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Private Wealth Management

Subjects : personal-finance, business-skills

Instructions:

Answer 50 questions in 15 minutes.
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Match each statement with the correct term.
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This is a study tool. The 3 wrong answers for each question are randomly chosen from answers to other questions. So, you might find at times the answers obvious, but you will see it re-enforces your understanding as you take the test each time.

1. What is measure of wealth?
- a subjective assessment of financial well-being based on perceived wealth
The demand for life insurance increases - regardless of age
- Deemed disposition = amount is usually based on the gains on assets leaving - as if the individuals sold the assets and realized the gains - Shadow period = could include a tax on income earned for a period after leaving
1. foundation 2. accumulation 3. maintenance 4. distribution

2. What are the advantages of hedging for low basis stock?
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n

3. characteristics of accumulation phase
The decedent's estate
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Earnings start to accelerate -Expenses increase - but so do savings -Long time horizon over which to recover from short-term losses -above-average risk tolerance

4. What is another name for a variable prepaid forward and What is its main purpose?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Multiple-security holding with one superstar - the result is a concentrated equity position - high specific risk - diversifies from concentrated - active and core concentrations into passive index positions
HC = PV of future labor income
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

5. What are the diffferent types of estate ownership rights?

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6. What are the advantages of the monte carlo approach to portfolio construction?
Extra investment value created by effective tax management
Distribution of outcomes provides a better indication of the risk/return tradeoff - show the tradeoff b/t short-term risk and ability meet long-term goals - incorporates the impact of taxes and the compounding effect of reinvestment - can build in f
Can borrow and/or use derivatives to diversify - ability to borrow (monetize) increased - owners retain upside potential of the original investment - not required to hodl illiquid assets - partners can change fund composition
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

7. Describe a cautious investor personality type.
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Most risk averse/least risk tolerant - primary focus is financial security: preservation of wealth - hard to advise - can over-analyze - slow in making decisions and then changing investments - low portfolio turnover/volatility
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Risk tolerance and decision-making style

8. situational profiling - considerations
Sources of wealth - measure of wealth - stage of life
More risk toelrant than than methodical investors - do their own research; very confident in their ability to make investment decisions - confidence in their ability to achieve their long-term investment objectives - unlike methodical investors - th
Tax on the entire value of assets held - principal + earnings - not just earnings - has the same effect as an accrual tax - only taxes are paid at a (usually) reduced rate
The government shares in both gains and losses

9. What are the equity holding life risk attributes for an investor?
Multiple-security holding with one superstar - the result is a concentrated equity position - high specific risk - diversifies from concentrated - active and core concentrations into passive index positions
The government shares in both gains and losses
When a decedent leaves no will or if the will is deemed invalid
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

10. What are the 3 categories of investors when discussing concentrated positions?
- extrepreneurs - for example - are usually familiar with taking business risk - they are willing to take risk b/c they feel they control their business and personal circumstances
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
Investors have too much confidence in their ability to forecast - they tend to discount or even ignore info that does not support their choices - they interpret info based on their current frame of mind and the medium through which it is received
Implied assets

11. Equation for total wealth.
Single publicly traded mature company stock or vested options - greater appetite for specific risk due to higher degree of control - less residual risk - b/c the firm is more mature - less liquidity risk - but may have restrictions - desires tax effi
Demand for insurance decreases; less human capital to replace
Total wealth = financial assets + human capital
Using HIFO accounting - an investor assumes the lot with the highest tax basis was sold to either maximize the loss for harvesting or minimize the taxable gain

12. What are the two sources of wealth?
- if you sell a security to harvest its loss and then reinvest the proceeds in a very similar security - the selling price fo the old security becomes the tax basis for the new security - in that case - the loss harvest only delays the payment of t
Investors have too much confidence in their ability to forecast - they tend to discount or even ignore info that does not support their choices - they interpret info based on their current frame of mind and the medium through which it is received
1) active 2) passive
Can borrow and/or use derivatives to diversify - ability to borrow (monetize) increased - owners retain upside potential of the original investment - not required to hodl illiquid assets - partners can change fund composition

13. Describe biased expectations in a behavioral finance context.
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Investors have too much confidence in their ability to forecast - they tend to discount or even ignore info that does not support their choices - they interpret info based on their current frame of mind and the medium through which it is received
Wealth transfer stage - focus on tax min. with trusts and foundations

14. What are the disadvantages of an outright sale of low basis stock?
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Determine: the client's contraints - as well as risk/return objectives - the best strategy - given capital market expectations for achieving the client's objectives - the appropriate strategic (long term) asset allocation which meets those goals
Provides clarification in the event of questions regarding suitability -process for resolution of disputes with client -helps identify issues to be resolved to avoid problems
Diligently gather the best possible investment info - tend to be conservative and - since they base decision on facts - they rarely form emotional attachments to investments - continually seek better info to confirm past investment decisions

15. What is mortality risk?
The testator
The risk of a premature death with accompanying loss of future human capital
Multiple-security holding with one superstar - the result is a concentrated equity position - high specific risk - diversifies from concentrated - active and core concentrations into passive index positions
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n

16. Calculating the required return component is driven by what 2 elements?
Risk tolerance and decision-making style
Earnings start to accelerate -Expenses increase - but so do savings -Long time horizon over which to recover from short-term losses -above-average risk tolerance
Most risk tolerant - fear that failing to respond to changing market conditions will negatively impact their portfolio - constantly adjust their portfolios in response to changing market conditions - tend to doubt investment advice. - high turnover a
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach

17. What are the psychological issues of low basis stock held by an investor?
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
A positive relationship
Client description -purpose of IPS -identification of duties - responsibilities -formal statement of objectives and constraints -calendar schedule for portfolio performance and IPS review -performance measures and benchmarks -considerations for devel

18. An investor's willingness to take risk is determined by what?

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19. What are the different methods of relief from double taxation?
Distribution of outcomes provides a better indication of the risk/return tradeoff - show the tradeoff b/t short-term risk and ability meet long-term goals - incorporates the impact of taxes and the compounding effect of reinvestment - can build in f
1) credit method 2) exemption method 3) deduction method
Both increase with longer holding periods and higher returns
Decisions should be optimal -process is dynamic - thus factors in changing circumstances -focus on long-term objectives -new investment advisors should be able to use the IPS

20. What are the disadvantages of hedging for low basis stock?
1) Traders (all gains short term) 2) Active investors (less churn - some gains taxed at reduced rates) 3) Passive investor (buy and hold - most gains are deferred) 4) Exempt investors (no investment taxes)
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
A will (also known as a testament)
1) Traders (all gains short term) 2) Active investors (less churn - some gains taxed at reduced rates) 3) Passive investor (buy and hold - most gains are deferred) 4) Exempt investors (no investment taxes)

21. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
Tax on the entire value of assets held - principal + earnings - not just earnings - has the same effect as an accrual tax - only taxes are paid at a (usually) reduced rate
Fixed income streat set at inception - usually no inflation adjustment - so real value falls over time - usually illiquid (can't withdraw funds) - lock in at the prevailing rate - which might be historically low
1) exhibit loss aversion rather than risk aversion 2) exhibit biased expectations rather than rational expectations 3) tend to segregate investments rather than considering them in a portfolio perspective
- cautious - methodical - individualistic - spontaneous

22. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
Quick to make decisions in the heat of moment (don't want to miss opportunities) - High PTO - Focus on return w/out considering risk - Don't consider themselves experts - Don't trust professionals
1) Financial market risk (reduced with efficient diversification) 2) Longevity risk (hedged w/ annuities) 3) Savings risk (hedged by employing a savings program and consuming less)
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Tax on the entire value of assets held - principal + earnings - not just earnings - has the same effect as an accrual tax - only taxes are paid at a (usually) reduced rate

23. When calculating a required return - you typically must identify what?
Payments are based on the performance of a mixed-asset class portfolio selected by the investor (client) - investor receives a fixed number of 'units' each period - value of each unit increases (decreases) during periods of rising (falling) market re
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Should use accrual-equivalent returns and after-tax risk
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

24. What are the general legal and regulatory considerations for individuals?
If board of director member = inside - prudent investor rules usually applies - recommend legal counsel for setting up personal trust or family foundation - if a trust - balance the needs of income beneficiaries and remainderment
Forced heirship rules (children have the right to parents' estate) - community property rights (each spouse has right to 1/2 the estate) - separate property rights (each spouse's estate considered separately)
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Total wealth = financial assets + human capital

25. What are investment objectives and constraints?
Demand for insurance decreases; less human capital to replace
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
A positive relationship
Anticipate individual investors' concerns and risk tolerance by specifying the investor's source of wealth - measure or adequacy of wealth in relation to needs - and stage of life -observables - reasonably objective

26. What are the disadvantages of hedging for low basis stock?
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
1) credit method 2) exemption method 3) deduction method
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)

27. four types of investors
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Sources of wealth - measure of wealth - stage of life
Using HIFO accounting - an investor assumes the lot with the highest tax basis was sold to either maximize the loss for harvesting or minimize the taxable gain
Methodical - cautious - individualist - spontaneous

28. What is the reinvestment caveat when considering tax loss harvesting?
Determine: the client's contraints - as well as risk/return objectives - the best strategy - given capital market expectations for achieving the client's objectives - the appropriate strategic (long term) asset allocation which meets those goals
Young -Building a foundation for future wealth -above avg risk tolerance
- if you sell a security to harvest its loss and then reinvest the proceeds in a very similar security - the selling price fo the old security becomes the tax basis for the new security - in that case - the loss harvest only delays the payment of t
Forced heirship rules (children have the right to parents' estate) - community property rights (each spouse has right to 1/2 the estate) - separate property rights (each spouse's estate considered separately)

29. What is the general relationship b/t a client's perception of wealth and risk willingness?
Iinvestors analyze ind. investments on a stand-alone basis - do not consider how the asset will affect portfolio risk and return - manifests itself as mental accounting/pyramiding - lack of diversification
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
A positive relationship
Excess capital

30. What are the 3 categories of investors when discussing concentrated positions?
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
Investors begin to shift portfolios into less volatile assets -Reduced focus on accumulating additional wealth and more focus on preserving current wealth -Reduced ability to recover from market downturns -diminishing risk tolerance
Single publicly traded mature company stock or vested options - greater appetite for specific risk due to higher degree of control - less residual risk - b/c the firm is more mature - less liquidity risk - but may have restrictions - desires tax effi
Income rising - assets growing - long time horizon - above-avg. ability to take risk

31. What are the equity holding life risk attributes for an entrepreneur?
Anticipate individual investors' concerns and risk tolerance by specifying the investor's source of wealth - measure or adequacy of wealth in relation to needs - and stage of life -observables - reasonably objective
1) credit method 2) exemption method 3) deduction method
Single privately-held stock - high degree of control - immature firm - very high unsystematic risk - face significant residual risk - limited or restricted liquidity - zero cost basis in the original investment - desires tax efficient transfer to hei
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

32. How does the nature of human capital affect the demand for life insurance?
The more equity-like - the less the demand for life insurance
Forced heirship rules (children have the right to parents' estate) - community property rights (each spouse has right to 1/2 the estate) - separate property rights (each spouse's estate considered separately)
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
1) Residence-residence = 2 individuals claim residence for the same individual 2) Source-Source = 2 countries claim authority over the same income (i.e. multinational company) 3) Residence-Source = individual is subject to residence jurisdiction and

33. What are the advantages of public exchange funds for low basis stock?
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education

34. What is tax alpha?
Investors begin to shift portfolios into less volatile assets -Reduced focus on accumulating additional wealth and more focus on preserving current wealth -Reduced ability to recover from market downturns -diminishing risk tolerance
The more equity-like - the less the demand for life insurance
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Extra investment value created by effective tax management

35. What is tax alpha?
Single privately-held stock - high degree of control - immature firm - very high unsystematic risk - face significant residual risk - limited or restricted liquidity - zero cost basis in the original investment - desires tax efficient transfer to hei
More risk toelrant than than methodical investors - do their own research; very confident in their ability to make investment decisions - confidence in their ability to achieve their long-term investment objectives - unlike methodical investors - th
Extra investment value created by effective tax management
- a subjective assessment of financial well-being based on perceived wealth

36. Any amount above core capital is considered what?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
The client's psychological profile
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Excess capital

37. What are the diversification techniques for low basis stock?
Required = critical financial objectives (e.g. living expenses - kids' college expenses) Desired = objectives the client would like to meet (e.g. - large bequests to family or charity - early retirement)
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Client description -purpose of IPS -identification of duties - responsibilities -formal statement of objectives and constraints -calendar schedule for portfolio performance and IPS review -performance measures and benchmarks -considerations for devel
The government shares in both gains and losses

38. benefits of IPS to manager
Provides clarification in the event of questions regarding suitability -process for resolution of disputes with client -helps identify issues to be resolved to avoid problems
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Sources of wealth - measure of wealth - stage of life

39. What is core capital?
Methodical - cautious - individualist - spontaneous
1) active 2) passive
The amount of assets (i.e.present value) necessary to meet all future liabilities
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock

40. What are the disadvantages of completion portfolios for low basis stock?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Extra investment value created by effective tax management
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will

41. What are the main characteristics of the foundation phase of life?
Acts as an operational guideline that represents the long-term - best interests of the investor - the process is dynamic and can incorporate changed circumstances (review at least annually) - the IPS allows continuity over time and portability to new
Early career 8accumulating education - developing skills - above-average ability to take risk
Distribution of outcomes provides a better indication of the risk/return tradeoff - show the tradeoff b/t short-term risk and ability meet long-term goals - incorporates the impact of taxes and the compounding effect of reinvestment - can build in f
Total wealth = financial assets + human capital

42. Why do individuals often take steps to avoid probate?
Using HIFO accounting - an investor assumes the lot with the highest tax basis was sold to either maximize the loss for harvesting or minimize the taxable gain
- if you sell a security to harvest its loss and then reinvest the proceeds in a very similar security - the selling price fo the old security becomes the tax basis for the new security - in that case - the loss harvest only delays the payment of t
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
It is expenseive - time consuming - public

43. What are the advantages of an outright sale of low basis stock?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
The amount of assets (i.e.present value) necessary to meet all future liabilities
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Quick to make decisions in the heat of moment (don't want to miss opportunities) - High PTO - Focus on return w/out considering risk - Don't consider themselves experts - Don't trust professionals

44. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
The demand for life insurance increases - regardless of age
Both increase with longer holding periods and higher returns
High need for financial security - High need to avoid losses - Don't like to make own investment decisions - Don't trust others to make investment decisions - either - Tend to select least volatile assets - Low asset turnover - Frequently miss invest

45. What is the most common estate planning tool?
The client's psychological profile
A will (also known as a testament)
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
Investors begin to shift portfolios into less volatile assets -Reduced focus on accumulating additional wealth and more focus on preserving current wealth -Reduced ability to recover from market downturns -diminishing risk tolerance

46. characteristics of foundation stage
- Deemed disposition = amount is usually based on the gains on assets leaving - as if the individuals sold the assets and realized the gains - Shadow period = could include a tax on income earned for a period after leaving
Young -Building a foundation for future wealth -above avg risk tolerance
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
The decedent's estate

47. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Total wealth = financial assets + human capital

48. When should you use a tax-exempt versus a tax-deferred account?
HC = PV of future labor income
Anticipate individual investors' concerns and risk tolerance by specifying the investor's source of wealth - measure or adequacy of wealth in relation to needs - and stage of life -observables - reasonably objective
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

49. When dealing with low basis stock - emotional issues can arise from what?
Provides clarification in the event of questions regarding suitability -process for resolution of disputes with client -helps identify issues to be resolved to avoid problems
- Deemed disposition = amount is usually based on the gains on assets leaving - as if the individuals sold the assets and realized the gains - Shadow period = could include a tax on income earned for a period after leaving
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Most risk averse/least risk tolerant - primary focus is financial security: preservation of wealth - hard to advise - can over-analyze - slow in making decisions and then changing investments - low portfolio turnover/volatility

50. As desire to leave an estate increases...
Payments are based on the performance of a mixed-asset class portfolio selected by the investor (client) - investor receives a fixed number of 'units' each period - value of each unit increases (decreases) during periods of rising (falling) market re
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Demand for life insurance increases
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging