Lesson 3 Flashcards
Asset Accumulation Phase (ages)
20-mid 50
Debt to net worth high
Conservation/Rick Management Phase (ages)
Late 20’s-Early 70’s
Distribution/Gifting Phase (ages)
Mid 40’s to End of Life
Age 20-30 (not married, no kids) goals
Lump Sum Purchase
Starting a Family
Retirement Planning
Age 20-30 (married, kids) goals
Lump Sum Purchase
Starting a Family
Retirement Planning
Education Funding
Age 30-40 Goals
Lump Sum Purchase
Starting a Family
Retirement Planning
Education Funding
Age 40-50 Goals
Lump Sum Purchase
Retirement Planning
Education Funding
Age 50-60 Goals
Lump Sum Purchase
Retirement Planning
Charitable Planning
Legacy Planning
Age 60-70 Goals
Lump Sum Purchase
Retirement Planning
Charitable Planning
Legacy Planning
Age 70+ Goals
Retirement Planning
Charitable Planning
Legacy Planning
Age 20-30 (not married no kids) Risks
Disability
Health
Property
Liability
Age 20-30 (Married with Kids) Risk
Untimely Death Disability Health Property Liability
Age 30-40 Risks
Untimely Death Disability Health Property Liability
Age 40-50 Risks
Untimely Death Disability Health Property Liability
Age 50-60 Risks
Untimely Death Disability Health Long Term Care Property Liability
Age 60-70 Risks
Untimely Death Disability Health Long Term Care Property Liability
Age 70+ Risks
Health
Long Term Care
Property
Liability
Curtis is 60 years old. He plans to retire in five years. He has amassed a net worth of $1,500,000 which he expects will sustain him during retirement. He is divorced with two adult independent children. Which phase of the life cycle is Curtis most likely in?
Conservation Phase
Two-Step Approach
Cover the risks (Insurance)
Save and Invest (Invest)
Three Panel Approach
Compares a clients actual financial picture with benchmark data:
1) Risk Management
2) Short-Term Savings & Debt Management
3) Long-term Savings and Investments
The Strategic Approach
Big picture goals considered with external environment to help identify “want” vs “need”. SWOT analysis of financial picture
Goals
Broadly defined asprirations to reach (i.e. Adequate Estate Plan)
Objectives
Divide goals into discrete actionable items (i.e. reduce or eliminate high interest debt)
Life cycle approach
Quick approach with simple data to produce plan based on anticipated needs
Metrics Approach
leverages qualitative benchmarks to determine where a client should be
Cash Flow Approach
Uses a statement of income and expeneses to make recommendation. Typically follows the strategic approach.
You have been working with your client, Brenda, for 3 months now. You developed a mission statement, goals, and objectives with the client. You are now constructing a plan that is led by the client’s mission statement. Which approach to financial planning are you utilizing?
Strategic Approach
3 Areas of Cash Flow Approach (in order)
1) Positive Annual Cash Impact (reduce coverage, raise deductibles)
2) Negative Cash Flow Impact (Purchase Life and hearlth insurance)
3) No Cahs Flow Impact (change beneficiaries)
What is Income for statement of cash flow
Cash inflows (Salary, Business Income, Interest, etc.)
Net Cash Flow Equation
Income (Chas inflows) - Savings (Cash Outflows) - Expenses (Cash Outflows) = Net Cash Flow
Types of Savings for statement of cash flow
Taxable Savings
Tax deferred savings (IRAs, 401(k))
Tax Free Savings (Roth IRA, HSA)
Net Discretionary Cash Flow Equation
Net discretionary cash flow = Income – Savings – Expenses
Net Discretionary Cash Flow Limitations
A limitation is that only recurring income and expenses are included. Excluded line items, such as the purchase or sale of an asset could have profound impacts
Pie Chart Approach
visual display of balance sheet and cash flow statement once internal data collected and financial statements prepared.
Question Poe Chart Approach Helps Answer
- What percentage of the client’s gross pay are they saving?
- What percentage of the client’s gross pay is spent on basic housing costs (principal, interest, tax, and insurance or rent plus insurance)?
- What percentage of the client’s gross pay is spent on debt repayments both excluding housing costs and including housing costs?
- What percentage of the client’s gross pay is left to live on?
Present Value of all Goals Approach
a multi-step process that gives clients a single dollar value to meet all their lifetime goals. Essentially, this approach helps a client put a price tag on what it would cost today to fund all of their goals and quantifies the amount they would need to start saving today over a certain time period in order to successfully achieve those goals.
Present Value of all Goals Approach Steps
Step 1 - Determine individual present values of each short, intermediate, and long-term goal.
Step 2- Sum these present values together
Step 3 - Reduce them by current resources (investment assets and cash and cash equivalents)
Step 4 - The net PV is considered a “debt” obligation to be retired over the remaining work life expectancy at a discount rate equal to the expected portfolio rate of return.
The Financial Statement and Ratio Analysis Approach
This approach uses data within financial statements to compute a variety of ratios which are then used to gauge a client’s financial health.
The Financial Statement and Ratio Analysis Approach Categories
- Luquidity Ratio
- Debt Ratio
- Financial Security Ratio
- Performance Ratio
Liquidity ratios
- Emergency Fund Ratio = Cash and Cash Equivalents / Non-Discretionary Expenses
- Current Ratio = Current Assets / Current Liabilities
Debt Ratios
Front-End Ratio = Housing Costs / Gross Income
Back-End Ratio = (Housing Costs + Other Debt Payments) / Gross Income
Debt to Asset Ratio = Total Liabilities / Total Assets
Savings Rate
Savings Rate = (Savings + Employer Contributions) / Gross Income (ideal is 10-15% or higher)
Metrics Approach
The metrics approach provides quantitative benchmarks for client to use as guidance for achieving comprehensive financial goals and objectives.
Metric Approach - Risk Management Benchmark
- Life Insurance - 12-16 times gross pay
- disability insurance - 60-70% of gross pay and guaranteed renewable
- Homesowners Insurance - Full replacement value of dwelling and content
Metric Approach - Short Term Saving Benchmark
- Emergency Fund - 3-6 times non-discretionary monthly outflows
- Housing Ratio - <28% of Gross Pay
- Housing and Debt - <36% gross pay
Metric Approach - Long Term Savings Benchmark
- Financial Security - 10-13% of gross pay (including employer match)
College Education Funding - save 3,000/6,000/ or 9,000 per child for 18 years in a 60/40 portfolio
During your work with your new client, Brian, you created several visual representations of how your client spends his money. Which approach to financial planning are you utilizing?
Pie Chart Approach
Which of the following statements is true? :
1) Debt ratios measure the ability to meet short-term obligations.
2) Liquidity ratios indicate how well a client manages debt.
3) Ratios for financial security determine the progress that the client is making toward achieving short-term financial security goals.
4) Performance ratios determine the adequacy of returns on investments given the risks taken.
4) Performance ratios determine the adequacy of returns on investments given the risks taken.
3 Tips for successful budgeting
1 - Be realistic with spending behavior.
2 - Budget a line item expense for miscellaneous expenses and unforeseen expenses.
3 - Being successful with a budget takes practice.
Budgeting process
Step 1 - Determine Clients Income
Step 2 - Fixed and Variable Expenses
Step 3 - Present Expenses (as % of income)
Step 4 - Net Discretionary Cash Flow (positive of negative)
Step 5 - Rectify
50/20/30 budget
The basic rule is to divide up after-tax income and allocate it to spend: 50% on needs, 30% on wants, and socking away 20% to savings.
Back of the envelope rule
bucketing/envelope approach
Pay Yourself First Rule
With this reverse budgeting strategy, you build your spending plan around savings goals, such as retirement, instead of focusing on fixed and variable expenses.
Zero Based Rule
a way of budgeting where your income minus your expenses equals zero. With a zero-based budget, you have to make sure your expenses match your income during the month. That way you’re giving every dollar that’s coming in a job to do.
Which of the following best describes the financial approach that provides a visual representation of the way in which a client distributes resources?
A) The strategic approach
B) The two-step/three-panel approach
C) The pie chart approach
D) The life-cycle approach
C
All of the following are best practices for helping clients to prepare a budget EXCEPT:
A) Build in a line-item expense for miscellaneous expenses and emergencies.
B) Calculate both the difference between income and expenses as well as the percent of expenses to income.
C) Recommend increasing expenses until net discretionary cash flow is neither positive nor negative.
D) Be realistic with spending behavior - but also add a line item for unforeseen expenses.
C
Which of the following would be considered a discretionary cash flow?
A) Food
B) Tuition
C) A Netflix subscription
D) An auto loan
D
Geraldo, aged 40, is married and has two sons. His primary goals are saving for retirement, paying down the mortgage on his new home, managing his risks, and funding his sons’ education. Which phase(s) of the life-cycle approach is Geraldo most likely in?
The asset-accumulation and conservation/risk management phases
Jackson is an accountant and contributes 10% of his salary to his 401(k). His employer makes matching contributions of 3% of Jackson’s salary. Last year, Jackson earned $60,000, but he received a raise and will earn $65,000 this year. Also, Jackson contributes $2,000 to an IRA at the end of each year. What is his total savings rate this year?
16.08%
Which of the following insurance recommendations will result in a positive cash flow?
A) Increase the amount of current coverage.
B) Change the name of the beneficiary to someone with a better credit score.
C) Raise insurance deductibles.
D) Purchase a new life insurance policy.
C
Which of the following best describes the financial approach that uses quantitative benchmarks that provide guidelines of where a client’s financial profile should be?
A) The metrics approach
B) The strategic approach
C) The cash-flow approach
D) The present value of goals approach
A
Evaluating your client’s emergency fund will fall into which of the following panels of the three-panel approach?
A) This would fall into Panel 1.
B) This would fall into Panel 2.
C) This would fall into Panel 3.
D) The emergency fund is not addressed in the three-panel approach.
B
Which of the following is the formula to calculate net discretionary cash flow (NDCF)?
income - savings - expenses = net discretionary cash flow
Jason earns an annual salary of $50,000. His company matches 50% of Jason’s 401(k) contributions of up to 6% of his compensation, which equals a maximum company contribution of 3%. Jason contributed $5,000 to the plan this year, and his company made the matching contribution before the end of the year. The balance of his account at year’s end was $95,000. What is his savings rate this year?
13.00%
