond Age Restrictions
Purchaser of these bonds must be at least 24 when bond is purchased
EE and I Bond Qualified expenses
Tuition and Fees ONLY
Disadvantages of UGMA and UTMA accounts
No restrictions on funding usage
Considered minor’s property one they reach age of majority (18/21)
Could Trigger Kiddie tax
Viewed as students asset for determining financial aid
ABLE Accounts
A tax favored account that can accept contributions for an eligible individual with a disability, or is blind, and who is designated beneficiary and owner of the account
ABLE age limits
Disability of blindness must have occurred before the age of 26
ABLE Tax Treatment
Income Tax- withdrawn earnings excluded from income to extent of qualified disability expenses
Gift Tax- Contributions are considered a completed gift for annual $17,000 exclusion
Estate Tax- Included in beneficiary’s estate after paying for medical bills and expenses
Types of Financial Aid
Grants
Scholarships
Loans
Work-Study
Grants
Pell Grants- Exceptional financial need can be for bachelors, graduate, or professional degree
Federal Supplemental Education Opportunity Grant (FSEOG)- undergraduate only, gives priority to those who also received a Pell Grant
Financial Aid: Loans
Federal Direct (Stafford Loans)-
Subsidized- US DoE pays interest while student is in school, 6 months after they leave school and during deferment.
Unsubsidized Loans- Student is responsible for all interest payments
Parent PLUS (direct PLUS) loans- Loan through US DoE. Must have good credit history.
Cost of attendance- other financial aid received = maximum PLUS loan
Work-Study
Funded by Federal, state and/or institutional allocations
Employer must match federal and state monies
School office of financial aid administers work-study program
Free Application for Federal Student Aid (FASFA)
Used to Determine eligibility for financial aid
2 year look back for reported income
Expected Family Contributions (EFC)
Income+ assets = EFC
22-47% of parents income
50% of students income
5.64% of parents assets
20% of students assets
Cost of attendance - EFC = Financial Aid
Financial Aid, EFCs and Retirement Accounts
Retirement assets are not counted towards EFCs
American Opportunity Tax Credit (AOTC)
$2,500/student
up to $1,000 refundable
$180,000 MAGI for MFJ
$90,000 MAGI Limit for HoH, Widow(er), or single
First 4 years of college ONLY
4 Tax years per eligible student
Must be at least half time
No Felony drug convictions
Lifetime Learning Credit (LLC)
Up to $2,000 per return
None refundable
Unlimited years of use
Minimum 1 course per tax year
Tuition and Fees are the only qualified expenses
