IFYF Unit 1 Review Question Answers

  • Introduction
  • Unit 1: Basic Building Blocks of Successful Financial Management
  • Unit 2: Investing Basics
  • Unit 3: Finding Money to Invest
  • Unit 4: Ownership Investments
  • Unit 5: Fixed-Income Investing
  • Unit 6: Mutual Fund Investing
  • Unit 7: Tax-Deferred Investments
  • Unit 8: Investing Small Dollar Amounts
  • Unit 9: Getting Help: Investing Resources
  • Unit 10: Selecting Financial Professionals
  • Unit 11: Investment Fraud



Unit 1

Basic Building Blocks of Successful Financial Management Review Questions & Answers

1.What are the three primary components of the financial planning process? Why is it graphically shown as a pyramid?

The building blocks of financial management concentrate on wealth — the protection, accumulation, and distribution of wealth. Visualizing the three blocks as a pyramid serves to remind us that the pinnacle, or peak, can only be built on a firm foundation of interlocking components.

Notice that the foundation, or wealth protection, precedes wealth accumulation. Although this may seem counter-intuitive, remember that the initial strategies of cash management, tax management, risk management, and the accumulation of an emergency fund are fundamental to a sound financial plan. In other words these plans must be in place before you can focus on wealth accumulation.

Fundamental to wealth accumulation is the identification of short- and long-term financial goals and the development and implementation of plans to achieve those goals. Wise use and management of credit is critical to successful wealth accumulation.

While it is everyone’s goal to postpone wealth distribution until far into the future, estate planning strategies, the focus of this step, may be needed early in the life cycle to protect your property, your heirs, and your wishes. Of course, reviews of all financial planning strategies should occur periodically, but are particularly important with changes in the tax laws or your personal or employment situation.

2. What four strategies are important to cash management?

  • Developing and following a budget that matches income to expenses including savings for goals.
  • Keeping financial records in a convenient and not too complicated system that is consistently used.
  • Maximizing the interest earned on checking and savings accounts by monitoring your financial statements and always moving excess funds to higher yielding accounts.
  • Preparing and monitoring financial statements (net worth and cash flow) to insure you are making financial progress.


3.Explain the two financial statements that are critical to effective cash management.

A net worth statement, or balance sheet, summarizes the assets and liabilities of a household. In other words, it compares today’s market value of all your assets with today’s outstanding balance on all your debts. Because these amounts change often, it is recommended that you complete the balance sheet on the same day every year as a standard for comparison.

A cash flow statement, also known as an income and expense statement, compares all sources of income and outflow over a period of time, typically one year. Summarizing income and expenses, regardless of the period of time, helps you monitor how you are managing your finances and provides useful information for future financial decisions.

4.What factors affect the amount needed for an emergency fund?

Experts recommend an emergency fund equal to 3 to 6 months of expenses; however, the exact amount varies with the situation of the individual or household. Keep in mind the objective is not to save less, but to have more funds in higher yielding accounts. Your age, health, job outlook, insurance coverage, access to credit, and other factors unique to your financial situation affect the exact amount needed. For example, access to low-cost credit and multiple sources of income could allow a household to have less specified for an emergency fund, with the plan that credit could be used for larger emergency expenses. Amounts beyond the 3 months of expenses, for example, could then be set aside for other savings goals or investments. You should consider having a larger emergency fund, or amount closer to the 6 months amount, if any of the following characterize your situation.

  • You do not consistently receive income because you are self-employed, a seasonal worker, or heavily dependent on commission-based earnings.
  • You, or a member of your household, are facing large medical or disability expenses.
  • You are responsible for large expenses for others, such as care for a relative or education costs.
  • You do not have insurance coverage to protect yourself from potential risks that could cause financial loss, OR you have coverage but have high deductibles that would need to be paid out-of-pocket in the event of an insurable loss.

5.Why might it be a good idea to subdivide your emergency fund among different short- and intermediate-term savings vehicles?

To minimize penalties for early withdrawal of funds (e.g., from a CD that has not matured) and to maximize interest earnings, you might consider subdividing your emergency fund among a combination of accounts provided by financial institutions (e.g., bank, credit union, etc.), mutual fund companies (e.g., money market mutual fund, short-term bond fund), or the U.S. Treasury. Be sure to consider convenience, safety (e.g, availability of FDIC insurance) and cost to open and operate the account when choosing your combination of products.

6.Why is planning for risk management crucial to the success of a financial plan?

Risks associated with yourself (life, health, disability, liability) and your property (homeowner’s or renter’s, auto, liability) represent potentially huge financial losses. Whereas excessive insurance is not recommended, adequate insurance coverage to protect from possible risk exposures is a cost-effective strategy. In other words, everyone pays a little, to subsidize the larger losses that periodically occur to some people. More importantly, you avoid going into debt or “robbing” funds saved for other goals by including the cost of insurance in your annual financial plan. To control costs, be sure to shop around.

7. Why might an income tax refund alert you to evaluate your tax withholding?

Some people like to receive a large annual tax refund. But in reality, they are providing the government an interest-free loan. Since banks don’t make interest-free loans, perhaps neither should you!! Review your tax withholding, and include the “extra” income in your annual budget or savings plan.

8.Changing IRS rules regarding IRAs, interest deductibility, and capital gains on a primary residence are just a few of the reasons you must continually review your financial plan. How did the change on the taxation of profits from the sale of a primary residence affect homeowners?

Taxpayers who sell their primary residence, after living there for 2 of the last 5 years, can exclude $250,000 of profit from capital gains taxes for an individual filer, or $500,000 for a couple filing jointly. Other qualifications include:

  • Only one spouse may be the owner, but both must meet the 2-year minimum to qualify for the higher exclusion.
  • The exclusion may be taken more than once, although generally only once in a 2-year period, and can be in addition to the old exclusion of $125,000.
  • A prorated exclusion is available if a sale occurs prior to the 2-year minimum due to poor health, job relocation, or unforeseen circumstances.

9. List the tangible and intangible benefits of identifying financial goals, the first step in wealth accumulation.

Identifying $MART financial goals to guide your personal, career, and financial success help you to:

  • Focus on the concrete and psychic rewards associated with goal accomplishment.
  • Stay motivated and in control, when many aspects of your financial future may seem out of your control.
  • Organize and direct your financial life.
  • Determine how much you need to save to accomplish your goals.
  • Maintain a constant framework, or foundation, for making decisions that may impact various life arenas.
  • Visualize your goals, an important step toward goal accomplishment, according to many experts.

10. Name two indicators that you may be headed for a debt problem.

“Red flags” of debt include:

  • Taking on more credit, as reflected in the number of bills coming in the mail. (Some people fear opening the mail!)
  • Building debt by paying only the minimum payment.

11.Investing is a recommended step within wealth accumulation, but debt repayment should occur first. Why? How might debt repayment affect your emergency cash reserve, a component of wealth accumulation?

Eliminating debt frees money for savings and investments, and may actually “earn” you a greater return. Does your savings account or other investment guarantee a return of 25% per year? Of course not, but paying off an 18% credit card debt “guarantees” you an after-tax return of 25% (18% / .72 = 25%) because you avoid future interest payments. Available, unused credit can supplement an emergency fund in the event of a major expense, thus freeing money to be moved into higher earning accounts. On the contrary, with high credit balances, you actually need a “larger” emergency reserve, which although recommended, in reality rarely occurs.

12.Why might a home be best considered as a day-to-day necessity and not an investment for the future?

For many, a home is a principal component of their wealth accumulation. In areas with rapid real estate appreciation, the return can be significant. In areas with low real estate appreciation, a home offers little more than a service – shelter – with no significant appreciation in value. These factors should be considered when purchasing your home, and making decisions about the amount needed to save for retirement or other long-term goals. The equity accumulated may be tapped for a loan, but should be done with extreme caution.

13.Investments are fundamental to wealth accumulation, but should occur after a strong financial foundation has been established. What foundation strategies are necessary?

Your investment plan should be built on a foundation of the following:

  • workable cash management system for monitoring and tracking income and expenses, including savings;
  • stable, sufficient emergency fund (in other words, it is not “robbed” to meet other expenses);
  • comprehensive risk management plan based on adequate insurance coverage and conscious decisions to self-insure;
  • tax management strategies to avoid overpayment of taxes; and
  • controlled credit usage to limit interest charges.

14.Funding the costs of children’s education and retirement are unique components of wealth accumulation. What common financial strategies should be considered to accomplish these goals?

Several common strategies apply to both of these typical wealth accumulation goals:

  • Determine the timing and cost of the goal(s).
  • Start investing early and save systematically.
  • Use time to your advantage — the amount needed to invest is more manageable.
  • Learn about sources of support (e.g., financial aid or scholarships for college or employer-provided benefits during retirement).
  • Use tax deferred investment strategies to your advantage.
  • Diversify your investments and periodically review your strategies, especially as you get closer to the date(s) the funds are needed.
  • If in doubt, seek help.
  • Do not sacrifice retirement savings when only one goal can be funded. There are more options for funding children’s education than there are for funding retirement.

15.Explain the three-legged stool analogy for retirement planning. Why might a fourth leg be needed for balance in the future?

Historically the retirement three-legged stool consisted of Social Security, employer retirement benefits (e.g., a pension) and personal savings. Aside from the fact people are living longer and expenses are greater, the stool is increasingly “shaky” today. Approximately a third of Americans admit that they are not saving for retirement, although there is growing concern over the future of Social Security. Both of these sources were planned as supplements to company benefits, which are not as stable as in the past. Benefits offered by employers have been reduced, and increasingly saving for retirement has become the responsibility of the employee. For too many Americans, a fourth leg of continued employment and steady income during retirement will be necessary. You can avoid this dilemma by starting early to save for retirement. Remember that time and tax savings are on your side.

16.According to many estimates, most adults in the U.S. die intestate. What does this mean and how can it be avoided?

Dying intestate means dying without a will; state law will then determine the distribution of any assets. Regardless of the amount of wealth accumulated, it is important to explore how state law would affect your property and your wishes for its use and distribution. Naming guardians for children is another important reason to write a will.