General Principles of Financial Planning Flashcards
Four tools used by the Federal Reserve to influence the money supply and interest rates
Reserve Requirement
Discount Rate
Open Market Operations
Excess Reserves
Reserve Requirement
Tool used by the Federal Reserve to influence the money supply and interest rates.
A percentage of deposits a bank must maintain in cash.
As the reserve requirement increases, there’s less cash available to lend, therefore the money supply decreases and interest rates increase.
As the reserve requirement decreases, there’s more cash available to lend, therefore the money supply increases and interest rates decrease.
Discount Rate
Tool used by the Federal Reserve to influence the money supply and interest rates.
The overnight interest rate at which member banks can borrow from the Federal Reserve to meet their reserve requirements.
As the discount rate increases, short-term interest rates increase as well.
As the discount rate decreases, short-term interest rates decrease as well.
Open Market Operations
Tool used by the Federal Reserve to influence the money supply and interest rates.
As the Federal Reserve buys or sells more government securities, the money supply is influenced and places pressure on interest rates.
To increase interest rates the fed will sell government securities, effectively reducing the money supply.
To decrease interest rates the fed will buy government securities, effectively increasing the money supply.
Excess Reserves
Tool used by the Federal Reserve to influence the money supply and interest rates.
Monies that a bank holds at the Federal Reserve (or central bank) in excess of the required reserve amount.
An increase in the excess reserves rate will cause more banks to hold excess reserves, which takes money out of the economy - this is contractionary.
A decrease in the excess reserves rate will cause fewer banks to hold excess reserves, which means they will have more money to lend into the economy - this is expansionary.
Financial Planning Process
- Understanding the client’s current personal and financial circumstances
- Identifying and selecting goals
- Analyze the client’s current course of action and potential alternative courses of action
- Developing the financial plan recommendations
- Presenting the financial planning recommendations
- Implementing the financial plan recommendations
- Monitoring the plan
“Uber Is A Drunk Person’s Immediate Motorvehicle”
Benchmarks
Elastic Demand Curve
Almost horizontal, sloping down and to the right.
When there’s a small change in price there’s a large change in quantity demanded.
Ex. luxury goods (exotic cars)
Inelastic Demand Curve
Almost vertical, sloping down and to the right.
When there’s a small change in price there’s a very little change in quantity demanded.
Necessities (ex. gasoline and pharmaceuticals)
“I” in Inelastic represents the vertical shape.
Business Life Cycle
Expansion
Peak
Contraction/Recession
Trough
Peak
GDP at its highest
Inflation and interest rates are peaking and unemployment rate is at its lowest levels
Contraction/Recession
GDP slowing
Inflation and interest rates are also beginning to decline
Unemployment rate begins to increase
Expansion
Increasing GDP, inflation rates, and interest rates
Unemployment rate decreasing
Trough
GDP, inflation, and interest rates at their lowest levels
Unemployment at it’s highest
Inflation, Interest Rates, Unemployment, and GDP during each phase of the business cycle
What are cyclical in nature and fluctuate directly with the business cycle?
Consumer durable goods and capital goods
Recession
6 consecutive months (2 quarters) of declining GDP.
Depression
18 consecutive months (6 quarters) of recession.
Three main goals of the Federal Reserve
- Maintain long-term economic growth
- Maintain price levels supported by the economy
- Maintain full employment
FDIC Insurance
Each depositor has a total of $250k of insurance per type of account ownership.
Four types of ownership: individual accounts, joint accounts, trust accounts, self-directed retirement accounts.
Accounts at separate banks each receive $250k of insurance.
Each person is deemed to own 50% of joint accounts.
Debts NOT discharged through Ch. 7 bankruptcy
Student loans
3 years back taxes
Alimony
Child support
Assets exempt from creditors in bankruptcy
Traditional and roth IRAs up to $1 million
Clearly identified rollover IRAs (unlimited) if not combined with other IRA monies.
Workers Compensation
Absolute form of liability
Regardless of fault, employee collects
Benefits are not taxable income
Balance Sheet
A listing of assets, liabilities and net worth - snapshot of account balances at “a moment in time”.
Dating will be “as of XX/XX/XXXX”
Assets - Liabilities = Net Worth
Cash and cash equivalents, invested assets, personal use assets, liabilities
Current Ratio
A measure of a client’s ability to meet short-term obligations.
Current assets include cash/cash equivalents and marketable securities (CDs less than 12 months in maturity, money market, savings, cash and accounts receivable).
Current liabilities include credit cards, short-term debts due in less than 12 months.
The higher the ratio the better.
Current Ratio = Current Assets / Current Liabilities
Should be greater than 1.0
Nondiscretionary Expenses
Expenses that do not go away if you lose your job: mortgage, utilities, food, car loan, property taxes, insurance premiums.
Housing Ratio (28%)
Monthly Housing Costs (PITI) / Monthly Gross Income
Should be 28% or less
Housing & All Other Debt Ratio (36%)
Monthly Housing Costs (PITI) + All Other Recurring Debt Payments / Monthly Gross Income
Should be 36% or less
Savings Ratio
Annual Savings (employee & employer contributions) / Annual Gross Income
Target 10-12% or gross income if client starts before age 32.
Target 20-25% of gross income if client starts at age 45-50.
Federal Pell Grant
NEED based and dependent on the EFC amount.
EFC determines a student’s eligibility and how much is awarded.
Only students that have not earned bachelors or professional degree qualify.
Stafford Loan
Primary type of financial aid provided by the US Department of Education.
Student loans.
Repayment begins after 6 month grace period of leaving school or falling below part-time status (6 semester hours).
Subsidized: interest is paid for by the federal government while the student is in school. NEED based.
Unsubsidized: interest begins to accrue when the funds are disbursed. NOT need based.
Not appropriate if parent intends to repay the loans.
PLUS Loans
Loan for parent to pay for their child’s education.
NOT need based, but depends on the parents credit score.
Not subsidized.
Appropriate for parents who can afford to make a loan payment but haven’t saved anything for education.
TIP: wealthy parents are a “PLUS”
Federal Perkins Loan
For students with exceptionally low EFC amounts.
NEED based.
Prepaid Tuition
Considered an asset of the parent for financial aid purposes.
529 Savings Plan
Considered an asset of the parent for financial aid purposes.
Appreciation is tax free if used for qualified education expenses.
Individual can contribute up to $85k in one year without any gift tax consequences (5x the annual gift tax exclusion amount of $17k). If couple elects gift tax splitting it is $170k in one year.
*No phase-out for contribution eligibility
Coverdell Education Savings Account (ESA)
Considered assets of the parent for financial aid purposes.
Contributions limited to $2k per year, per beneficiary.
Funds must be used or distributed by age 30.
Contributions cannot be made beyond the beneficiary’s 18th birthday.
*High phase-out for contribution eligibility
Series EE Savings Bond
Purchased for face value.
Parents must own the bonds and must be 24 years or older when purchased.
Can be rolled into a 529 or coverdell.
Bond must be redeemed in same year as education expenses.
*Lower phase-out for eligibility
UGMA/UTMA
Considered an asset of the child for financial aid purposes.
Taxation of unearned income may be subject to kiddie tax.
Risk that child uses assets for something other than education.
UTMA can include real estate, stocks, mutual funds, or bonds.
UGMA only includes stocks, mutual funds and bonds.
Deductibility of Student Loan Interest
Interest on student loans is deductible above the line (before AGI) and is limited to $2,500.
Loan must have been used for qualified education expenses.
Deductible for the life of the loan.
Lifetime Learning Credit
Tax credit available for tuition and fees related to undergraduate, graduate, or professional programs.
Tax credit amount:
- 20% of up to $10k in qualified expenses per year.
- Maximum credit per taxpayer (“per family”) is $2k per year.
- Can be claimed for an unlimited number of years.
American Opportunity Tax Credit
Applies to tuition and fees for the first four years of post-secondary education.
Tax credit amount:
- 100% of first $2k in qualified expenses.
- 25% or second $2k in qualified expenses.
The maximum tax credit per student is $2,500 per year.
The per student credit is based on the number of dependent students on the family’s tax return.
The limit is good for the first four years of a degree or certificate program.
Coordination of American Opportunity Tax Credit and Lifetime Learning Credit
An individual may NOT claim both AOTC and LLC for the same child in the same year.
An individual may NOT use an AOTC or LLC for the SAME expense paid by a qualified tuition program.
An individual MAY use the AOTC or LLC in the same year a distribution from a qualified tuition plan or 529 plan, just not the same expenses.
Employer Education Assistance
An employer may pay for or reimburse an employee for education expenses.
An employer may pay (directly or to the employee) eligible student loan repayments after March 27, 2020 and before January 1, 2026. Not included in employee income and does not qualify for above the line deduction.
Any benefit or reimbursement is not included in income up to $5,250.
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.
Fiduciary Duty
Duty of loyalty: place interests of the client above interests of the CFP professional/firm; avoid conflicts of interest or fully disclose if material.
Duty of care: CFP professional must act with the care, skill, prudence, and diligence that prudent professional would exercise.
Duty to follow customer instructions: CFP professional must comply with all objectives, policies, restrictions, and other terms of the engagement and all lawful direction of the client.
Required written documentation that must be provided to a client in a financial planning engagement
Privacy policy
Services and products
How the client pays
How you, your firm, and related parties are compensated
Public discipline
Referral compensation
Terms of engagement
Required written documentation that must be provided to a client in a financial advice engagement
Privacy policy
CFP Continuing Education
30 hours every 2 years, of which, 2 hours must be CFP board ethics
Rules for notifying the CFP Board in the case of being charged, convicted, or involved with adverse conduct
CFP certificant shall notify CFP board in writing of any charge or conviction or a crime, expect misdemeanor traffic offenses or traffic ordinance violations unless such offense involves use of alcohol or dugs, or of any professional suspension or bar within 30 calendar days after the date on which the certificant is notified of the charge, conviction, suspension or bar.
Conduct ALWAYS deemed unacceptable
Felony conviction for theft, embezzlement or other financially-based crimes.
Felony conviction for tax fraud or other tax-related crimes.
Revocation of a financial professional license, unless the revocation is administrative in nature (renewal fees).
Felony conviction of any degree of murder or rape.
Felony conviction for any other violent crime within the last 5 years.
Conduct PRESUMED unacceptable
Two or more personal or business bankruptcies.
Revocation or suspension of a non-financial professional license, unless the revocation is administrative in nature.
Suspension of a financial professional license, unless the suspension is administrative in nature.
Felony conviction for non-violent crimes (including perjury) within the last 5 years.
Felony conviction for violent crimes other than murder or rape that occurred more than 5 years ago.
Exceptions to registrations with the SEC
Any BD whose advisory services are solely incidental to the conduct of business.
Lawyers, accountants, teachers and engineers whose advice is solely incidental to their profession.
Banks and bank holding companies that are not investment companies.
Publisher of a bonafied newspaper, magazine, or periodical of regular circulation.
Advisors whose advice and services are related strictly to securities guaranteed by the US government.
Such person not within the intent of the law as the SEC may designate by rules, regulations or order.
*TABLEs are incidental - Teachers, Accountants, Brokers, Lawyers, and Engineers
Exemptions from registration
Advisors whose clients reside in their state of business and who don’t provide advice, services, analyses or reports regarding nationally listed securities.
Advisors whose only clients are insurance companies.
Advisors solely to venture capital funds.
Advisors solely to private funds less than $150 million.
Foreign advisors without a place of business in the US.
*VIPs are SaFE from exemptions - Venture capital, Insurance companies, Private funds less than $150 million, home State, Foreign advisors, securities not on a national Exchange
Brochure Rule
Must be provided to the client before or at the time of entering into a contract.
Compliance is accomplished by providing the client with a separate written narrative comprised of information in Part 2A and B and Part 3.
Procedural Rules Key Dates
Felony
An offense punishable by one or more year in jail or over $1,000
Investment Advisor
Someone who is in the business of providing advice about securities for compensation.
*An investment advisor knows his ABC’s - Advice, Business, Compensation
Accredited Investor
Must have $1 million net worth exclusive of personal residence, OR
Make a minimum of $200k in each of the two most recent years if single ($300k if joint) with a reasonable expectation of the same income level in the current year.
Monetary Policy
Policy and means by which the Federal Reserve controls the money supply and influences interest rates.
Three main goals:
- Maintain long-term economic growth
- Maintain price levels supported by the economy
- Maintain full employment
GDP
Gross Domestic Product
The value of total output within a country (regardless of asset ownership) over a period of time.
GNP
Gross National Product
The value of total output by the citizens of a country, regardless of where the production takes place.
TVM “Annuity”
any recurring cash flow of the same amount for a certain period of time.
Annuity due - first payment occurs at time period zero ((Ex. retirement and education funding) . BEG mode.
Ordinary annuity - first payment occurs at time period one (debt repayments i.e. care loans, mortgage payments, student loans). END mode.
*If you are going to press the PMT key for any amount other than zero, ask yourself when it starts to determine BEG/END mode
Net Present Value (NPV)
Measures the excess or shortfall of cash flows based on the discounted present value of the future cash flows, less the initial investment.
NPV = Present value of future cash flows - cost of the investment
+ NPV = good investment
0 NVP = assumed discount rate is earned
- NPV = bad investment
Internal Rate of Return (IRR)
Compounded annual rate of return.
IRR >= required rate of return - good investment
IRR < required rate of return - bad investment
