Financial Planning: Conflict of Interest
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Financial Planning: Conflict of Interest

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Questions and Answers

What is hyperinflation most commonly a result of?

  • A shortage of goods in the market
  • Excessive government spending
  • An abundance of paper currency (correct)
  • An increase in international trade

    • How is income defined in the context provided?

  • Any monetary support received from family or friends
  • Revenue generated from business operations only
  • Payments received that can be used for spending or savings (correct)
  • Only earnings from investments and salaries

    • What unique characteristic does fiat currency possess?

  • It has no intrinsic value (correct)
  • It is universally accepted without governmental declaration
  • It is determined by foreign exchange rates
  • It possesses a value based on commodity backing

    • What does real wage growth measure?

    <p>Wage increases adjusted for inflation</p> Signup and view all the answers

    What is the relationship between credit and debt as described?

    <p>Credit must be obtained prior to incurring debt</p> Signup and view all the answers

    What is the primary purpose of a Statement of Advice (SoA)?

    <p>To set out the advice and the context for that advice</p> Signup and view all the answers

    Under what condition can advice be given without providing a SoA?

    <p>If the advice involves selling a product only</p> Signup and view all the answers

    What essential detail should be included in a SoA if advising on replacing one product with another?

    <p>Potential losses from disposing of the original product</p> Signup and view all the answers

    Which of the following is NOT a required component of a Statement of Advice (SoA)?

    <p>A complete list of all financial products available in the market</p> Signup and view all the answers

    How can a financial planner avoid conflicts of interest when recommending products?

    <p>By ensuring the client knows the planner's commission structure</p> Signup and view all the answers

    What must a Statement of Advice include regarding the adviser?

    <p>Contact details, name, and qualifications</p> Signup and view all the answers

    When must a SoA be provided to a client?

    <p>Before any actions implementing the advice are taken</p> Signup and view all the answers

    Which of the following is a valid reason to replace one product with another in a SoA?

    <p>Demonstrated benefits of switching to the alternative product</p> Signup and view all the answers

    What is a primary characteristic of bad debt?

    <p>It is typically associated with short-term consumption.</p> Signup and view all the answers

    How does paying off a home mortgage relate to financial strategy?

    <p>It can reduce financial stress by eliminating non-deductible debt.</p> Signup and view all the answers

    Which of the following best describes a characteristic of good debt?

    <p>It funds investments expecting to gain returns.</p> Signup and view all the answers

    In terms of financial planning, why is funding long-term consumption using debt considered less problematic?

    <p>Depreciating assets accompanied by a tangible utility can offset costs.</p> Signup and view all the answers

    What is a significant characteristic of revolving credit?

    <p>It allows for ongoing borrowing up to a certain limit.</p> Signup and view all the answers

    What distinguishes passive income from earned income?

    <p>Earned income involves active work or labor.</p> Signup and view all the answers

    What often constitutes a source of financial stress related to homeownership?

    <p>The percentage of disposable income allocated toward a mortgage.</p> Signup and view all the answers

    What is the role of credit in relation to debt?

    <p>Credit represents the initial phase of accumulating debt.</p> Signup and view all the answers

    What is a key characteristic of equity compared to debt?

    <p>Equity provides a residual claim on cash flows.</p> Signup and view all the answers

    Which of the following best describes bond ETFs compared to traditional bonds?

    <p>Bond ETFs provide lower management fees.</p> Signup and view all the answers

    What does the equity risk premium refer to?

    <p>The excess return of equity over equivalent risk bonds.</p> Signup and view all the answers

    In which circumstance might investors face significant short-term volatility in their portfolio?

    <p>When investing in equities during market downturns.</p> Signup and view all the answers

    What is the first step for an individual interested in investing in public company shares?

    <p>Contacting a broker to set up a trading account.</p> Signup and view all the answers

    Why might retirees be particularly affected during market downturns?

    <p>They often rely on equity returns for retirement income.</p> Signup and view all the answers

    What is a common practical consideration when investing directly in shares?

    <p>Understanding market trends for better decision-making.</p> Signup and view all the answers

    Which statement accurately reflects the consequences of investing in equities compared to cash?

    <p>Equities tend to outperform cash investments in the long run.</p> Signup and view all the answers

    Why is proper documentation essential for shareholders?

    <p>To prove ownership and manage tax and legal obligations.</p> Signup and view all the answers

    Which type of broker provides comprehensive advice and research along with trade execution?

    <p>Full-service broker</p> Signup and view all the answers

    What is a common consequence of transaction costs when buying and selling shares?

    <p>Reduced overall returns due to fees and commissions.</p> Signup and view all the answers

    What does capital gains tax apply to?

    <p>Profit made when shares are sold.</p> Signup and view all the answers

    Which analysis method focuses on assessing a company's financial health and future prospects?

    <p>Fundamental analysis</p> Signup and view all the answers

    What challenge do investors face when trying to invest in private companies?

    <p>They are less accessible and typically require personal connections.</p> Signup and view all the answers

    What paradox is presented by the Efficient Market Hypothesis (EMH)?

    <p>That information is already reflected in share prices, challenging the need for analysis.</p> Signup and view all the answers

    What information do investors typically seek before deciding which shares to buy?

    <p>Insights from both technical and fundamental analysis.</p> Signup and view all the answers

    Study Notes

    Financial Planning: Conflict of Interest

    • Financial planners (FP) should not put their own interests above those of the client
    • A conflict of interest occurs when an FP recommends a product solely for the commission they earn, rather than based on the client's needs
    • Disclosing commissions is crucial and recommendations must be objective and based on the client's circumstances and goals

    Statement of Advice (SoA)

    • A SoA outlines the advice and the context of the advice
    • When personal advice is given, a SoA must be provided before implementing any actions based on that advice
    • A SoA must include:
      • Product details and reasons for the recommendation
      • Details about the advisor, including qualifications and contact information
      • Remuneration and benefits received by the advisor, including how and to whom they are distributed
      • Information about any association that might influence the advice
      • A warning if the advice is based on inaccurate or insufficient information
      • Reasons for product replacements
    • Advice can be provided without a SoA in minimal investment circumstances:
      • Investments, basic deposit products, or super amounts are under $15,000
      • Advice consists solely of an offer to sell a product
      • The client explicitly states they don't intend to buy
      • No sale or issue results from the offer
      • Advice is given over the phone for traded products (subject to client approval and an FSG provided)
    • When a SoA recommends replacing a product:
      • Benefits of changing to an alternative product
      • Losses incurred by the client from disposing of the original
      • Charges for disposing of the original product
      • Charges for switching to a new product
      • Other significant consequences of the action

    Key Financial Concepts

    • A PDS (Product Disclosure Statement) is a legal document required to be provided to investors before they invest in a financial product
    • A PDS should include information about the product, such as its risks, fees, and potential returns
    • A unit of account allows for the valuation of different elements using a common unit for calculation, valuation, and comparison, providing precise monetary measurement
    • Fiat currency is declared legal tender by a government, meaning it is used to acquire goods and services and pay financial obligations
    • Fiat currency has no intrinsic value
    • Hyperinflation occurs when a currency becomes practically worthless, often resulting from an excessive amount of paper money, which reduces the value of money
    • Income is the main source of spending and saving
    • Income can be earned through salary/wages, passively through investments (interest, dividends, rent), or other receipts
    • Capital amounts (sale of assets), gambling winnings, and gifts are not typically considered income but may be subject to tax rules

    Salary/Wages and Real Wage Growth

    • The main source of income is typically earned through salary/wages
    • Nominal wage growth is currently positive and increasing
    • However, real wage growth (inflation adjusted) is a more accurate measure of purchasing power
    • Compared to a base of 100 in March 2020, real wage growth is declining, putting current buying power at levels comparable to December 2008
    • Initial years in the workforce often require a period of "catch up" in earnings

    Credit and Debt

    • Credit is the initial stage of a debt transaction, allowing a borrower to take on debt
    • Bad debt is characterized by:
      • No asset being purchased
      • Interest paid is not tax deductible
      • Spending provides only intangible benefits
    • Good debt is used:
      • To build assets
      • To fund investments with the expectation of earning sufficient returns to offset the purchase price
    • Examples of bad debt:
      • Spending on nights out, clubbing, drinking
    • Examples of good debt:
      • Funding depreciating assets with a useful lifetime (cars, furniture, white goods)
      • Funding assets with a potential to appreciate in value (homes, vintage cars, boats, holiday homes, renovations)

    Paying off Non-Deductible Debt

    • Home mortgage loans typically consume 20-40% of disposable income, sometimes more
    • Investing by paying off home mortgage loans (saving on interest) is a low-risk strategy
    • Even though the return from saving on mortgage outgoings is not tangible compared to a cash investment return, it offers a sense of gratification
    • Paying off a mortgage is not subject to market volatility, and variable rate loans contribute to some variability in return, making it a relatively risk-free approach
    • Paying off non-deductible debt can often provide better returns than taxable investment income

    Types of Debt

    • Fixed Payment Loans:
      • Personal loans, car loans, BNPL (Buy Now Pay Later), and home mortgage loans
      • Secured vs unsecured
      • Fixed payments over a finite period of time (used in annuity formulas)
    • Revolving Credit:
      • Credit cards, overdrafts, lines of credit

    ETF vs CMT

    • Bond ETFs have gained popularity due to their flexibility, lower costs, intraday trading, diversified bond exposures, and lower management fees

    Debt and Equity: Key Differences

    • Debt:
      • Imposes a contractual obligation for the company to make regular payments of interest and principal to lenders
    • Equity:
      • Represents a residual claim on the cash flows generated by the firm's assets
      • Dividends are paid after interest
      • Capital is returned after borrowings are repaid
      • An equity risk premium exists
      • Can be generated internally (retained earnings) or externally (new issues)

    Long-Term vs. Short-Term Returns on Equities

    • Equities (stocks) have historically delivered stable, higher returns compared to other asset classes like bonds or cash
    • Long-term equity investments tend to outperform other investments
    • Short-term equity investments can be risky due to market volatility
    • Market volatility can lead to significant losses in the short term, as exemplified by the COVID-19 pandemic and the 2008 Global Financial Crisis
    • The S&P/ASX200 Index experienced a 50% decline in 2008, significantly impacting investors, particularly retirees

    Practical Considerations and Risks of Direct Share Investment

    • How and Where to Buy Shares:
      • Shares of public companies are listed and traded on stock exchanges like the ASX
      • Investors require a broker and trading account to buy shares
      • The ASX provides educational resources for new investors
    • Which Shares to Buy:
      • Requires research on companies, understanding market trends, and diversification to reduce risk
    • Finding Share Price Information:
      • Investors need access to reliable, timely information about share prices for informed decisions
    • Use of Brokers:
      • Brokers facilitate buying and selling shares
      • Full-service brokers offer advice and research, while discount brokers execute trades at lower fees
    • Transaction Costs:
      • Buying and selling shares incur costs like brokerage fees and commissions, affecting overall returns
    • Documentation of Ownership:
      • Proper documentation is essential to prove ownership of shares and manage tax and legal obligations
    • Taxation of Share-Related Income:
      • Income from shares, like dividends, is subject to taxation, and capital gains tax applies to profits from selling shares
    • Valuation of a Share:
      • Understanding share valuation is crucial for investment decisions, requiring an assessment of a company's financial health, future prospects, and market position

    Direct Investment in Shares in Australia

    • Public Companies:
      • Shares of public companies are easily accessible through the ASX
      • A broker facilitates buying and selling
      • The ASX provides resources for beginners
    • Private Companies:
      • Investment in private companies (unlisted) is more challenging as these shares are not publicly traded
      • Typically requires a personal connection with the company's owners or principals

    Methods for Selecting Shares

    • Fundamental Analysis:
      • Involves analyzing a company's financial statements, earnings, growth potential, industry position, and economic factors to determine its intrinsic value
      • Aims to find undervalued stocks with strong growth potential
      • Evaluates current management
      • Compares with similar companies in the same line of business
      • The market requires efficient fundamental analysis, but the EMH assumes that information is already reflected in share prices (the paradox of the EMH)
    • Technical Analysis (Charting):
      • A time series prediction technique using price history charts and other indicators

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    Description

    This quiz covers essential concepts in financial planning, focusing on conflicts of interest and the importance of objective advice. Learn how to effectively disclose commissions and provide a Statement of Advice (SoA) that meets client needs. Understanding these principles is crucial for ethical financial advising.

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