CFP Module 2 flashcards

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

Net worth

Total assets at fair market value minus total liabilities. It is measured at a single point in time and does not show the cash flows that produced the change.

Cash flow surplus

Income minus expenses, debt service, and taxes. A positive surplus funds goal contributions and savings; a persistent deficit must be closed by borrowing or drawing down assets.

Emergency reserve

Liquid funds covering three to six months of essential expenses, extended to six to twelve months when income is variable, single-earner, or commission-based.

Human capital

The present value of a person's expected future earnings. It is largest early in a career and declines as financial capital replaces it over time.

Goal prioritization rule

Fund mandatory, non-recoverable goals first, then discretionary goals. Sequence by time horizon and by the cost of falling short of each goal.

529 plan taxation

Contributions are not federally deductible; earnings grow tax-deferred and qualified education withdrawals are tax-free, while non-qualified withdrawals tax earnings plus a penalty.

Real return formula

Real return equals (1 + nominal return) divided by (1 + inflation) minus one. It expresses a goal or return in today's purchasing power.

Portfolio expected return

The weighted average of each holding's expected return. Portfolio variance also depends on covariances, so diversification lowers risk without lowering expected return.

CAPM required return

Required return equals the risk-free rate plus beta times the market risk premium. Beta captures systematic risk, which diversification cannot eliminate.

Sharpe ratio

Portfolio return minus the risk-free rate, divided by the portfolio's standard deviation. Higher values indicate better risk-adjusted performance when comparing portfolios.

Rule of 72

Doubling time in years is approximately 72 divided by the annual percentage return. The exact value is the natural log of two divided by the log of one plus the rate.

Bond duration

A measure of price sensitivity to yield changes. Percentage price change approximates negative duration times the change in yield, with convexity correcting larger moves.

Asset location

Placing tax-inefficient assets such as taxable bonds and REITs in tax-advantaged accounts, and tax-efficient broad index equity in taxable accounts, to improve after-tax returns.

Rebalancing

Returning holdings to policy target weights. It is a risk-control action that restores intended exposure rather than a forecast of future returns.

Risk tolerance components

Ability to take risk reflects capacity such as horizon, liquidity, and income stability; willingness reflects attitude. The binding constraint governs the final allocation.

Retirement accumulation formula

Future value equals present value times (1 + r)^n plus the payment times the future value annuity factor, where r is expected return and n is years remaining.

Capital needs method

Required nest egg equals the annual retirement income need multiplied by an annuity factor for the expected retirement duration at the assumed real return.

Replacement ratio

Retirement income as a percentage of pre-retirement gross income, commonly planned at 70 to 85 percent after adjusting for eliminated savings and work expenses.

Sequence-of-returns risk

The risk that poor returns early in retirement, while withdrawals occur, deplete capital faster than the same average return earned in a different order.

Safe withdrawal rate

The initial inflation-adjusted percentage drawn from a portfolio. Four percent is a planning benchmark, not a guarantee; outcomes depend on horizon, fees, and asset mix.

Social Security claiming

Benefits are reduced for claiming before full retirement age and increased for delaying past it up to age 70. Spousal and survivor benefits follow separate rules.

Required minimum distributions

Mandatory annual withdrawals from traditional tax-deferred retirement accounts after the required beginning age. Roth IRAs are exempt from lifetime RMDs.

Gross estate

All property owned at death plus specified lifetime transfers, including retained interests, general powers of appointment, and certain gifts made shortly before death.

Taxable estate

Gross estate minus deductions for debts, administration expenses, and charitable and marital transfers. The applicable exclusion amount is then applied to the result.

Marital deduction

An unlimited deduction for property passing to a surviving spouse, which defers estate tax but leaves assets in the survivor's estate unless a credit shelter or portability election is used.

Portability election

A surviving spouse may use the deceased spouse's unused exclusion amount, but only if a timely estate tax return is filed electing portability.

Annual gift exclusion

A per-recipient, per-year amount that can be given free of gift tax. Gifts above it use lifetime exclusion rather than necessarily triggering current tax.

Basis at death

Inherited assets generally receive a stepped-up basis to fair market value at the date of death, while lifetime gifts carry over the donor's original basis.

Intestacy

Dying without a valid will. Assets then pass under state statute, typically to spouse and descendants, rather than according to the decedent's wishes.

Marginal vs effective rate

The marginal rate applies to the next dollar of income; the effective rate equals total tax divided by total taxable income. Planning decisions use the marginal rate.

Tax-equivalent yield

The tax-exempt municipal yield divided by one minus the marginal tax rate. It converts a municipal yield into the comparable taxable yield for comparison.

Capital gains holding period

Gains on assets held one year or less are short-term and taxed at ordinary rates; longer holdings are long-term and qualify for preferential rates.

Fiduciary standard

A duty to act in the client's best interest with loyalty and care, including disclosure of conflicts. It is stricter than the suitability standard.