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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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1. Describe the equity holding life three stages from the perspective of the stock.
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
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Starts as a private stock held by an entrepreneur - Sold publicly in IPO (now held by exec - still major part of wealth - less specific risk b/c more mature) - Contributes less and less specific risk as other securities are added to portfolio - ends

2. What are the disadvantages of completion portfolios for low basis stock?
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
The reduction in return caused by the payment of taxes
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely

3. What are the main characteristics of variable annuities?

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4. What are the advantages of public exchange funds for low basis stock?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
Wealth transfer stage - focus on tax min. with trusts and foundations

5. What are the different stages of life?
Excess capital
The more equity-like - the less the demand for life insurance
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)
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

6. What are the disadvantages of hedging for low basis stock?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Typically very loyal to the firm - views the concentrated position as a positive - does not desire diversification - b/c feels in control of the future - as entrepreneurs delegate more and more control to others - they strive for more and more divers
Risk tolerance and decision-making style
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase

7. characteristics of maintenance phase
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
Total wealth = financial assets + human capital
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
Demand for life insurance decreases

8. As wealth increases...
1) active 2) passive
Demand for life insurance decreases
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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will

9. What is typically considered when imposing an exit tax?
- 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
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
The testator

10. What is tax alpha?
Starts as a private stock held by an entrepreneur - Sold publicly in IPO (now held by exec - still major part of wealth - less specific risk b/c more mature) - Contributes less and less specific risk as other securities are added to portfolio - ends
If human capital is equity-like - allocate financial assets more to fixed income - if the human capital is fixed-income like - allocate financial assets more to equities
Extra investment value created by effective tax management
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase

11. Who is responsible for gains/losses in a taxable (accrual taxation) account?
When a decedent leaves no will or if the will is deemed invalid
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
The government shares in both gains and losses

12. When should you use a tax-exempt versus a tax-deferred account?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging

13. Describe an individualistic investor personality type.
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
The decedent's estate
- the higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm

14. When should you use a tax-exempt versus a tax-deferred account?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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
Early career 8accumulating education - developing skills - above-average ability to take risk
More subjective than situational profiling -helps to understand how an investor perceives risk and return. -Bridges the differences between traditional finance and behavioral finance -Methodical - cautious - individualist - spontaneous

15. characteristics of methodical investor
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
Early career 8accumulating education - developing skills - above-average ability to take risk
1) revocable trust = the settlor can rescind the trust and resume ownership of the assets 2) irrevocable trust = the settlor relinquishes ownership and control 3) fixed trust = pattern of distributions to the beneficiaris is predetermined by the sett
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

16. What are the main types of investors?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Both increase with longer holding periods and higher returns
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
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)

17. What are the main types of investors?
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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)
The decedent's estate

18. What are the disadvantages of an outright sale of low basis stock?
A will (also known as a testament)
1) active 2) passive
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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

19. What are the different types of trusts?
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
- the higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
1) revocable trust = the settlor can rescind the trust and resume ownership of the assets 2) irrevocable trust = the settlor relinquishes ownership and control 3) fixed trust = pattern of distributions to the beneficiaris is predetermined by the sett

20. What should an investor use in mean-variance optimization
Long stock position + long put + short call - long put protects downside (like purchasing insurance) - short call generates income to at least partially offset the cost of the put
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)
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
Should use accrual-equivalent returns and after-tax risk

21. characteristics of spontaneous investor

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22. sources of wealth
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Entrepreneurial activity (likely to have highly concentrated portfolio) -inheritance - one-time windfalls (may be more willing to diversify) -built up over long periods of safe employment (e.g. middle mgr - easier to divest than huge entrepreneurial
1) Source jurisdiction = country levies taxes on all income generated within its borders - whether by citizens or foreigners 2) Residence jurisdiction = a country taxes income of its residents whether generated inside or outside the country (most pre
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

23. What is the general relationship between tax drag% and tax rate when capital gains taxes are deferred and B=1; and as investment horizon increases and return increases?
The government shares in both gains and losses
When a decedent leaves no will or if the will is deemed invalid
Sources of wealth - measure of wealth - stage of life
Tax drag % = tax rate - as the investment horizon increases - tax drag is unchanged - as the investment return increases - tax drag is unchanged - as the investment horizon increases - value of the tax deferral increases - as the inestment return inc

24. typical IPS elements
- 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 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 client's psychological profile
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

25. What are the advantages of hedging for low basis stock?
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Risk tolerance and decision-making style
Sources of wealth - measure of wealth - stage of life

26. benefits of IPS to client
A will (also known as a testament)
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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

27. What are the diversification techniques for low basis stock?
The more equity-like - the less the demand for life insurance
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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
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

28. Why do individuals often take steps to avoid probate?
1) source of wealth 2) measure of wealth 3) stage of life
A will (also known as a testament)
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
It is expenseive - time consuming - public

29. Describe biased expectations in a behavioral finance context.
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
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 higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm
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

30. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
- 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
- cautious - methodical - individualistic - spontaneous
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)
1) source of wealth 2) measure of wealth 3) stage of life

31. typical IPS elements
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
Sources of wealth - measure of wealth - stage of life
Both increase with longer holding periods and higher returns
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

32. What are the equity holding life risk attributes for an entrepreneur?
More subjective than situational profiling -helps to understand how an investor perceives risk and return. -Bridges the differences between traditional finance and behavioral finance -Methodical - cautious - individualist - spontaneous
Long stock position + long put + short call - long put protects downside (like purchasing insurance) - short call generates income to at least partially offset the cost of the put
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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

33. Any amount above core capital is considered what?
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
An investor focuses on gains and losses - prefer certain (riskless) gains and uncertain losses - are willing to face incerased risk to avoid losses - causes investors to exhibit risk-seeking behavior
Excess capital
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

34. 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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
1) source of wealth 2) measure of wealth 3) stage of life
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

35. What are the different stages of life?
If human capital is equity-like - allocate financial assets more to fixed income - if the human capital is fixed-income like - allocate financial assets more to equities
The amount of assets (i.e.present value) necessary to meet all future liabilities
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Extra investment value created by effective tax management

36. What are the psychological issues of low basis stock held by an executive?
- the higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
HC = PV of future labor income
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

37. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
Long stock position + long put + short call - long put protects downside (like purchasing insurance) - short call generates income to at least partially offset the cost of the put
Both increase with longer holding periods and higher returns
Total wealth = financial assets + human capital
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

38. What is the eifference in willingness to take risk between active and passive wealth creators?
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
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) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Active wealth creators typically have an above-avg. willingness to take risk - passive recipients of wealth typically have an average or below-average willingness to take risk

39. What is intestate?
Total wealth = financial assets + human capital
When a decedent leaves no will or if the will is deemed invalid
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Retirement -Wealth has been accumulated -Liabilities paid off -Investor looking to live off of portfolio and/or considering distributions to others -need + ability to bear risk really starts to decline

40. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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) 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
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase

41. What are the benefits of an IPS to the adviser?
Excess capital
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
Extra investment value created by effective tax management

42. What are the different methods of relief from double taxation?
The demand for life insurance increases - regardless of age
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
1) credit method 2) exemption method 3) deduction method
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

43. characteristics of distribution phase
Retirement -Wealth has been accumulated -Liabilities paid off -Investor looking to live off of portfolio and/or considering distributions to others -need + ability to bear risk really starts to decline
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Active wealth creators typically have an above-avg. willingness to take risk - passive recipients of wealth typically have an average or below-average willingness to take risk

44. What are the 3 categories of investors when discussing concentrated positions?
Implied 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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Early career 8accumulating education - developing skills - above-average ability to take risk

45. template for return objective
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Income rising - assets growing - long time horizon - above-avg. ability to take risk

46. When calculating a required return - you typically must identify what?
When a decedent leaves no will or if the will is deemed invalid
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Hedged with life insurance - think of the life insurance as a replacement for lost human capital

47. Why would someone want to use a valuation discount?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

48. What is measure of wealth?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
- 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
- a subjective assessment of financial well-being based on perceived wealth
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

49. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
Entrepreneurial activity (likely to have highly concentrated portfolio) -inheritance - one-time windfalls (may be more willing to diversify) -built up over long periods of safe employment (e.g. middle mgr - easier to divest than huge entrepreneurial
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up

50. What are the advantages of hedging for low basis stock?
Retirement -Wealth has been accumulated -Liabilities paid off -Investor looking to live off of portfolio and/or considering distributions to others -need + ability to bear risk really starts to decline
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool