Estate planning 2.7 2 a2 answers

Second Edition

PERSONAL FINANCIAL PLANNING

Lewis J. Altfest

Personal Financial Planning

FINANCIAL MANAGEMENT

Block, Hirt, and Danielsen Foundations of Financial Management Sixteenth Edition

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INVESTMENTS

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INTERNATIONAL FINANCE

Eun and Resnick International Financial Management Seventh Edition

REAL ESTATE

Brueggeman and Fisher Real Estate Finance and Investments Fifteenth Edition

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FINANCIAL PLANNING AND INSURANCE

Allen, Melone, Rosenbloom, and Mahoney Retirement Plans: 401(k)s, IRAs, and Other Deferred Compensation Approaches Eleventh Edition

Altfest Personal Financial Planning Second Edition

Harrington and Niehaus Risk Management and Insurance Second Edition

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The McGraw-Hill/Irwin Series in Finance, Insurance, and Real Estate Stephen A. Ross Franco Modigliani Professor of Finance and Economics Sloan School of Management Massachusetts Institute of Technology Consulting Editor

Second Edition

Personal Financial Planning

Lewis J. Altfest, Ph.D. Pace University

PERSONAL FINANCIAL PLANNING, SECOND EDITION

Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2017 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. Previous edition © 2007. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.

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ISBN 978-1-259-27718-4 MHID 1-259-27718-6

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Certified Financial Planner Board of Standards, Inc., is a professional regulatory organization based in the United States of America that fosters professional standards in personal financial planning so that the public had access to and benefits from competent and ethical financial planning. They can be reached at (800) 487-1497, or on the Web at www.cfp.net. CFP® Certification Exam Questions © 2014, 2004, 1999, 1996, 1994 CFP Board. Used with permission.

All credits appearing on page or at the end of the book are considered to be an extension of the copyright page.

Library of Congress Cataloging-in-Publication Data

Altfest, Lewis J., author. Personal financial planning/Lewis J. Altfest. Second edition. New York, NY: McGraw-Hill/Irwin, [2017] LCCN 2015035267 ISBN-13: 978-1-259-27718-4 (alk. paper) ISBN-10: 1-259-27718-6 (alk. paper) LCSH: Finance, Personal. Financial planners. LCC HG179 .A4484 2017 DDC 332.024—dc23 LC record available at http://lccn.loc.gov/2015035267

The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites.

mheducation.com/highered

To my wife, Karen. Her success as a financial planner after receiving a Ph.D. in an unrelated field made her inputs particularly valuable in constructing this text and its second edition. Perhaps more importantly, through her ability to balance a career and dedication to our children and the quality of our lives together, she created an environment that made this book possible.

vi

About the Author Lewis J. Altfest, Ph.D., CFP, CFA, CPA, PFS Lewis J. Altfest has balanced a career in financial planning and investing with one as an associate professor of finance. He began as an accountant working for a then “Big 8” accounting firm and became a Certified Public Accountant. After some shorter-lived ventures, he joined the Wall Street firm of Wertheim and Co. in its investment research department. He held similar positions with Lehman Brothers and Lord Abbett & Co. At Lord Abbett & Co., an investment management firm, he rose to become Director of Investment Research, Chief of Long Range Strategy, and a general partner of the firm. At the same time, he began seriously pursuing a Ph.D. and teaching part-time. It was at Lord Abbett that Lewis Altfest decided to focus on helping individuals instead of institutions. He wanted to become the “Consumer Reports of Financial Planning,” that is, to provide unbiased financial and investment advice and to dedicate himself to instructing students and the public on financial matters. In 1982, he established a financial planning and investments firm along with another individual and in 1983 incorporated a firm performing activities by himself. At about the same time, he joined the faculty of Pace University as Associate Professor of Finance. His wife, Karen C. Altfest, joined him in business shortly thereafter (his son some 20 years later), and together they have established a nationally recognized multi-person financial and investment advisory firm, Altfest Personal Wealth Management Inc., located in New York City. Dr. Altfest has been active in financial planning industry matters for over 30 years, in- teracting with other planners nationwide, and has been an original member and a member of the board of directors of the National Association of Personal Financial Advisors and served on the board of directors of the IAFP New York Chapter, the predecessor of the Financial Planning Association, and on the board of the Educational Foundation of NAPFA as well. He was named one of NAPFA’s 30 most influential advisors in 2013. Over the past 30+ years, Dr. Altfest has been named to Best Planners in the United States lists by Money magazine, Worth Magazine, Mutual Funds Magazine, and Medical Economics. Over the past 10 years and again in 2014 Barron’s named Dr. Altfest one of the “Top 100 Independent Financial Advisors in the Nation.” In 2014, he was inducted into Research magazine’s Hall of Fame, and Dr. Altfest’s firm was named by Financial Times magazine as one of the Top 300. In 2014, he received The Best Practices Award Recognizing Altfest Personal Wealth Management as a Best Managed Firm by Investment News. He has been included among Bloomberg’s “Top Wealth Managers.” He was also awarded the Lifetime Achievement Award by Financial Planning magazine. At Pace University, he has been active in many pursuits, including serving on the University’s employee benefits committee, chairing the Lubin School’s Graduate Division tenure committee, and chairing the finance department’s recruitment and tenure committees. He has published academic research papers in financial planning and investing and has two other books, Introduction to Business (Harper and Row), and Lew Altfest Answers Almost All Your Questions about Money (McGraw-Hill), which he co-authored with his wife. Dr. Altfest participates in many professional and academic associations today, includ- ing the FPA, NAPFA, CFA Institute, and AICPA, and is an original member of the Academy of Financial Services. His advice and research have been quoted in such media as The New York Times, The Wall Street Journal, Newsweek, US News and World Report, Fortune, BusinessWeek, Money Financial Advisor, Financial Planning, Investment News,

About the Author vii

Bloomberg Wealth Manager, and Bottom Line, and he has written a monthly column for Medical Economics for over a decade. He has appeared on CBS, ABC, NBC, CNN, CNBC, and others. For his role in the development of the financial planning profession, the Business and Economics Alumni Society of the City College of New York chose Dr. Altfest as their 2006 Career Achievement Award recipient. Baruch College, the then undergraduate division of City College of New York, provided him with the Alumnus of Distinction Award in 2012. He has been named an Alumnus of the Year by CUNY Graduate Center Alumni Association, where he received his Ph.D. degree. You can catch him on Saturdays and Sundays relaxing on the deck of his weekend home, alternately doing work, talking to Karen, and gazing at the birds in the treetops, which one of his clients assured him would add years to his life.

viii

Preface GOALS OF THE BOOK

Personal Financial Planning is designed to be used for the study of personal finance and financial planning from a planner’s perspective. This text goes beyond the traditional per- sonal finance texts to teach students how to do actual financial planning and integrates the theory and practice of personal finance. This book incorporates a theory of personal financial planning that demonstrates the similarities and differences between personal and business finance and integrates the entire body of financial material presented. It is intended to utilize the theoretical contri- butions over the past half-century, particularly modern portfolio theory, to elevate the level of presentation. At the same time, its goal is to remain easy to understand and use- ful in real life. Instructors of education courses, whether for general or CFP® certification prepara- tion purposes, may consider the text’s practical combination of planning facts, analysis, and frequent step-by-step instructions attractive. Experienced financial planners and other professionals looking for a one-volume reference to the planning field from a prac- titioner’s perspective, or who may be considering pursuing the Certified Financial Planner™ (CFP®) certification should also find the book appealing. Those who would like to plan their own financial future in a comprehensive way also should find the text informative.

THEMES This text is unified by a few themes. One is that the household resembles a business and can profitably use its financial techniques. Another is that decisions for the household, for you, include all operations and all assets and obligations. In other words, decisions are ultimately made on an integrated basis. Whether we are engaged in investment activities or mapping retirement plans, we are performing household operations that fall under personal financial planning’s mandate. Our personal financial planning objective is effective household operations that we achieve through logical, businesslike financial procedures. Households whose activities are financially efficient have the foundation for personal goal achievement. This approach is covered in more detail in Chapter 4.

ORGANIZATION In keeping with its practical emphasis, Personal Financial Planning is largely ordered around the parts of a financial plan. Its parts all funnel into the final section, Integrated Decision Making. The approach is illustrated in Figure A. Many of the chapters that require active planning use a full or modified process- oriented approach that takes the student through the methodology point by point. This approach not only provides an easy-to-follow structure; it also better prepares financial planning majors for more advanced material to come.

Preface ix

Content Personal financial planning is an unusually broad discipline that requires knowledge of topics ranging from mathematics to human interaction. Not coincidentally, there is an introductory chapter in Part One that presents virtually all the mathematical material needed in simple fashion with solved examples for each step. It is a feature of the book that all new concepts are followed by examples using generic calculator solutions where possible and Excel-based solutions in the text and on the website. The human side of the process, which is often overlooked, is presented in Chapter 3 in the sections that stress communications and goal setting. Human actions are expanded on in a separate chapter, “Behavioral Financial Planning” (Chapter 18), which presents the latest thinking on the topic. Practical examples of its contributions are given in each major area of personal financial planning. In keeping with the practical nature of the text there is a final chapter, “Completing the Process,” that truly explores the finishing process. To the author’s knowledge, this is the only textbook to cover PFP integration and overall decision making in detail. The chapter could have been called simply “Completing the Financial Plan.” However, it essentially does more, indicating how certain tools and practices demonstrate the comprehensive na- ture of PFP and improve the completion process. It is this integration that requires overall decision making that differentiates personal financial planning from personal finance and from other professions that offer financial advice. Personal finance and investments courses alike tend to treat financial investments as the centerpiece of investment material. There are other assets, namely human-related and real assets, that importantly enter into decision making. In Chapter 8, “Household Investments,” these investments, often given less emphasis, are described and analyzed in detail. The text has one review chapter in Part Six, “Planning Essentials.” Chapter 16, “Stocks, Bonds, and Mutual Funds,” provides those without a proper background, or students in need of a review, with a quick upgrading in usable knowledge in investment categories. Included is descriptive material on stocks, bonds, mutual funds, and exchange-traded funds.

VII Integrated Decision

Making

I Planning Basics

II Ongoing

Household Planning

III Portfolio

Management

VI Planning

Essentials

IV Specialized

Planning

V Tax and Estate

Planning

FIGURE A Sections of the Book

x Preface

Normal Financial Coursework and CFP® Preparation Current or possible future CFP® candidates can receive credit toward CFP® requirements in a regular financial planning course.1 Personal Financial Planning provides all the specific material necessary to comply with CFP® required content areas. It is an appropri- ate method of presentation for all students, not just financial planning majors. Its emphasis on practical material, theory, case study analysis, and “how to do it approach” provides a broader experience for both one-time students and those headed for CFP® status. Professors who desire further descriptive coverage, including those who prefer enhanced CFP® certification preparation information, will find special chapters for that purpose as well. Suggested syllabi and outlines are provided for classes: 1) intended solely for students interested in a CFP® and 2) for combined regular survey and CFP® students. This will accommodate all students interested in applying for CFP® credit as detailed in the Instructor’s Manual found on the book’s website.

FEATURES There are a number of features throughout the chapters to help bring the text material to life.

The goals of each chapter are stated at the beginning of that chapter. They are most of- ten expressed in action-oriented terms to emphasize the usefulness of the material in daily situations.

A key feature is the use of a single case study that is developed throughout the text. Each chapter starts with a relevant sentence or two from that chapter’s event. Significantly at chapter’s end, Dan and Laura’s day-to-day problems are stated and an- swered from a financial planning practitioner’s point of view. This ongoing case study also reviews the chapter’s material and places it in a broader context. The case permits the student to understand how the chapter’s material can be applied to real-life situa- tions and experience the information-gathering process as a professional interviewer would. Reviewers have said that this case study, which is deeper than a typical academic one, is more interesting and closer to a student’s own experiences.

Almost every chapter starts with a minicase called “Real-Life Planning.” It sets the stage for the educational material to follow. Students have found these “stories,” largely based on the author’s own experiences with clients and told in a nontechnical manner, an interesting, easy-to-relate-to way to begin the chapter.2

Key words are presented in boldface to highlight terms and concepts that are emphasized.

Practical Comments are often used to underscore the situations in which real human actions differ from the way the book tells you it should be done. These highlighted

1 The course must comply with coverage of CFP® required areas. If it does the student can receive credit toward eligibility for the exam and the CFP® within a normal academic curriculum without it being taken through a CFP® Board-Registered Program. “The CFP® Board will consider granting credit toward the educa- tional course work requirement for CFP® certification if: 1. You can submit documentation that you have successfully completed equivalent approved upper division level college or university coursework at a regionally accredited college or university . . .” See CFP® Board education requirement for further details— http://www.cfp.net/become-a-cfp-professional/cfp-certification-requirements/education-requirement. 2 Certain material has been altered in part to protect the identities of the people who are discussed.

boxes’ recommendations, given to meet the issues at hand, carry the tone of a financial planner who has dealt extensively with these circumstances.

Tables and figures have been placed throughout the text. Wherever useful, the tables have presented a summary of factual material in an easy-to-refer-to manner.

As we mentioned, there are many examples given, particularly in mathematical and more-difficult-to-describe concepts. Special efforts are made to provide an answer for every type of problem, often including an explanation of why a particular step is taken.

Excel is explained and solutions are given for all appropriate problems in the appendix to the text and on the website. In addition, calculator solutions are provided on a generic pictorial basis in the body of the text where possible, thereby allowing any financial calculator to be used to solve those problems. Where problems are more complex, key- strokes of two leading calculators, the HP12C and the TI BAII Plus, are illustrated right in the example.

An actual comprehensive financial plan is provided on the website. It is based on the Dan and Laura case study presented by chapter, but this time in a more compact manner after final decisions have been made. Students should gain an appreciation for how an actual financial plan looks and, together with chapter presentations, how it is developed.

There are many end-of-chapter study tools to be used for self-study and/or homework:

The salient points of the chapter are placed here. Together with the goals section and key terms, it can guide the student into a better understanding of the chapter’s points.

This feature provides in one place a useful compendium of important terms introduced in the text.

Selected websites indicate where additional information can be obtained.

A select list of questions is presented representing a mixture of factual and evaluative matters. The problems stress mathematical computation as a practical exercise of the chapter’s numerical material.

®

A broad list of former CFP® certification examination questions is provided. These demonstrate selected areas of emphasis for those contemplating taking the exam. They also present many practical questions that require students to demonstrate knowledge of the chapter’s topics.

There is a second case study, called Case Application, that is similar in approach to the first one about Dan and Laura. However, instead of having a solution given in the text, this one is to be prepared and submitted by the student and/or discussed in class.

Instructors who wish to schedule a term project for students doing a financial plan for “clients” can do so. In my experience of over 30 years teaching PFP to matriculating

Preface xi

undergraduate and graduate students, this assignment is very popular. The knowledge derived from the two case studies in each chapter and the full financial plan on the web- site enable students to prepare their plans well.

There are also a Glossary and Suggested Readings at the end of the book.

CHANGES IN SECOND EDITION This book goes beyond the presentation of basic facts to teach people how to perform per- sonal financial planning. Since the first edition, the field has become more sophisticated both from the standpoint of the professionals who offer PFP and the consumers who increas- ingly desire broader and deeper knowledge from their financial advisors. At the same time, the public and many students want practical information presented in easy-to-understand terms that don’t speak down to them. Feedback on the first edition indicated that students felt the book was easy to read. The second edition, as described below, adds new sections and text material that significantly enhances the ease of understanding, practicality, and further relatability to college students and provides a lively new Life Cycle Planning section. It also has a subtle new summary of many chapters done in a partly narrative style.

College Age Case Study and Overall Chapter Review A new third case study, called “College Student Case Study and Review: Amy and John,” has two purposes. The first is to provide college-age undergraduate and graduate students, many of whom have not yet established their own households, with issues and interests they can relate to. It presents Amy and John as students with varying challenges and gives instructions on how to overcome them in appropriate chapters. The second purpose is to present a summary of these chapters, whether used as an introduction to or summation of the key points in the text. This partly narrative summary is set in a simpler and less formal style. Those looking for a simple placing together of the major ideas of the chapter irre- spective of their ages should find this case study highly useful.

Professional Advice This new boxed section presented in many chapters adds more news you can use. It presents recommendations on how to resolve common problems people encounter. It is based on the author’s more than 30 years of experience as a practitioner helping literally thousands of people.

Life Cycle Planning This new section placed at the end of most chapters takes the reader through age-related issues ranging from college days to post retirement. It is presented in an action-oriented style from a practitioner’s standpoint. Its approach is intended to be concise and informal.

New Real Estate Chapter It is clear that interest in real estate, whether it be the home or independent properties, has grown sharply in recent periods. This new Chapter 9, “Real Estate and Other Assets,” presents a simplified description of the topic. It also provides a brief description of other alternatives to stocks and bonds.

Revision of Capital Needs Analysis Chapter Chapter 17, “Capital Needs Analysis,” presents the traditional answer to calculating the amount needed to bring about a comfortable retirement. A new, simpler method for calcu- lating that amount is also given.

xii Preface

Modification of Financial Investments Chapter Chapter 10, “Financial Investments,” shifts practical step-by-step information on selecting investments and constructing a portfolio using mutual funds from the background invest- ments in Chapter 16 and simplifies other technical information. It also provides more at- tention to exchange-traded funds (ETFs), which have grown more popular in recent years.

Updating Financial Planning Taxes, economic circumstances, retirement planning, investments, and insurance alterna- tives are among the areas that have changed since the first edition. Taken together, the financial planning field has grown in numbers and sophistication. These new factors have been reflected in the second edition throughout the book.

SUPPLEMENTS Online Learning Center www.mhhe.com/altfest2e The Online Learning Center contains the following assets, which are password-protected for instructors only:

Instructor’s Manual. Includes solutions for end-of-chapter questions, problems, and case studies.

Test bank. Word files containing 30–40 questions, including true-false, multiple choice, and essays, prepared by Aron Gottesman, Associate Professor of Finance, Pace University.

PowerPoint slides. PowerPoint slides for each chapter to use in classroom lecture settings, created by Aron Gottesman, Associate Professor of Finance, Pace University.

New Second Edition Instructor Material:

session provided by type of student (undergraduate, graduate finance major, non- finance major, CFP® prep, combined regular survey and CFP® prep, simpler approach, adult education).

The comments are based on the author’s more than 30 years of teaching the course.

Preface xiii

xiv

I am grateful to the following professionals who read individual or multiple chapters and offered their helpful comments. They verified facts, pointed out discrepancies, added to the material presented, and otherwise contributed to a more polished product.

Roy Ballentine, CFP®

Ballentine, Finn & Co., Inc. Janet Briaud, CFP®

Briaud Financial Planning, Inc. Gayle Buff, CFP®, CFA Buff Capital Management Alfred C. Clapp, Jr. Financial Strategies & Services Corp. Larry Copperman Steve Aronoff PC David Drucker, CFP®

Fieldstone Financial Management Group, LLC Louis Feinstein Louis I. Feinstein, CPA, PC

Linda Gadkowski, CFP®

Beacon Hill Financial Educators, LLC Harvey M. Goldfarb All Risk Insurance Agency, Inc. Gary Greenbaum, CFP®, CFA Greenbaum and Orecchio, Inc.

®

Family Financial Architects, Inc. Mary A. Malgoire, CFP®

The Family Firm, Inc. J. Michael Martin, CFP®

Financial Advantage Inc. Ed O’Hanlon Kieffer & Hahn LLP

Haseeb Ahmed Johnson C. Smith University M. J. Alhabeeb University of Massachusetts Mike Barry Boston College Conrad Ciccotello Georgia State University Sheran Cramer University of Nebraska—Omaha

University of Akron

Penn State University—Erie J. Jeffrey Lambert, CFP®

University of California—Davis Extension Jennifer LeSure IVY Tech State College in Indianapolis

Ann Perkins North Dakota State University Bruce L. Rubin Old Dominion University Deanna Sharpe University of Missouri—Columbia David Sinow University of Illinois Michael Snowdon The College for Financial Planning Gene R Stout Central Michigan Don Taylor The American College

®

Texas A&M University—Commerce Glenn Wood Winthrop University

Acknowledgments My personal thanks to all academic reviewers. Each contributed importantly to the final copy. Their knowledge of the material and understanding of what it takes to communicate it effectively significantly enhanced the book.

Acknowledgments xv

Tom Orecchio, CFP®, CFA Greenbaum & Orecchio, Inc. Morton Price Cowan Liebowitz & Latman Alan Romm Independent Broker Bruce Ross, CFP®, CLU, ChFC Ronald Rutherford, CFP®

Rutherford Asset Planning, Inc.

Suzette Rutherford, CFP®

Rutherford Asset Planning, Inc. Harry Scheyer, CFP®, CPA/PFS Pinnacle Financial Advisors LLC Bob Veres Inside Information Henry Wendel, CFP®

Wendel Financial Planner & Investment Advisor

I would like to thank my colleagues at Pace University who assisted me by providing con- structive suggestions, including Michael Szenberg, Ron Filante, Aron Gottesman, Qi Lu, Jouahn Nam, Alan Tucker, and P. V. Viswanath. I am also grateful to my graduate assis- tants over the term of this project. One in particular stands out. Oktay Veliev not only was extremely helpful in production aspects treating the book as if it were his own but was responsible for many of the creative diagrams and software examples. Finally, I am grateful to members of my professional staff. Ekta Patel, Dawn Brown, and Michael Prendergast were of material assistance as were administrative staff members Helen Cummings and Marina Marsillo. However, three others stand out. The first is Karen C. Altfest, who provided a strong contribution in overall advice and chapter reviews. The second is Paul Palazzo, who made a major contribution to the case study and helped in several other areas. Lastly, I want to thank Dr. Abe Fenster for his constructive sugges- tions, pedagogy, and continuing support in the strategy and execution of this book. The second edition benefited importantly from Andrew Altfest, whose assistance in all areas of the book was very valuable. I also received a material contribution from the analytical and updating skills of Don Korn. In addition, members of my professional staff reviewed and made suggestions including Paul Palazzo. Significant contributions were made by Dawn Brown, Boyan Doytchinov, Brett Fry, Steven Cadoff, and Brendan McEwan. Dr. Abe Fenster continued his high level support in the revised edition that was in total very important. Harvey Goldfarb of All Risk Insurance was a huge help with the life insurance example and data, as was Alex Smith of Ashton Benefits with health insur- ance as well and Richard Rothberg of Cooley LLP was invaluable with the Estate Planning chapter. Finally, thanks for editorial assistance to Prateeksha Sabhani, Yisroel Zylberberg, and Matthew Suchow, all of whom made substantive improvements to the book. It is my hope that this book will contribute to the further development of personal finan- cial planning and enhance the stature of the discipline, the instructors who teach the course, the professionals who practice its fundamentals, as well as motivate students in its career possibilities.

Lewis J. Altfest

(LJA@Altfest.com)

xvi

PART SIX Planning Essentials 505

16 Stocks, Bonds, and Mutual Funds 506

PART SEVEN Integrated Decision Making 535

17 Capital Needs Analysis 536

18 Behavioral Financial Planning 579

19 Completing the Process 612

PART EIGHT* Further Specialized Topics (Web Chapters) 1

A Educational Planning 2

B Background Topics 30

C Special Circumstances Planning 54

D Career Basics 82

E Regulation 96

APPENDIX* A Modern Investment Theory

B Employee Benefits

C Behavioral Finance—Applications