Tuesday, November 27, 2012

Who Has the Best Series 7 Sample Questions?

There are SO many urban legends connected to the Series 7 it makes my head hurt sometimes. One of the most popular is that some vendors have "actual test questions" in their possession. This is absurd on its face because even if Company XYZ had those questions, all other vendors would simply order the materials and eliminate any advantage--also the national pass rate would rise to about, oh, 100%, right?. One would also have to be unaware of a current FINRA lawsuit trying to punish and stop a vendor in this industry from taking exams for the purpose of memorizing test questions. Finally, one would have to assume that the Series 7 wants you to memorize endless factoids and simply spit back the most current/updated version of those facts.
Another shaky assumption is that since the exam is hard, the best questions are the "really hard ones," right?
IDK--what does a "hard question" look like? Is it really hard to read? Does it have 5 or 6 negative words in it? If so--that company has no idea what your test looks like. Are the questions 500 words long? Same deal. The actual Series 7 exam will expect  you to know your vocabulary terms very well, but it will go much further than that--you will be forced to figure out the right answer more often than not. The questions will usually seem unfamiliar on first read; your job is to take the facts and eliminate the wrong answer choices. Some of your questions will be lay-ups, but most will force you to think creatively and on-your-feet. If you can do that and get 3 of every 4 questions right, you will be done with this ordeal. If not, you'll have to try again in 30 days or so.
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Series 7 Sample Suitability Question

As you've heard, the Series 7 has many questions concerning suitable recommendations to investors . . . like this one:

One of your customers is in her early 50's. She is concerned about losing purchasing power once she retires from teaching in 10 years, with a modest defined benefit pension. The money she has to invest is an inheritance from a favorite aunt. She has no need to liquidate the investment until she retires, and she may wait several years after that. You would most likely recommend which of the following investment vehicles?
A. deferred indexed annuity
B. deferred variable annuity
C. long-term bond mutual fund
D. immediate fixed annuity

EXPLANATION: first, PLEASE stop doing the Sesame-Street-inspired one-of-these-things-is-not-like-the-other thing. I made Choice C different from the other three, but it's still wrong. Why? Bonds don't protect purchasing power. Fixed annuities also do not protect purchasing power, so we can eliminate Choice D. At this point, the answer seems obvious, doesn't it? She needs the upside of the stock market that the variable annuity offers.  The indexed annuity is all about the guaranteed minimum rate of return--the annuitant does not get the upside on the S&P 500. Not really. So, eliminate Choice A, and we're done here.


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Wednesday, November 14, 2012

A Few Words on Taxation

Now that the elections are over, let's clear up some confusion over taxation. First, how do wealthy people like Mitt Romney get by with paying just 13.7% income tax? In our current cynical climate, many assume he must be getting some sort of seedy political favors from his friends in Washington, DC, but the truth is much less interesting. Fact is, people that wealthy can live on dividends and long-term capital gains (trading profits). For close to a decade now those income sources are taxed at just 15%, regardless of one's income bracket. I just had a spirited phone discussion with a buddy last night, and it took a few tries to convince him that a lower tax on dividends makes perfect sense. Like most people, he thought companies pay dividends as kind of a pass-through to their owners. No, no, no--dividends come from "net income AFTER tax." Starbucks paid $674 million of income tax as a corporation last year. AFTER that, they were left with net income of $1.385 billion. So, the profits of the company have been taxed at this point. If the board of directors wants to pass out 72 cents-per-share of that after-tax profit to the shareholders/owners, why should the owners get taxed at all? I don't think they should, but the Republicans were only able to convince the Democrats to lower the tax rate to 15% back when George W was in office. Of course, to get that benefit, you have to own the dividend-paying stock in a taxable account. If it's in your IRA or 401(k), nothing here applies to you. But, what the heck would a Mitt Romney need with an IRA? Defer $6,000 a year? Why? And, he'd have to have earned income to make an IRA contribution--his income is mostly from dividends and capital gains. Then, with huge charitable contributions, he can bring the rate down from 15%, as he did. He paid a huge amount of taxes, but the percentage was 13.7%.
The rest of us live mostly on earned income; therefore, our income is taxed at various tax rates. At the same time the dividend and long-term capital gains rates dropped to 15%, Congress put the following tax brackets into place: 10%, 15%, 25%, 28%, 33%, 35%. Most recently, everybody's first $8,500 of income was taxed at just 10%. Then, the next so-much was taxed at 15%, and so on. If you made, say, $400,000 after all deductions, you would pay tax at all six of those tax rates--the last $21,000 or so would be taxed at 35%. Unfortunately, unless Congress passes new legislation, those tax brackets are going to revert to where they were about a decade ago. The 10% bracket goes away--ouch--and the 35% bracket becomes 39.6%, with about a 3-point jump in all the other brackets.
Wow. Yes, the tax code is always in play, but right now it is about as uncertain as it's ever been. People who will retire in 10 years now have to factor in that they may retire in a higher tax bracket--that diminishes the benefit of deferring their income in a retirement account. They might want to use a taxable account, but if the lower tax rates on dividends and capital gains are taken away or reduced, that might not be so attractive either. Would we be shocked if Congress reduced or eliminated the tax break on municipal bond interest? Yes, but it could still happen. And that would do some nasty things: it would cause the price of municipal bonds to plummet, which would push their yield up astronomically, thereby increasing the borrowing costs of states, cities, school districts, etc. through the roof. Would politicians at the federal level pass off so much of a burden to the states? If it helps them get re-elected, I think they would do just about anything, don't you?
Notice how even a brief discussion of a few aspects of taxation can get very detailed. It's no wonder that political activists prefer to steer the debate towards meaningless phrases like "a tax on job creators" or "paying your fair share." They'd probably lose their audience real quick if they got down to substance. You, unfortunately, do have to know the basics of this blog post when you sit down to take your Series 7 Exam. Exam Help