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CFP: General Principles of Financial Planning

CFP · Work through your exam, one topic at a time.

All guide sections

General Principles of Financial Planning

Core tools

Planning rests on financial statements - balance sheet (assets − liabilities = net worth) and cash flow statement (inflows − outflows) - and on time value of money: PV, FV, PMT, annuity due versus ordinary annuity, NPV, and IRR.

Ratios worth memorizing

  • Emergency fund: liquid assets ÷ monthly expenses (target 3–6 months)
  • Current ratio: current assets ÷ current liabilities (target ≥ 1.0)
  • Savings ratio: savings ÷ gross income (roughly 10–15%)
  • Housing ratio 1: PITI ÷ gross monthly income (≤ 28%)
  • Housing ratio 2: total debt ÷ gross monthly income (≤ 36%)

Traps

  • Use the marginal rate for a projected change in income; use the average rate only to describe the overall burden.
  • Strip inflation out of long-horizon goals: real return ≈ (1 + nominal) ÷ (1 + inflation) − 1.
  • Human capital (future earning power) does not belong on the balance sheet.
  • Annuity-due payments occur at the beginning of the period; set the calculator to BGN and clear it afterward.
  • Education funding: 529 plans offer tax-deferred growth and tax-free qualified withdrawals; Coverdell ESA contributions are capped at $2,000 per beneficiary per year.

Rule of thumb

Rule of 72: years to double ≈ 72 ÷ return. At 6%, money doubles in about 12 years.

Worked example. A client expects an 8% nominal return with 3% inflation. Real return = (1.08 ÷ 1.03) − 1 = 4.85%. Doubling $100,000 in real terms takes about 72 ÷ 4.85 ≈ 15 years, not 9.