Financial Planning Skills Certification Grade 3 flashcards

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

Financial planning process

The six sequential steps: establish the engagement, gather client data and goals, analyze the situation, develop recommendations, present and implement, and monitor the plan on an ongoing basis.

Fiduciary duty

A legal obligation to act in the client's best interest, combining a duty of loyalty that requires managing conflicts and a duty of care requiring competence and diligence.

Engagement letter

A written agreement defining the scope of services, fees, deliverables, timeline, and each party's responsibilities, signed before analysis and recommendations begin.

Net worth

Total assets valued at fair market value minus total liabilities. It measures accumulated wealth at a point in time and excludes future income expectations.

Emergency reserve

A liquid cash buffer of typically three to six months of essential expenses, sized longer for single-income households or those with variable commission-based earnings.

Goal specification

A properly defined goal states a target amount, a target date, a priority ranking relative to other goals, and the inflation rate used to project its future cost.

Savings rate

Annual savings divided by gross income. It is the most controllable variable determining whether long-horizon goals are funded.

Zero-based budgeting

A budgeting method that assigns every unit of income to a specific purpose, including savings and debt reduction, so that income minus assignments equals zero.

Fixed versus variable costs

Fixed costs are contractual and slow to change; variable costs are discretionary and are the practical lever when a household must correct a cash flow deficit quickly.

Risk handling methods

Four responses to risk: avoidance, reduction through loss control, retention or self-insurance, and transfer through insurance. Retention suits low-severity, high-frequency losses.

Indemnity principle

Insurance restores the insured to the pre-loss financial position rather than improving it, so over-insurance beyond actual loss is not collectible.

Human life value method

A life insurance sizing approach that capitalizes the insured's expected future earnings, net of personal consumption, to measure the economic value lost at death.

Needs analysis method

A life insurance sizing approach that totals projected obligations such as debt, education, and income replacement, then subtracts existing resources including savings and existing policies.

Risk tolerance components

Ability to take risk reflects financial capacity, horizon, and income stability; willingness reflects psychological attitude. The lower of the two constrains the allocation.

Diversification benefit

Combining assets whose correlation is below positive one reduces portfolio volatility for a given expected return; the benefit increases as correlation approaches negative one.

Sharpe ratio

A risk-adjusted performance measure equal to portfolio return minus the risk-free rate, divided by the portfolio's standard deviation. Higher values indicate better return per unit of volatility.

Asset location

Placing tax-inefficient holdings such as taxable bonds and REITs in tax-advantaged accounts, and tax-efficient holdings such as broad equity index funds in taxable accounts.

Defined benefit plan

A pension promising a formula-based benefit, often salary multiplied by an accrual rate and years of service. The employer bears investment risk.

Defined contribution plan

A retirement account specifying contributions rather than benefits. The employee bears investment risk and longevity risk, and the balance depends on contributions and returns.

Sequence-of-returns risk

The risk that withdrawals during an early market decline permanently impair a retirement portfolio more than the same decline occurring during the accumulation phase.

Replacement ratio

Retirement income target expressed as a percentage of pre-retirement gross income, commonly 60 to 80 percent, adjusted for reduced work expenses and pension income.

Marginal tax rate

The rate applied to the next unit of income. Planning decisions use it, whereas the effective rate, total tax divided by total income, describes the overall burden.

Tax deferral

Postponing tax on income or gains so that the pre-tax amount compounds. The benefit equals the tax saved multiplied by the growth earned on it until withdrawal.

Wash-sale rule

A rule disallowing a realized loss for tax purposes when a substantially identical security is repurchased within a specified window around the sale.

Taxable estate

The gross estate minus deductions for debts, administration expenses, charitable transfers, and qualifying spousal transfers. Estate tax applies only to the amount above the exemption.

Probate

The court-supervised process of validating a will and distributing assets titled in the deceased's name. Beneficiary-designated and jointly held assets generally bypass it.

Revocable trust

A trust in which the grantor retains the power to amend or revoke. It typically avoids probate but does not remove the assets from the grantor's taxable estate.

Step-up in basis

A tax rule resetting the cost basis of inherited assets to fair market value at death, eliminating capital gains accrued during the deceased's lifetime where permitted.

Know-your-client rule

A compliance obligation to collect and document a client's objectives, financial situation, risk tolerance, and constraints before making any recommendation.

Conflict of interest disclosure

Written disclosure of commissions, referral fees, and other benefits that could bias advice. Disclosure does not permit advice contrary to the client's interest.

Loss aversion

The tendency to feel losses roughly twice as intensely as equivalent gains, producing premature selling in downturns and reluctance to realize losses for tax purposes.

Rule of 72

A shortcut estimating the years required to double a value as 72 divided by the annual growth rate in percent; at 6 percent, doubling takes about 12 years.