CFP Module 4 cheat sheet

Net worth = total assets − total liabilities; cash-flow statement tracks inflows and outflows over a period, not a point in time.

Emergency fund target is typically 3–6 months of essential expenses; 6–12 months if income is variable or single-earner.

Time value of money: FV = PV(1 + r)^n; PV = FV / (1 + r)^n; annuity and perpetuity formulas assume level payments and constant rate.

Real return ≈ nominal return − inflation (exact: (1 + nominal)/(1 + inflation) − 1); use real return for goal funding in today's dollars.

Goal funding: required annual savings rises with the gap between assumed return and inflation, and falls with a longer time horizon.

Human capital (present value of future earnings) plus financial capital equals total economic wealth; insurance protects human capital.

Budget ratios: housing ≤ 28–36% of gross income; total debt service ≤ 36–43%; savings rate should rise as income grows.

Inflation-adjusted goal amount = today's cost × (1 + inflation)^years; then discount at the portfolio return to find the lump sum needed today.

Education funding: 529 plans grow tax-deferred, qualified withdrawals are federal-tax-free, and owner retains control of the account.

Expected portfolio return = Σ (weight_i × expected return_i); portfolio risk depends on covariance, not just weighted average volatility.

Diversification reduces unsystematic risk; systematic (market) risk remains and is the risk that commands a risk premium.

CAPM: E(R) = Rf + β(E(Rm) − Rf); beta measures sensitivity to market movements, with the market beta equal to 1.0.

Sharpe ratio = (portfolio return − risk-free rate) / standard deviation; higher is better for comparing risk-adjusted performance.

Duration approximates bond price change for a 1% yield change: %Δprice ≈ −duration × Δyield (modified duration).

Realized compound yield differs from YTM when coupon payments are reinvested at rates other than the YTM.

Tax-efficient asset location: place tax-inefficient assets (taxable bonds, REITs) in tax-deferred accounts and tax-efficient equities in taxable accounts.

Rebalancing to target weights enforces a sell-high/buy-low discipline; thresholds or calendar rules define when to act.

Standard deviation measures total risk; a two-asset portfolio's variance = w1²σ1² + w2²σ2² + 2w1w2ρσ1σ2.

Accumulation phase focuses on savings rate and asset allocation; distribution phase adds sequence-of-returns risk and longevity risk.

Replacement ratio targets commonly range 70–85% of pre-retirement gross income, adjusted for lower work expenses and higher health costs.

Capital needs method: required lump sum = annual real spending need ÷ assumed real return, adjusted for finite horizon and Social Security offsets.

Safe withdrawal analysis: a 4% initial real withdrawal from a balanced portfolio historically supported ~30-year horizons, but is not guaranteed.

Sequence-of-returns risk: early losses during withdrawals cause permanent damage; a cash reserve or flexible spending reduces it.

Defined benefit pension: monthly benefit often = years of service × benefit factor × final average pay; consider survivor and COLA options.

Social Security claiming: delaying past full retirement age raises the benefit by roughly 8% per year up to age 70; early claiming reduces it.

Required minimum distributions begin at the IRS-specified age; the divisor comes from the Uniform Lifetime Table and rises with age.

Inflation erodes purchasing power: at 3% inflation, costs roughly double in about 24 years (Rule of 72: 72 ÷ 3).

Risk handling techniques: avoidance, reduction (loss control), retention (self-insurance), and transfer (insurance); choose by frequency and severity.

Insurable risk requires a large number of independent exposure units, accidental loss, determinable loss, and no catastrophic concentration.

Life insurance need: capital retention (income approach), human life value, and needs analysis (DIME: debt, income, mortgage, education).

Term insurance is pure death benefit; permanent policies add cash value with higher premiums and surrender charges in early years.

Property-casualty: coinsurance clause requires coverage of a stated percentage of replacement cost or claims are reduced proportionally.

Estate transfer tools: wills (probate), revocable living trusts (avoid probate, no tax benefit), irrevocable trusts (remove assets from the estate).

Unlimited marital deduction defers estate tax between spouses; portability transfers an unused exclusion to a surviving spouse.

Annual gift tax exclusion allows tax-free present-interest gifts per recipient per year; gifts above it use lifetime exclusion or require filing.

Beneficiary designations on retirement accounts and insurance override the will; failing to update them is a common planning error.