AFP Exam 1 flashcards

32 cards. Read the term and the definition here. The deck at the top of this page is optional.

Fiduciary Duty

A legal obligation to act solely in the client's best interest, placing client interests ahead of the planner's compensation or affiliations, and disclosing all material conflicts.

Six-Step Planning Process

Establish and define the relationship, gather client data and goals, analyze the data, develop recommendations, implement the recommendations, then monitor progress and update the plan.

Suitability Standard

A weaker standard than fiduciary duty requiring only that a recommendation be appropriate for the client's situation, without an obligation to put the client first.

Quantitative versus Qualitative Data

Quantitative data are measurable facts such as income, assets, liabilities, and insurance coverage; qualitative data are subjective factors such as goals, values, and risk tolerance.

Risk Tolerance: Willingness and Ability

Willingness is the client's psychological comfort with volatility; ability is financial capacity to absorb losses. The lower of the two governs the allocation.

Goal Specificity Requirement

A goal is analyzable only when it specifies a target amount, a target date, and a funding source; missing any element makes projections unreliable.

Time Horizon Buckets

Short-term goals (roughly zero to three years) require liquidity and low volatility; intermediate and long-term goals can accept more market risk for higher expected return.

Net Cash Flow

Total household inflows minus total outflows over a period. A negative result must be funded by drawing down assets or borrowing, which is unsustainable long term.

Emergency Reserve Target

A liquid fund covering three to six months of essential expenses, extended to six to twelve months for single-income, variable-income, or high-job-risk households.

Liquidity Ratio

Liquid assets divided by monthly expenses. It estimates how many months a household can meet expenses without new income or asset sales.

Marginal versus Effective Tax Rate

The marginal rate applies to the next dollar of income; the effective rate equals total tax divided by total income and reflects the blended burden across all brackets.

Wash Sale Rule

A capital loss is disallowed when substantially identical securities are purchased within thirty days before or after the sale; the disallowed loss adjusts the new position's basis.

Bracket Management

Timing income and deductions to shift taxable amounts from high-bracket years to low-bracket years, subject to phaseouts, thresholds, and the alternative minimum tax.

Tax Credit versus Deduction

A credit reduces tax owed dollar for dollar; a deduction reduces taxable income and therefore saves tax equal to the deduction multiplied by the marginal rate.

Risk Handling Methods

Five approaches to risk: avoidance, reduction, retention, transfer, and sharing. Insurance transfers a defined low-probability large loss to an insurer for a premium.

Human Life Value Method

An insurance need calculation equal to the present value of the insured's expected future earnings net of self-maintenance costs, representing economic value lost at death.

Own-Occupation Disability Definition

A policy pays when the insured cannot perform the material duties of their own occupation, the most favorable definition and the most expensive to purchase.

Coinsurance Clause

A property policy provision paying loss multiplied by the ratio of insurance carried to insurance required, capped at the policy limit, penalizing underinsurance.

Portfolio Expected Return

The weighted average of each asset's expected return using portfolio weights; portfolio risk depends additionally on the correlations among the assets.

Sharpe Ratio

Excess return above the risk-free rate divided by standard deviation. It measures return earned per unit of total volatility and allows comparison across portfolios.

Rebalancing Threshold Rule

Restoring target weights when an asset drifts beyond a preset band, such as five percentage points, rather than only on a fixed calendar schedule.

Efficient Frontier

The set of portfolios offering the highest expected return for each level of risk; portfolios below it are inefficient because a better risk-return combination exists.

Sequence-of-Returns Risk

The danger that poor investment returns early in retirement, combined with withdrawals, permanently deplete a portfolio even if average returns are adequate.

Safe Withdrawal Rate

A planning heuristic estimating the initial percentage of a portfolio that can be withdrawn annually, inflation-adjusted, with low historical probability of depletion over a set horizon.

Required Minimum Distributions

Mandatory annual withdrawals from tax-deferred retirement accounts beginning at the statutory age, calculated by dividing the prior year-end balance by a life-expectancy factor.

Monte Carlo Simulation

A retirement projection method running many randomized return sequences to estimate the probability that a plan funds all goals, reported as a success rate rather than a single outcome.

Step-Up in Basis

Inherited assets generally receive a basis equal to fair market value at the decedent's death, eliminating capital gains tax on appreciation during the decedent's lifetime.

Unlimited Marital Deduction

An estate and gift tax deduction allowing unlimited transfers between spouses, deferring rather than eliminating estate tax, which may apply at the survivor's death.

Portability Election

A timely election allowing a surviving spouse to use the deceased spouse's unused estate and gift tax exclusion amount, avoiding waste of the first spouse's exemption.

Beneficiary Designation Control

Contract provisions on retirement accounts and life insurance naming who receives assets; these designations override instructions in a will and must be coordinated with the estate plan.

Restricted Stock Unit Taxation

RSUs are taxed as ordinary income when they vest, based on fair market value at vesting; no election is available to accelerate taxation to the grant date.

Section 83(b) Election

A filing within thirty days of receiving restricted property to be taxed at grant on fair market value, rather than at vesting, shifting appreciation to capital gain treatment.