Unit 19: Client Profile Flashcards
A family balance sheet is used to:
determine the overall net worth and liquidity of that client. It only includes assets and liabilities, not income, such as salary, dividends, or interest, or amounts paid for expenses.
An individual’s net worth is
the difference between the individual’s assets and the individual’s liabilities.
Behavioral finance
the theory that people frequently fail to fully analyze situations where they must make complex judgements
Overconfidence
experienced investors tend to overestimate their abilities
Conservatism
many investors have a hard time changing their existing beliefs, even when new information is presented to them
Herd behavior
A market drop may be followed by panic selling
Anchoring
the tendency to base expectations upon the first information received which may or may not be accurate. Once a thought has anchored in your mind, it is difficult to move away from it.
Regret aversion
The investor prepares himself in such a way as to avoid distress over an adverse outcome.
Aggressive Risk Tolerance
Investors are willing to risk greater amounts and withstand market volatility in exchange for the change to realize substantial returns
- May be willing to sustain losses of 10%, 25%, or even 50% on an investment
Moderate Risk Tolerance
Investors can tolerate some loss but not nearly at the level of the aggressive investor
Conservative Risk Tolerance
want the relative safety of guaranteed income with low risk to loss of principal
Preservation of Capital
bank-insured CDs, savings accounts, and money market funds
Investor is sacrificing the opportunity for higher income and is exposed to inflation (purchasing power) risk.
Bank Insured CDs
- Eliminate interest rate risk (value remains constant)
- They are NOT savings accounts with a maturity date
- They would be included as an asset on a family balance sheet
- They are insured by the FDIC up to the current limit (limits are not tested)
- Each bank sets the interest rate it will pay on those CDs with smaller banks typically offering more competitive rates
On the exam, the first choice for the preservation of capital should always be:
bank-insured CDs
Current Income
investors seeking current income will normally focus on individual securities or mutual funds that invest in fixed-income investments such as: government bonds/notes and agency bonds, corporate bonds, preferred stock, and utility company common stock.
Capital growth
common stock investments generally provide a means to preserve and increase the buying power of an investors money over and above the inflation rate.
Although subject to short-term volatility, the equity market tends to provide investment returns over time.
Speculation
speculative investments offer the opportunity to earn substantial returns but carry a commensurate amount of risk
- High volatile stocks, high-yield junk bonds, options on stocks or stock indexes, commodity futures
College Tuition
- Investors planning for college tuition often invest in 0-coupon bonds that mature when the tuition expenses are due
- Coverdell ESAs and Section 529 plans because of their tax advantages
Old-Age Survivors and Disability Income (OASDI)
provides monthly benefits designated to replace, in part, the loss of income due to retirement, disability, or death
To receive Old-Age Survivors and Disability Income (OASDI):
- To qualify for full benefits, an individual must have at least 40 quarters of employment
- Waiting until age 70 to claim benefits gives the individual an 8% compound return from full retirement age. If you don’t need the funds and are in health, it is generally worth the wait.
Benefits for an ex-spouse.
- If a person has an ex-spouse and a current spouse, both spouses are entitled to the benefits when the man is still alive and both can be entitled to survivor’s benefits.
- If you’re divorced and were married to the man for at least 10 years, you’re eligible for some of your ex’s Social Security. But you you must be unmarried at the time you become eligible to claim on your ex’s Social Security.
Any benefits paid to a divorced spouse do not reduce any payments due the ex’s current spouse if he remarried. That can mean two (or more) spouses receiving identical benefits while the man receives his as well
Capital Needs Analysis
used to determine how much life insurance is necessary to meet future needs. Factors used for computation:
- Project client’s future earnings
- Estimate life expectancy
- Account for inflation
- Existing assets
Should a client become disabled, there are 3 possible sources of replacement income:
workers comp, social security, disability insurance
Workers’ Compensation
if an employee is injured on the job, WC can provide protection to cover medical expenses, replace lost income, and provide death benefits to the family
Social Security
to receive payments, you must meet their strict definition of disabled which is:
You must not be able to engage in any substantial gainful activity (SGA) because of a medically-determinable physical or mental impairment:
- That is expected to result in death, or
- That has lasted or is expected to last for a continuous period of at least 12 months
Disability Insurance
most agree that it is wise to purchase a private disability insurance policy. Waiting and benefit periods can be adjusted based on the client’s needs and finances. The amount of insurance can be determined by the information derived from the client’s income, assets, and occupation.
- An application for disability insurance coverage can be denied in the case of a hazardous occupation
Taxes may be reduced by using the following three strategies
- Assets and Income Shifting
- Tax Deferral
- Tax-Free Income
Asset and Income Shifting
shift investment assets and income to a person in a lower tax bracket, trusts may also be used to shift assets and income
Tax Deferral
contributions to a qualified retirement plan or tax-sheltered annuity are not taxed until withdrawn. Investing funds that have not been taxed allows a substantially larger portion of the investor’s money to earn income or capital gains, also not taxed until withdrawn.
Tax-Free Income
Most muni bonds pay interest that is free from federal taxation, although they are generally subject to state income tax unless issued in the taxpayer’s state of residence. Depending on the investor’s tax bracket, muni bonds may result in higher returns on an after-tax basis.
- Other potential sources of tax-free earnings are Section 529 plans, Roth IRAs, and Coverdell ESAs
Time Horizon
an investor’s time horizon and liquidity needs will determine the level of volatility the client should assume. Over a 20- or 30-year time frame, dramatic short-term volatility is acceptable, even to those who are risk averse. Money that is needed within 3-5 years should be invested for safety and liquidity.
The longer the time horizon,
the more market risk the account can accept and vice versa.
Time horizon does not end
at retirement age. The portfolio has to last throughout retirement until death.
Life Cycle Considerations
an investor’s goals may change over time, especially as they move from one phase of life to another
Small cap
market cap $300 mil to $2 bil
Large cap
market cap of more than $10 bil
- Generally felt that the larger the market cap, the more conservative the investment
Growth Funds
focus on generating capital gains rather than income
Income Funds
focus on income
Combination Funds
combines the objectives of growth and current income
Specialized (Sector) Funds
specialize in particular economic sectors or industries. They offer high appreciation potential but may also pose higher risks to the investor because of their lack of diversification among industries or geographic areas
- Examples: gold funds, insurance funds, technology funds, and utility funds
Special Situation Funds
buy securities of companies that may benefit from a change within the corporations or in the economy
Index Funds
invest in securities to mirror a market index and reflect the passive style of portfolio management. Turnover of securities is minimal therefore, it generally has lower management costs and minimal taxable capital gains.
Foreign Stock Funds
long-term capital appreciation is their primary objective although some funds also seek current income. Involve foreign currency risk.
International funds
have their entire portfolio invested in securities issued outside the United States. Remember, if you will be traveling international, you’ll be outside the United States.
Global funds
have the portfolio invested around the globe,including U.S. securities.
Bonds Funds
primary investment objective is income.
- Some invest solely in investment-grade corporate bonds.
- Others invest only in government issues for added safety or seek to maximize income with lower-rated issues that entitle greater risk but potential higher returns.
Tax-free (Tax-Exempt) Bond Funds
invest in muni bonds that produce income exempt from federal income tax. Only suitable for those in higher tax brackets.
U.S. Government and Agency Securities Funds
purchase securities issued by the U.S. Treasury or an agency of the U.S. Government such as Ginnie Mae.
Foreign Bond Funds
invest in foriegn sovereign and/co corporate debt issues
Balanced Funds
invest in stocks for appreciation and bonds for income
- Might contain 60% stocks and 40% bonds
Asset Allocation Funds
split investments between stocks for growth, bonds for income, and money market instruments (or cash) for stability. The fund adviser switches the % of holdings in each asset category to the performance of that group.
Money Market Funds
no-load, mutual funds that serve as temporary holding accounts for investors’ money
- money market instruments have a max maturity of 397 days
- most suitable for investors whose financial goals require liquidity above all
An investment in a money market fund is not
insured or guaranteed by the FDIC or any other government agency. Although a MMF seeks to preserve the value of the investment at $1 per share, it is possible to lose money by investing in a MMF.
