RFP Module 4 key terms

The principle that a sum of money available today is worth more than the same sum received later, because today's money can be invested to earn a return. It underpins compounding, discounting, and annuity valuation.

The value today of a future cash flow or stream of cash flows, obtained by discounting at an appropriate rate. It allows comparison of amounts received at different points in time on a common basis.

The amount to which a current sum or series of payments will grow after earning a stated rate of return over a given number of periods. It measures the end-point result of compounding.

The process by which investment earnings are reinvested so that later returns are earned on both the original principal and previously accumulated interest. More frequent compounding at the same nominal rate produces a higher effective return.

The rate used to convert future cash flows into present value. It reflects the time value of money plus a premium for risk, and a higher rate reduces the present value of distant cash flows.

The true annual return after accounting for compounding within the year. It exceeds the nominal rate whenever compounding occurs more than once a year, and it is the correct rate for comparing products with different compounding frequencies.

A snapshot listing a household's assets at market value minus its liabilities, producing net worth at a point in time. It is paired with a cash flow statement to assess financial position and progress.

A record of money coming in and going out over a period, usually a month or year, separating income from expenses and savings. It reveals surplus or deficit and supports budgeting decisions.

Liquid savings set aside to cover unexpected expenses or income loss without borrowing or selling long-term investments. It is typically sized at several months of essential living expenses and held in low-risk, accessible accounts.

An investor's emotional and psychological willingness to accept investment losses or volatility in pursuit of return. It differs from risk capacity, which is the financial ability to absorb losses.

The financial ability of a household to withstand investment losses without jeopardizing goals, determined by income stability, time horizon, and obligations. A client may tolerate risk they cannot financially afford.

The division of a portfolio among asset classes such as equities, fixed income, and cash. It is the primary driver of portfolio risk and return and should follow from goals, horizon, and risk profile.

Spreading investments across assets, sectors, and geographies so that poor performance in one holding is offset by others. It reduces unsystematic risk but cannot eliminate market-wide risk.

Risk that affects the whole market, such as interest rate shifts, inflation, or recession, and cannot be removed by diversification. Investors are compensated for bearing it through expected return.

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

A statistic between minus one and plus one describing how closely two investments move together. Combining assets with low or negative correlation improves diversification for a given level of return.

The minimum return an investor demands to commit funds to a particular investment, reflecting the risk-free rate plus compensation for risk. It is used as the discount rate in valuation.

The extra expected return above the risk-free rate that investors require for holding a risky asset. It widens as perceived risk rises and is a core input in expected return estimation.

The degree to which an investment's returns fluctuate around their average, commonly measured by standard deviation. Higher volatility means a wider range of possible outcomes over a holding period.

Periodically buying and selling holdings to restore a portfolio to its target asset allocation after market movements have shifted the weights. It controls drift in risk exposure and enforces a disciplined sell-high, buy-low process.

The length of time before invested funds will be needed for a goal. Longer horizons generally permit more growth-oriented, volatile assets because there is more time to recover from downturns.

The ease and speed with which an asset can be converted to cash at close to its fair value without a significant discount. Cash and money market instruments are highly liquid; property and private holdings are not.

The danger that an asset cannot be sold quickly, or can only be sold at a materially reduced price, when cash is needed. It is elevated in thinly traded or illiquid holdings such as real estate.

The structured process of identifying, measuring, and addressing exposures through avoidance, reduction, retention, or transfer. Insurance is the principal transfer tool used in personal financial planning.

Shifting the financial consequences of a loss to another party, typically an insurer, in exchange for a premium. It is appropriate for low-frequency, high-severity exposures rather than routine small losses.

The amount the insured pays out of pocket before the insurer covers a claim. A higher deductible lowers the premium but increases retained risk, so it should be set at an affordable level.

Deliberately accepting a loss exposure and funding it from one's own resources rather than insuring it. It suits small, frequent, or predictable losses and requires adequate reserves.

The amount paid, usually periodically, to an insurer in exchange for coverage. It is priced according to the insurer's expected claims, expenses, and profit, adjusted for the insured's risk characteristics.

The insurer's process of assessing an applicant's risk before issuing a policy. It determines whether coverage is offered and at what premium, and may result in exclusions or loadings.

A specified event, condition, or property that a policy does not cover. Clients must understand exclusions because they define the boundary of protection and may require separate coverage.

The amount the insurer guarantees to pay on a life policy claim or at maturity, before any bonuses or adjustments. It forms the basis for calculating the death benefit and premium.

An obligatory annual levy in Islamic finance on qualifying wealth held for one lunar year above a minimum threshold, payable at a standard rate to specified categories of recipients. It applies to assets such as savings, gold, and business holdings.

The minimum wealth threshold above which Zakat becomes due, traditionally set against a value of gold or silver. Only the amount exceeding the threshold is subject to the levy.

Wealth categories subject to Zakat, commonly including cash and bank balances, gold and silver, trade inventory, and certain receivables. Personal residence and everyday tools are generally excluded.

The portion of income remaining after allowable deductions, exemptions, and reliefs, on which tax is computed at the applicable rates. It differs from gross income and from total income before reliefs.

The rate applied to the next unit of taxable income within a progressive system. It is used to evaluate the tax saving from an extra deduction or the tax cost of additional income.

A deduction or allowance that reduces taxable income or the tax payable, granted to encourage specified activities or to recognize personal circumstances. It differs from a tax credit, which reduces tax directly.

An amount subtracted from gross income before tax is calculated, lowering taxable income. Its value depends on the taxpayer's marginal rate, unlike a credit which is worth its face amount.

Arranging affairs within the law to reduce tax liability, such as using permitted reliefs or timing income. It is legitimate, though aggressive schemes may be challenged by authorities.

Illegally concealing income or misrepresenting facts to reduce tax owed. It is a criminal offence carrying penalties, and a planner must never assist or facilitate it.

A legal document directing how a person's assets are distributed after death and appointing guardians or executors. Without a valid will, distribution follows statutory intestacy rules.

The situation where a person dies without a valid will, so a fixed statutory formula determines who inherits. Outcomes may differ sharply from the deceased's wishes and can cause hardship for dependants.

The person named in a will to administer the estate, pay debts and taxes, and distribute assets to beneficiaries. The role carries legal duties and may require probate court confirmation.

The legal process of validating a will and authorizing the executor to administer the estate. It can be time-consuming and costly, which is why planners often recommend structures that bypass it.

A legal arrangement in which a settlor transfers assets to a trustee who holds and manages them for beneficiaries under stated terms. Trusts can control distribution, protect assets, and avoid probate.

The person or institution holding legal title to trust assets and obliged to manage them in the beneficiaries' interests under the trust deed. Fiduciary duties include prudence, loyalty, and accounting.

A person or entity entitled to receive assets or benefits under a will, trust, or insurance policy. Clear, current beneficiary designations help ensure proceeds reach the intended recipient without dispute.

The total accumulated fund needed at retirement to finance the desired lifestyle for the expected lifespan. It is estimated by projecting expenses, adjusting for inflation, and discounting future withdrawals.

The percentage of a retirement portfolio drawn each year to fund living expenses. A sustainable rate depends on expected returns, inflation, and the length of retirement.

The risk that a person outlives their financial resources in retirement. It is addressed through conservative withdrawal rates, guaranteed income sources, and planning for a longer-than-average lifespan.

A contract, typically with an insurer, that converts a lump sum into a stream of payments, often for life. It provides longevity protection but may carry fees and limited liquidity.

The general rise in prices over time, which erodes the purchasing power of money. Planners must project it into retirement and education goals so that future costs are not underestimated.

The return on an investment after removing the effect of inflation, approximating the nominal return minus the inflation rate. It measures growth in actual purchasing power.

A stated interest or return rate before adjusting for inflation or intra-year compounding. Comparing nominal rates alone can mislead when inflation or compounding frequency differs between options.

A written, integrated set of recommendations covering goals, cash flow, risk, investments, tax, retirement, and estate matters, with assumptions and review dates. It links client objectives to specific actions and measurable targets.