AFP Exam 1 key terms

A legal obligation to act solely in another party's best interest, placing the client's welfare above the advisor's own. It requires loyalty, disclosure of conflicts, and prudent care in giving advice.

A requirement that a recommendation be reasonably appropriate for a client's objectives, financial situation, and needs. It is a lower bar than fiduciary duty because it does not demand undivided loyalty.

Any circumstance that could reasonably bias professional judgment, such as commissions, referral fees, or ownership in a recommended product. Advisors must disclose it clearly so clients can evaluate the advice.

The process of collecting and documenting a client's finances, goals, time horizon, and attitudes toward risk before giving advice. It underpins every later recommendation and must be updated as circumstances change.

A client's willingness and emotional ability to accept investment losses or uncertainty in pursuit of higher returns. It differs from risk capacity, which is the financial ability to absorb losses.

The financial ability of a household to withstand losses without jeopardizing essential goals, driven by income stability, liquidity, and time horizon. A client may tolerate risk they cannot actually afford.

The period over which money is invested before it is needed for a goal. Longer horizons generally permit more volatility, while short horizons call for greater stability and liquidity.

A goal stated as specific, measurable, achievable, relevant, and time-bound. This framing converts vague wishes into targets that can be quantified, funded, and monitored in a financial plan.

An approach that links each pool of assets to a specific objective, such as retirement or education, with its own horizon and funding schedule. It makes trade-offs between competing goals explicit.

A record of money coming in and going out over a period, usually monthly, organized by income and expense categories. It reveals whether a household runs a surplus or deficit.

A forward-looking spending plan that allocates expected income among needs, wants, savings, and debt repayment. Comparing actual results to the plan highlights where behavior must change.

Liquid savings set aside to cover several months of essential expenses during job loss, illness, or unexpected repairs. It protects long-term investments from being sold at unfavorable times.

The percentage of gross or net income a household saves and invests rather than spends. It is often the single most powerful lever for reaching long-term goals.

A snapshot listing assets at fair value minus liabilities at outstanding balances. Tracking it over time shows whether overall financial position is improving.

The ease and speed with which an asset can be converted to cash without a significant loss of value. Cash and money market funds are highly liquid; real estate and private holdings generally are not.

The rate applied to the next dollar of taxable income, reflecting the taxpayer's highest bracket plus applicable surtaxes. It governs the value of deductions and the cost of additional income.

Total income tax paid divided by total income, expressing the average burden across all dollars earned. It is typically lower than the marginal rate in a progressive system.

An amount subtracted from gross income before tax is computed, so its value equals the deduction times the marginal rate. It reduces taxable income rather than the tax itself.

A direct reduction of the tax owed rather than of taxable income, making it generally more valuable than an equal-sized deduction. Some credits are refundable if they exceed the liability.

A deduction available whether or not the taxpayer itemizes, such as contributions to certain retirement or health accounts. It lowers taxable income for everyone who qualifies.

A fixed deduction amount set by tax law that taxpayers may claim instead of itemizing. It creates a floor of untaxed income and simplifies filing for most households.

Profit realized when an asset is sold for more than its cost basis, taxed at preferential rates if the asset was held long enough. Losses can offset gains subject to rules.

The amount originally invested in an asset, adjusted for reinvested distributions, fees, and certain events. Gain or loss on sale is measured against this figure.

Selling investments at a loss to offset realized gains or ordinary income, then repositioning to maintain market exposure. Wash-sale rules restrict repurchasing substantially identical securities too soon.

An additional tax, commonly ten percent, imposed on withdrawals from tax-advantaged retirement accounts before the qualifying age, unless an exception applies. It discourages using retirement money for current spending.

The minimum amount that must be withdrawn annually from most tax-deferred retirement accounts once the account owner reaches the statutory age. Failure to withdraw triggers a steep excise tax.

An individually owned retirement account funded with contributions that may be deductible, growing tax-deferred, with withdrawals taxed as ordinary income. Contribution eligibility depends on earned income and other plan coverage.

A retirement account funded with after-tax dollars that grows and is withdrawn tax-free when qualified conditions are met. It offers tax diversification and has no lifetime distribution requirement for the owner.

Moving money from a traditional tax-deferred account into a Roth account, triggering ordinary income tax on the converted amount. It can be valuable when the current rate is lower than expected future rates.

Holding assets across taxable, tax-deferred, and tax-free accounts so withdrawals can be sequenced for efficiency. It gives retirees flexibility to manage brackets in any given year.

The division of a portfolio among asset classes such as stocks, bonds, and cash. Research attributes most return variability over time to this decision rather than to individual security selection.

Spreading investments across assets, sectors, and regions so that no single loss dominates the portfolio. It reduces unsystematic risk but cannot eliminate market-wide risk.

Market-wide risk that affects all securities and cannot be removed through diversification, such as recessions or interest-rate shifts. Investors are compensated for bearing it.

A measure of how much a security or portfolio tends to move relative to the overall market. A beta above one implies greater volatility than the market; below one implies less.

A statistical measure of how widely returns vary around their average, commonly used as a proxy for volatility. Higher values indicate a wider range of possible outcomes.

Periodically buying and selling to restore a portfolio to its target asset mix after market moves. It controls risk drift and imposes a disciplined sell-high, buy-low behavior.

Placing asset types in the account structures where they are taxed most favorably, such as bonds in tax-deferred accounts. It complements allocation by improving after-tax returns.

The process by which investment earnings generate their own future earnings, producing exponential growth over time. Starting early matters more than the exact rate for long-horizon goals.

A written document recording a portfolio's objectives, target allocation, constraints, and rebalancing rules. It guides decisions during volatile markets and documents the client's instructions.

The present value of a person's future earnings from work, which is often the largest asset a young household owns. It supports the need for life and disability insurance.

A method of sizing a life insurance death benefit by totaling obligations such as debt, income replacement, and education costs, then subtracting existing resources. It focuses on the survivor's actual shortfall.

Coverage that pays a death benefit only if the insured dies during a stated period, with no cash value. It delivers the most protection per dollar for temporary needs.

Coverage that remains in force for life and accumulates cash value, typically with level or adjustable premiums. It can address lifelong needs and estate liquidity but costs more per dollar of death benefit.

The savings component inside a permanent policy that grows tax-deferred and can be borrowed against or withdrawn. Loans reduce the death benefit if unpaid.

Coverage that replaces a portion of earned income when illness or injury prevents work. Key provisions include the definition of disability, elimination period, benefit period, and own-occupation wording.

The waiting time between the onset of a disability and the start of benefit payments. A longer period lowers premiums and assumes the household can self-fund the early months.

Excess liability coverage that sits above auto and homeowners limits and can also fill gaps such as libel or personal injury. It protects accumulated assets from large judgments.

Arranging how assets are held, transferred, and taxed at death or incapacity. It includes wills, trusts, beneficiary designations, and powers of attorney.

The court-supervised process of validating a will, paying debts, and distributing assets. It is public and can be slow, so planners often use trusts or beneficiary designations to avoid it.

A contract provision naming who receives an account or policy at the owner's death. It typically overrides a will, so outdated forms can defeat the client's stated intentions.

A trust created during life that the grantor can amend or revoke, typically used to avoid probate and manage assets during incapacity. Assets must be retitled into the trust to be effective.

A legal document authorizing an agent to act on the principal's behalf on financial matters. A durable version survives the principal's incapacity, which is essential for planning.

A tax rule that resets the cost basis of inherited assets to fair market value at the date of death. It can eliminate capital gains tax on appreciation during the decedent's lifetime.

The schedule by which an employee earns nonforfeitable rights to employer contributions or stock awards. Unvested amounts are lost upon departure, which affects job-change decisions.

An employer contribution tied to the employee's own deferrals, often a percentage of pay up to a limit. Failing to capture the full match leaves guaranteed money on the table.

A grant of company shares that is delivered after a vesting schedule, taxed as ordinary income at delivery. It carries value even if the share price falls, unlike options.

The danger of holding too much wealth in a single stock, employer, or sector, where one adverse event can devastate the portfolio. Equity compensation commonly creates it.

A written, integrated set of recommendations covering cash flow, taxes, insurance, investments, retirement, and estate matters. It states assumptions, priorities, and an implementation schedule.

The ongoing process of comparing actual results with plan assumptions and updating recommendations as life or markets change. It turns a one-time document into a continuing relationship.