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Private Wealth Management

Subjects : personal-finance, business-skills

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1. What are the psychological issues of low basis stock held by an entrepreneur?
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
- cautious - methodical - individualistic - spontaneous
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
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

2. Define capital gains taxes.
Taxes paid on the gain (long or short position) when an asset is sold or purchased
The reduction in return caused by the payment of taxes
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
Excess capital

3. What is an equity collar? What is the purpose of the underlying positions
Implied liabilities
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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

4. What are typical characteristics of active wealth creators?
Both increase with longer holding periods and higher returns
- 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
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital

5. characteristics of cautious investor

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6. What are the main types of investors?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
1) source of wealth 2) measure of wealth 3) stage of life
A positive relationship
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)

7. What are the equity holding life risk attributes for an executive?
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
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)
Demand for life insurance increases
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

8. What are the diversification techniques for low basis stock?
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
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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

9. characteristics of maintenance phase
Sources of wealth - measure of wealth - stage of life
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
1) source of wealth 2) measure of wealth 3) stage of life
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

10. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
Methodical - cautious - individualist - spontaneous
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

11. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
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)
Early career 8accumulating education - developing skills - above-average ability to take risk
Deterministic = use point estimates to generate a forecasted value such as an expected return or terminal value Monte Carlo = use probability distributions of inputs to generate expected returns with accompanying probability distributions

12. As wealth increases...
Demand for life insurance increases
Demand for life insurance decreases
It is expenseive - time consuming - public
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n

13. As probability of death increases...
The demand for life insurance increases - regardless of age
Both increase with longer holding periods and higher returns
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) active 2) passive

14. Describe a cautious investor personality type.
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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
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
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

15. When dealing with low basis stock - emotional issues can arise from what?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
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

16. What are the diversification techniques for low basis stock?
- 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
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
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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

17. What is loss aversion?
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
Should use accrual-equivalent returns and after-tax risk
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)
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification

18. What are typical characteristics of passive recipients of wealth?
It is expenseive - time consuming - public
Total wealth = financial assets + human capital
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)

19. What are ways that individuals can avoid probate?
The client's psychological profile
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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
A will (also known as a testament)

20. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
A will (also known as a testament)
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax

21. stages of life
The testator
Implied liabilities
1. foundation 2. accumulation 3. maintenance 4. distribution
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

22. characteristics of foundation stage
Implied assets
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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Young -Building a foundation for future wealth -above avg risk tolerance

23. What is core capital?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Early career 8accumulating education - developing skills - above-average ability to take risk
The amount of assets (i.e.present value) necessary to meet all future liabilities

24. What are the different retirment risks and how can they be hedged?
Excess capital
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
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)

25. Equation for total wealth.
Deterministic = use point estimates to generate a forecasted value such as an expected return or terminal value Monte Carlo = use probability distributions of inputs to generate expected returns with accompanying probability distributions
A will (also known as a testament)
Deterministic = use point estimates to generate a forecasted value such as an expected return or terminal value Monte Carlo = use probability distributions of inputs to generate expected returns with accompanying probability distributions
Total wealth = financial assets + human capital

26. What are the disadvantages of an outright sale of low basis stock?
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
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
The risk of a premature death with accompanying loss of future human capital
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale

27. four types of investors
Extra investment value created by effective tax management
Methodical - cautious - individualist - spontaneous
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
1) active 2) passive

28. What are the benefits of an IPS to the adviser?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Methodical - cautious - individualist - spontaneous
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

29. What are the disadvantages of hedging for low basis stock?
Sources of wealth - measure of wealth - stage of life
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
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)
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)

30. characteristics of cautious investor

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31. Describe asset segregation in a behavioral finance context.
Extra investment value created by effective tax management
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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

32. 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
The decedent's estate
When a decedent leaves no will or if the will is deemed invalid

33. 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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Both increase with longer holding periods and higher returns
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

34. What are the disadvantages of private exchange funds for low basis stock?
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
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
1) common progressive (progressive) 2) heavy dividend tax (progressive) 3) heavy capital gain tax (progressive) 4) heavy interest tax (progressive) 5) light capital gain tax (progressive) 6) flat and light (flat) 7) flat and heavy (flat)

35. All costs associated with probate are born by whom?

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36. What are the different types of trusts?
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Risk tolerance and decision-making style
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)

37. characteristics of accumulation phase
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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
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

38. What are the main characteristics of the accumulation phase of life?
- cautious - methodical - individualistic - spontaneous
1) credit method 2) exemption method 3) deduction method
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk

39. What are the 3 categories of investors when discussing concentrated positions?
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
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)
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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. characteristics of methodical investor
It is expenseive - time consuming - public
Demand for life insurance increases
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

41. What is an equity collar? What is the purpose of the underlying positions
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
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)
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
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

42. Describe the different types of double taxation conflicts.
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Both increase with longer holding periods and higher returns
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
When a decedent leaves no will or if the will is deemed invalid

43. 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) source of wealth 2) measure of wealth 3) stage of life
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Hedged with life insurance - think of the life insurance as a replacement for lost human capital

44. What are the disadvantages of completion portfolios for low basis stock?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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
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

45. 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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
The amount of assets (i.e.present value) necessary to meet all future liabilities

46. An investor's ability to take risk depends on what?

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47. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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)
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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

48. Why do individuals often take steps to avoid probate?
- cautious - methodical - individualistic - spontaneous
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
It is expenseive - time consuming - public
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)

49. Why would someone want to use a valuation discount?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Income rising - assets growing - long time horizon - above-avg. ability to take risk
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
The reduction in return caused by the payment of taxes

50. What is intestate?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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
When a decedent leaves no will or if the will is deemed invalid
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

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