Ch 1: Building an Investor Profile

filing tax returns (married vs unmarried)

*Unmarried* taxpayers may file a tax return marked *single* or, if they maintain a household for their dependents, they may file a return marked *head of household*. Head of household filing qualifies the individual for *lower rates* and a *higher standard deduction.* *Married* couples may either file a return marked *jointly* or as *married filing separately*. Since *filing jointly provides more tax benefits*, this is usually the *best option* for married couples. A person's filing status is dependent on her marital situation on *December 31 in the year for which the return is being filed. Therefore, if a couple is divorced as of December 31, 20XX, each person is *considered unmarried for the entire year.* So if you like start getting divorced in Feb 2020 you will be divorced by Dec 2020 and you have to file as unmarried in April even if you're still not divorced. (What if you file in April as married then decide to get a divorce in July and you ARE divorced by Dec 2020. What would happen?)

Special tax treatment for qualifying cash dividends

A *qualified dividend* is a type of dividend that's taxed at the *same rate as long-term capital gains*, rather than at an investor's ordinary rate. Generally, *most regular dividends from U.S. companies that have normal company structures (i.e., corporations) are qualified*. However, dividends that are received from a real estate investment trust (*REIT) are still taxed at ordinary income rates* since an REIT doesn't pay corporate income tax if it distributes a minimum percentage of its income. (90%)

net worth

A customer's *wealth* is usually *equated to her net worth*. As illustrated on the personal balance sheet, the customer's *net worth is the difference between what she owns and what she owes*. A person's wealth is difficult to determine without her *full financial profile*. A person with a *high income is not necessarily wealthy since she may also be carrying a large amount of debt*. Another person with modest income may have accumulated a significant amount of money over her lifetime because she made wise investment decisions, saved a substantial part of her income, or had little or no debt. As a general rule, the *greater a person's net worth, the more investment risk she's able to tolerate. And conversely, the lower the net worth, the more conservative the investment strategy should be.*

marginal tax rate

A person's marginal rate represents the tax rate that applies to any *additional* dollars of taxable income earned. Since the U.S. income tax system is progressive, a person's tax rate rises as his taxable income rises through two or more tax brackets. A person's marginal tax rate is the rate he pays on the taxable income that falls into the highest bracket reached (e.g., 10%, 12%, 22%, 24%, 32%, 35% and 37%). For instance, if a person has taxable income that falls into three brackets, he will pay at the 10% rate on the first portion, the 12% rate on the next portion, and the 22% federal tax rate *on only the third portion*. Therefore, his marginal tax rate is 22%.

capital reserve as an investment objective

As a general rule, most persons should commit to establishing a *cash reserve* that's equal to at least *three months' living expenses*. In situations where a customer's income is unpredictable, it may be wise to maintain a larger cash reserve. Capital reserves should be kept in a *safe, liquid investment* such as a money-market fund.

meeting fiduciary obligations

At times, assets are being invested for the benefit of a third party, such as a child or incapacitated relative. In these cases, the *RR must look at the profile and objective* of the *beneficiary*, *not* the person making the ultimate investment decisions.

suitability

Broker-dealers have a suitability obligation to each of their customers. For *non-institutional (retail) customers*, broker-dealers and their registered persons must have a *reasonable basis* for recommending a transaction or investment strategy. These recommendations must be based on the information obtained from the customers which is then used to identify their investment profile. A customer's investment profile contains the following: age, other investments, financial situation and needs, tax status, investment objectives and experience, investment time horizon, liquidity needs, risk tolerance, any other info obtained from the customer. (Educational background is not important). The suitability requirements apply to *both* any recommended *transaction* (e.g., the purchase of a specific security) and any investment *strategy* (e.g., day trading or margin trading). An investment recommendation should be in the customer's best interest. *Simply receiving the customer's acceptance of a recommendation doesn't relieve the firm of its suitability obligation*. This prohibits RRs from placing their own interests ahead of their customers' interests. Basically any kind of investment that is trying to earn higher commissions for the RR is a violation. Recommending one product over another for commission, recommending use of margin for higher commissions, breakpoint sales, or recommending a new issue thT being promoted by a firm to keep your job- those are all violations

Reg BI obligations

Brokerage firms must fulfill the following four specific obligations in order to satisfy their overall duty under Regulation BI: 1. Disclosure - Provide certain required disclosures regarding any recommendation made to a retail customer and the relationship between the firm and the customer before or at the time of the recommendation. 2. Care - Exercise reasonable diligence, care, and skill in making recommendations. 3. Conflicts of interest - Establish, maintain, and enforce written policies and procedures that are reasonably designed to address conflicts of interest. 4. Compliance - Establish, maintain, and enforce written policies and procedures that are reasonably designed to achieve compliance with Reg BI.

Verification of investor accreditation of sophistication

Certain investments require investors to have a *minimum net worth or level of earnings*, as well as an *understanding* of the level of risk and reward. Investors who satisfy these standards are deemed *accredited and sophisticated*. Broker-dealers must *verify* that customers meet these standards before recommending and allowing them to invest. Many of these investments generally fall under the guidelines of the *SEC's Regulation D.* Using a principal-based approach, the SEC provides *issuers* and any broker-dealers that act on behalf of the issuers with a number of factors to consider when determining the status of the investor. Some of these factors include the *nature of the purchaser* and the type of accredited investor it claims to be, the *amount and type of information that the issuer has about the purchaser*, and the *nature of the offering* (e.g., the minimum investment amount). The SEC has created the following suggested methods to use when verifying an investor's accredited status: ---To review previously filed IRS *tax forms* and other tax forms (e.g., Form W-2 and Schedule K-1) in order to determine the investor's *income* ---To review bank and brokerage account statements and other statements of assets for the *prior three months* to determine the investor's *net worth* ---To obtain written confirmation of the investor's *accredited status* from broker-dealers, registered investment advisers, attorneys, and accountants (CPAs) The SEC doesn't stipulate that any one of these methods *must* be used; instead, the *requirement is to take reasonable steps to ensure that the persons to whom the solicitations are being directed are accredited investors.*

Form CRS

Client Relationship Summary form, part of the 2019 Reg BI (regulation best interest) initiative thing It is a disclosure form that BDs must provide for retail customers. No longer than 2 pages. Provides retail investors with info about the nature of their relationship with their financial professional in an easy-to-understand format New customers *must* receive a copy of form CRS by *no later than the time they open a brokerage account, place and order, or receive a new recommendation* for an account type, securities transaction, or investment strategy All existing customers will receive for CRS early in the summer of 2020 *BDs must file form CRS with the Central Registration Depository (CRD)*, while registered *investment advisers* must file form CRS with the *Investment Adviser Registration Depository (IARD)* as part 3 of Form ADV

growth

Customers whose main objective is growth want their *capital to appreciate.* These customers usually expect that the capital will grow at a higher rate than other investments, ultimately *outpacing the rate of inflation*. Growth investments are often used to *increase assets in the long term* for some *future* use, such as retirement or college expenses. However, these investments involve a *greater risk to principal* than income-oriented investments. *Common stocks and equity mutual funds* are examples of growth investments.

Earned (Ordinary) Income

Earned income is compensation a person receives for providing goods or services and includes *salaries, commissions, and wages earned through employment (including self- employment)*. Earned income is taxed at what's often referred to as the customer's tax bracket. In technical terms, this tax bracket is considered the customer's *marginal tax rate.*

FINRA's suitability rule

FINRA's suitability rule has the following three obligations: *the reasonable basis obligation*: which requires a member firm and its RRs to have a reasonable basis to believe that a recommendation is suitable for *at least some investors*. If the firm or its RRs don't understand a product, it shouldn't be recommended to customers. *the customer-specific obligation*: which requires a member firm and its RRs to have a reasonable basis to believe that a recommendation is suitable for a *particular* customer based on the customer's investment profile. *the quantitative obligation*: which requires a member firm and its RRs to have a reasonable basis to believe that a series of recommended transactions, even if suitable for a customer, are *not excessive* when the customer's investment profile is taken into consideration.

capital gains and capital losses

If appreciated assets are *later sold*, there may be a resulting *taxable event*. *For profits on sales, the length of time the asset was held will determine the amount of tax that must be paid.* *Capital gains*: Capital gains are generated when an *investment is sold for a greater value than its cost basis*. If the investment had been held for *one year or less* at the time of the sale, the gain is considered *short-term* and is taxed at the same rate as *ordinary income*. However, if the investment had been held for *more than one year*, the gain is considered *long-term* and is taxed at a *maximum rate of 20%.* *capital losses*: Capital losses are generated when an investment is *sold for less value than its cost basis.* As with capital gains, if an investment had been held for one year or less at the time of the sale, the loss is considered *short-term*. If the asset had been held for more than one year, the loss is considered *long-term*. Capital losses are *not taxed*; instead, the IRS requires capital losses and capital gains to be *netted*. The netting of capital losses against capital gains may be done with *no maximum dollar limitation*. The result will be a net capital gain (taxable) or a net capital loss. (Greater detail on the treatment of gains and losses will be covered later.)

social values

In addition to financial return, many investors are concerned about the social and environmental impacts of the *companies* in their investment portfolios. Companies' policies and practices with respect to issues such as human rights, global warming, and ethical labor standards are among the many elements that customers prioritize. *Investors may request that the RR follow socially responsible investment strategies*. However, an *RR should explain that this may require the exclusion of some investments and strategies*. Based on these restrictions, an RR *may not be able to take advantage of the same market trends or opportunities* that would otherwise be available with other strategies

financial goals and investment objectives

In addition to understanding the current financial profile of his customers, an RR needs to determine their financial goals. While certain customers may have a wide range of unique goals, there are a *large number of common goals*. The financial services industry usually *classifies* customer goals into broad categories of investment objectives. These include capital reserve, preservation of capital, liquidity, current income, growth, college funding, retirement funding, speculation, tax relief, meeting fiduciary obligations

income/income statement

Includes salary, wages, alimony, investment income, qualified withdrawals from retirement plans Generally, the greater a person's income, the more investment risk he is able to tolerate, and the lower the income, the more conservative the investment strategy should be Source and reliability of income are also important (is it steady or does it fluctuate?) As part of the overall profiling process, an RR may need to assist a potential customer in creating an *income statement* to determine the customer's *cash flow.* Cash flow refers to the movement of cash into and out of an account or business. Once the customer's cash flow has been determined, an RR is then able to calculate the customer's *discretionary* or *net income* by adding up the total income and subtracting all taxes and required payments (bills). The income statement helps illustrate the sources of a person's income and the customer's lifestyle/how much he spends and on what Subtracting the monthly expenditures from growth income results in the customer's *discretionary income* Discretionary income is basically the amount of money he has left each month after essential expenses are met and this is the money that we can focus on for investing. *Generally, persons with a greater amount of discretionary income may adopt more aggressive investment strategies.*

estate and gift taxes

Individuals may *transfer assets* or give a *gift* of up to *$15,000 per year* to any number of persons (related or unrelated) without incurring gift taxes. A married couple may combine their individual gifts for a total of $30,000 per recipient. For gifts *over* $15,000 per person, per year, the donor is required to file a *gift tax return*. A couple wants to give grandkids $ but doesn;t want to file a gift tax return. They can give up to $30,000 per kid per year. So if they have ten grandkids, thats $300,000 year max Also, if the value of a person's *estate* exceeds a certain amount, an *estate tax return is required to be filed* and a tax may be assessed. The *marital deduction* allows a husband and wife to give each other an unlimited amount of property without incurring gift taxes. The spouse who dies first may also leave an unlimited amount to the survivor without incurring estate taxes.

investment analysis tools

Investment analysis tools now exist. It is a technological tool that provides simulations and statistical analyses of the likelihood of different investment outcomes when specific investments are made or strategies are implemented *Firm requirements:* in order to provide such a tool to investors, the firm must: --describe the criteria, methodology, and the tool's limitations --explain that results may vary over time and from use to use --describe the universe of investments the tool considers and how investments are selected, whether certain investments are favored over others, and that other investments may provide similar or superior results --display a disclosure that the projections are provided by the firm's investment analysis tool --provide FINRA with access to the tool (unless it is solely used by institutional investors in which case it is NOT required to be provided to FINRA-- but if provided to retail investors, FINRA needs access)

Preservation of capital (different from capital reserve!)

Investors who are concerned with the potential *loss of capital* will invest in securities that provide *safety*. Although achieving a return on their investment is desired, they're more concerned with *preservation of capital*. In other words, they don't want to put their *principal at great risk*. Customers with this objective often invest in U.S. government securities, insured certificates of deposit, or money-market funds.

age

Investors who are farther from typical retirement age are generally able to tolerate more risk in their portfolios than those who are closer to retirement Young people have more time to earn money and replace losses, while older people have usually already peaked their earnings so what they have is what they have-- fewer opportunities to replace losses Therefore, some long-term investments like equities are not suitable for aging investors who will likely not outlive the benefit One general approach that's used by many professionals is to *subtract a client's age from 100 to determine the percentage of assets that should be invested in stocks.* The assumption is that the older the client, the less the risk tolerance, and therefore the less money that should be invested in equities.

speculation

Investors who indicate speculation as an investment objective are seeking investments that have the potential for *above-average returns.* *RRs are responsible for disclosing to a customer that investments offering greater profit potential also carry a higher degree of risk.* With these investments, it's possible for a customer to lose his *entire principal*. Some of the speculative activities may involve *day trading in margin accounts* or investing in asset classes such as *derivatives, hedge funds, and small- or micro-cap stocks.* RRs should be *cautious* when recommending speculative investments to customers., The RR must make certain that the customers *(1)* have sufficient financial resources to bear the loss, *(2)* understand the risks involved, and *(3)* have portfolios that are diversified with less risky investments

current income

Investors whose primary investment goal is current income are interested in investments that produce a *steady, reliable stream of cash*. Investors typically need this income to defray daily living expenses, *particularly during retirement*. Some examples of income-producing investments include *most bonds, preferred stocks, and fixed annuities*. The *downside* to income investments is that they usually produce little, if any, growth of the original amount invested. This may be a problem over time, since *inflation* erodes the purchasing power of the income.

liquid net worth

It's important to remember that the net worth figure represents everything a person owns. However, a *more realistic assessment of a person's worth may be her liquid net worth.* Liquid net worth *excludes* assets that are *not readily convertible into cash* such as real estate, limited partnership interests, and stock in small companies. When analyzing a customer's financial profile, RRs must consider her *liquid net worth* (e.g., stocks, bonds, mutual funds, and savings accounts) to accurately evaluate her financial position.

college funding

Many customers begin an investment program to provide for their children's college education. Parents (and grandparents) have some flexibility in their investment choices. Funds may be invested in Uniform Gifts/Uniform Transfers to Minors Act (UGMA/UTMA) accounts to be used for education expenses; however, other options include Coverdell Education Savings Accounts and college savings programs, such as 529 Plans.

personal balance sheet

Of course, income and its potential taxation is only one part of an individual's financial picture. An RR should also document *what a customer owns (total assets)* and what she *owes (total liabilities)*. By listing the customer's total assets and *subtracting* her total liabilities, the RR can create a *personal balance* sheet and calculate the customer's net worth. Simply put, *Total Assets - Total Liabilities = Net Worth.* Balance sheets would include assets (i.e. tangible property, investments, savings), then liabilities, and use those to calculate net worth. Details on those next

Regulation of Customer Interactions

Once a customer's objectives have been established, it's imperative that the account be handled in a manner that *conforms to accepted industry practices* and the rules and *regulations of the various regulatory bodies*. The purpose and objectives of these rules are to accomplish the following goals: --Promotion and enforcement of just and equitable principles of trade and business --Maintenance of high standards of commercial honor and integrity by member firm personnel --Prevention of fraudulent and manipulative activity and procedures --Prevention of unreasonable profits, commissions, or other changes --Protection of investors and the public interest --Collaboration with government and other agencies to promote fair practices and eliminate fraud and, in general, to carry out the purpose of FINRA and other registered securities organizations

know your customer and suitability

Once an RR has collected all of the background information on his customers, he may begin to formulate his recommendations. *Under industry rules, all recommendations must be suitable* based on the facts disclosed by the customers regarding their other securities holdings, financial situation, and needs. Remember, the determinant of *fair* dealings with customers is *suitability, not profitability*. A recommendation that results in a significant profit may still be viewed by regulators as unsuitable. Conversely, a recommendation that results in a significant loss may, in fact, have been suitable. *A broker-dealer must use reasonable diligence to learn the important facts regarding every customer*. This obligation also extends to any person who is authorized to act on behalf of a customer, including an RR who has been given the authority to enter orders in a customer's account. Only after a registered representative understands the financial needs of his customers may the proper investment recommendations be made.

Non Financial Considerations

Personal characteristics of a customer is almost equally as important in determining suitability of investments as financial considerations are These factors include age, time horizon, investment experience (sophistication), risk tolerance, and social values

investment experience (sophistication)

Previous investment experience provides insight about a *customer's ability to understand an RR's investment recommendations and the accompanying risks*. An experienced investor is more likely to be able to understand the reason for certain recommendations being made. Also, an investor who has purchased specific products in the past is likely able to comprehend the risks and benefits of the recommendations of similar investments.

occupation

RRs handle different customers partially based on their occupations. Do they have steady reliable income or fluctuating income that requires cash reserves to survive dry periods? Sometimes a person's occupation may trigger additional regulatory obligations like if a client is employed by another FINRA member or a publicly traded company-- then special reporting rules apply

Reg BI retail customer vs FINRA's definition

Reg BI serves to supplement FINRA's existing suitability rules, so firms are required to comply with both rules However, one change implemented by Reg BI applies to the difference between a "retail customer" (as used by Reg BI) and FINRA's use of the term "institutional customer." FINRA's definition of an institutional customer *includes* a natural person who has total assets of at least $50 million; however, *Reg BI doesn't establish a dollar limit*. In other words, for a natural person who has assets exceeding $50 million, the provisions of Reg BI *will* apply, while for other institutional investors (e.g., banks, IAs, investment companies), FINRA's suitability rules apply.

Sales contests

Regulation BI effectively bans all sales contests, quotas, bonuses, and other non-cash compensation that are tied to sales of *specific securities* or specific *types* of securities within a limited period. However, compensation that's based on other metrics, such as *total sales, asset growth or accumulation, or customer satisfaction* is still permitted. Training and education meetings are also permitted as long as attendance is *not* based on selling certain products within a limited period. Current SRO rules on non-cash compensation were updated to reflect that the rules must be consistent with Reg BI.

Reg BI

Regulation Best Interest New SEC package of rulemakings to enhance transparency about retail customers' relationships with BDs and IAs. Only applies to retail customers (and their non-professional legal representative). Their definition of a retail customer has no net worth limit so like even a person with $50 million + assets is still regulated with BI rules even though FINRA would technically categorize this person as an institutional investor Broker-dealers are subject to Reg BI, whereas investment advisers are subject to the provisions of the Investment Advisors Act of 1940. Reg BI applies to any recommendations that are made to retail customers and extend beyond securities or portfolio recommendations, including whether an investor should roll over a 401(k) into an IRA or recommendations as to the type of account that a retail customer should open.

time horizon

Represents the amount of time that a customer has available to achieve his financial goals. Generally, the *longer an investor's time horizon, the more volatility (fluctuation) the portfolio can tolerate. Investors with short time horizons usually require more stable, conservative investments since they will need their money sooner.* For example, a 35-year-old investor who is planning for retirement will normally have a time horizon of 25 to 30 years, while a 55-year-old investor will usually have a much shorter period before retirement. Also, the parents of an infant may have nearly 18 years to save for college, while the parents of a teenager will have far less time.

risk

Risk is defined as the *chance taken that an investment's actual return may be different from its expected return*. Customers will react differently to the concept of risk. The fact that a customer is able to afford losses doesn't mean that an investment is suitable. Suitability has to do with their *risk tolerance* *Regulatory agencies and courts* have made it extremely clear that, given all of the circumstances, suitability is dependent on whether the investment was appropriate for the customer, not simply on whether the customer is able to afford the losses. *Risk tolerance:* The ability of customers to tolerate risk is not based solely on their financial resources; it also considers their *values and attitudes*. Two customers with the same financial resources could perceive risk differently. An RR needs to pay careful attention to what investors say about their tolerance for risk, since *an investment that goes against a customer's expressed wishes is never suitable.* Even if a young guy is super into all risky investments and likes the risk, an RR should try to meet that but also explain that the customer should try to have a few less risky positions in his overall portfolio. Unfortunately, some customers may have *uncertainty* about their attitude toward risk, especially if they're new to investing. In these situations, some RRs use *questionnaires* to help the customers understand their risk preferences. The customer's answers are then compiled to form a *psychological profile regarding risk tolerance.*

liquidity

Some investors have a significant need to be able to access their funds within a short period —in other words, they desire liquidity. While *money-market mutual funds and T-bills* provide a lower return than other investments, these products are relatively safe and allow investors to have ready access to their capital.

taxation

Tax implications must be taken into account when making recommendations to customers. Frequently, customers will ask registered representatives to recommend specific investments that will suit their tax status. Although taxation is an important consideration, it should not be the sole factor in the recommendations being made. *Types of taxes*: Taxes may be classified as either *progressive (graduated)* or *regressive (flat)*. *Progressive tax* is a system in which a person with a higher income will pay taxes at a higher percentage of her income than a person with a lower income. Progressive examples include *income tax, gift tax, or estate tax*. On the other hand, a *regressive tax* has the *same rate* regardless of the amount of income which means that it hits lower-income individuals harder. Regressive examples include *sales tax, excise tax, or Social Security tax.* The laws concerning U.S. taxation are complex and constantly changing. In addition to paying taxes to the U.S. government (federal taxes), individuals may also need to pay taxes to the state, county, and/or city in which they live. The remainder of this section will focus primarily on those areas of the tax code that affect securities and securities transactions.

alternative minimum tax

The *Alternative Minimum Tax (AMT)* was introduced as a method of calculating tax liability to ensure that *wealthy individuals* who derived income from *certain types of investments* pay *at least a specified minimum* amount of taxes. By applying the AMT, investors are not able to avoid paying taxes altogether. For purposes of calculating the AMT, some taxpayers are required to *adjust* their taxable income based on their investment in assets that produce certain *tax-preference* items. Tax-preference items may include interest on certain municipal bonds, various depreciation expenses, and a variety of events that result from owning limited partnership interests. Under AMT rules, these taxpayers must compute their income taxes twice. They must first calculate their taxes using the standard method, and then they must recalculate their tax liability using the AMT method. The taxes due will be the *greater* of the two calculations.

assets

The asset component of the net worth equation represents what a customer owns and includes: Primary residence and other real estate Automobiles Personal possessions like furniture, jewelry, and clothing Government and corporate bonds Stocks Mutual funds and annuities Pension plans and 401k plans Individual retirement accounts Money market funds nd CDs Savings accounts Cash in checking accounts To make this analysis easier you may categorize a customer's personal assets like "tangible assets" (eg real estate and personal possessions), "investments" (eg stocks, bonds, retirement plans), and "savings" (eg money-market funds, checking and savings accounts) By asking a customer to list her assets, an RR is able to determine her current holdings and investment strategies. Knowing the *composition of a customer's current portfolio is as important as knowing her net worth*. Without this information, it's difficult for the RR to recommend investments and adequately diversify the customer's portfolio. There are several ways in which an RR's recommendations may be affected by the customer's current portfolio. For instance, a significant portion of a customer's liquid net worth may be concentrated in the stock of his employer. This is a common situation for customers who have worked for the same corporation for a number of years and whose compensation has included stock options. In these circumstances, an *RR may recommend that the customer sell a portion of the shares in her company's stock and diversify her portfolio by purchasing other securities.*

Taxation -- Series 7 Application

The exam may include customer profile questions that contain *limited information*. For example, if the customer is a *doctor* who is seeking *bond interest* to supplement his earned income, a person must *be able to tie together the ideas* that the doctor is likely in a *high tax bracket* and that a *tax-free bond may be the most desirable*. Conversely, if the customer is a *conservative retiree* who is seeking *bond income*, the best choice may be a *U.S. Treasury security*. The reasoning for this choice is the *assumption that the retiree's tax bracket is lower* and *safety of principal* is likely a primary concern. Keep in mind, U.S. Treasury securities are considered to have very low credit risk.

liabilities

The liabilities component of the net worth formula represents what a customer owes to her creditors and includes: Mortgage and home equity loans Automobile loans Credit and balances Student loans Debit balances used to buy stock on margin

taxation of investment income

The manner in which income is taxed is often a function of the source of that income. *Most earned, passive, deferred, and investment (portfolio) income is taxed as ordinary income which is based on an individual's tax bracket.* However there is special tax treatment for qualifying cash dividends

passive income

This category of income is derived from a business venture in which an *investor does not have an active role*. Income received from a *limited partnership* (a type of direct participation program) is an example of *passive income*. Passive income is *taxed in the same manner as both earned and investment income*. The difference is that *passive losses* may only be used to *offset other passive income or gains*, but may *not* be used to offset *earned income or portfolio (investment) income*.

retirement funding

Today, since life expectancy has increased, a significant goal for many investors is to have money available for *retirement.* Investors who plan to retire in their *mid-60s* will need a retirement portfolio that will *last 20 years or more*. When a person is planning for retirement, he should *avoid* constructing a portfolio that's so focused on *income and preservation of capital that he risks having inflation seriously erode the purchasing power of his retirement income over time*. In other words, a client who is focusing on his retirement goals needs to be careful about avoiding one risk (loss of principal) only to be faced with another (inflation). The RR should also determine whether the investor is taking advantage of available retirement plans. Usually, the *best* strategy for investors is to maximize their contributions to a *tax-deferred* retirement plan, such as a 401(k), *before* they consider investing retirement assets elsewhere The goal of saving enough money to live comfortably during retirement is *complicated by two factors*— first, income ceases once people retire, and second, even modest *inflation* may have a significant impact on the long-term purchasing power of their retirement assets. Although this is a generalization, *most people will need an income that's equivalent to 70% of their current pre-tax income when they retire*. Keep in mind that individual circumstances may make this number higher or lower. the government has passed legislation creating a number of different retirement plans that allow investors to save money for retirement on a tax-deductible and/or tax- deferred basis. (addressed later)

Titles

Under Reg BI, unless a broker-dealer is also a registered investment adviser (i.e., the firm is dually registered as a broker-dealer and an adviser), the SEC has stated that it's a violation of the disclosure obligation to use either the term "adviser" or "advisor" in its title. From a practical standpoint, if an registered representative is neither Series 65 or Series 66 registered and currently uses either of these terms in her title, her firm must provide her with a different title that she can use on all of her marketing materials. *To use either term, the representative must take and pass either the Series 65 or 66 Exam.* So I will be an adviser as well as a broker

Institutional suitability

When dealing with institutional customers, the *suitability obligations may vary* based on the nature of the institution. Some of these customers are sophisticated and manage billions of dollars, while others may be relative novices in the investment process. For a broker-dealer to determine the extent of its suitability obligations to an institutional customer, it must consider the following two guidelines: 1.) The firm and the RRs servicing the account must have a reasonable basis to believe that the institutional customer is capable of evaluating investment risks independently, both in regard to the specific securities and the different investment strategies 2.) The institutional customer must affirmatively state that it is exercising independent judgement in evaluating the recommendations When conducting business with institutional customers, the *reasonable basis and quantitative obligations standards still apply*, but the customer-specific obligation standard does *not*.

investment income/portfolio income

income derived from owning various types of investments. Of particular importance is the understanding of the local, state, and federal tax consequences of each type of investment income. (Although a brief overview of each form of investment income will be provided, the details of each form will be covered in the subsequent chapters that are devoted to specific products.) *Dividend income* This form of investment income is paid to owners of *equity securities*. Since dividends may be paid in cash or in additional shares of stock, each form of payment is treated differently for tax purposes. ----A *cash dividend* is typically paid out quarterly or semiannually. These payments are *taxable in the year of receipt.* ----A *stock dividend* is paid in the form of additional shares. These payments are *not taxable* at the time of receipt. Rather than declaring the additional shares as income, the stockholder must *adjust the cost basis per share* of her position in the stock *Interest income* This form of investment income is derived from the *ownership of certain debt securities (bonds)*. The tax treatment of interest that's received by investors *differs according to the bond's issuer.* Although the tax treatment of each type of bond will be covered more thoroughly in later chapters, the following is a summary of three of the more popular types of bond investments: ---*corporations*: Federal, state, and local tax (fully taxable) ---*US Government securities*: Federal tax, *NO* state and local taxation ---*Municipalities*: *NO* federal tax, and maybe state and local tax depending on issuer and he customer's state of residency Deferred income earned income in an account which requires that taxes be paid at a later date. The earnings derived from *retirement plans and annuities*, such as IRA, Keogh, and 401(k) plans, or other retirement accounts, are not currently taxed. Instead, *taxes are deferred until withdrawals* are taken from the account. These withdrawals are *taxed as ordinary income* at the individual's current tax bracket. (at the marginal tax rate)

Developing a customer profile/know your customer

key considerations: -Financial factors -Personal characteristics -Financial objectives and goals -Know your customer the following get into that

financial considerations

occupation, income, taxation, capital gains/losses, etc.

tax relief

some investors have substantial incomes that are subject to tax at high marginal rates. These customers often search for investments that will provide them with tax relief. Some investments, such as *municipal bonds, produce income that's tax-exempt (i.e., the investor is not required to pay federal taxes on the interest*). Other investments, such as annuities, traditional IRAs, and employer- sponsored retirement plans, are *tax-deferred* (i.e., the investor is not required to pay taxes on the income that's produced until a later date). Another potential advantage offered by a small number of investments (e.g., limited partnerships) is that they may provide the customer with *tax credits or deductions*. (A *tax credit* provides a *dollar-for-dollar reduction of the investor's tax liability*, while a *deduction simply *reduces an investor's taxable income.*)