Private Wealth Management

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• 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. characteristics of spontaneous investor

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2. What are the main characteristics of the maintenance phase of life?
Young -Building a foundation for future wealth -above avg risk tolerance
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
- a subjective assessment of financial well-being based on perceived wealth


3. template for return objective
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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


4. What are the advantages of private exchange funds for low basis stock?
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)
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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
Implied liabilities


5. What are the different methods of relief from double taxation?
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
Extra investment value created by effective tax management
1) credit method 2) exemption method 3) deduction method
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education


6. 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
Risk tolerance and decision-making style
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
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


7. What are the diversification techniques for low basis stock?
A positive relationship
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
1) source of wealth 2) measure of wealth 3) stage of life
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


8. 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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized


9. Human capital is sometimes referred to as what?
Implied assets
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
- 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
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


10. What risks must be considered when discussing each concentrated investor category?
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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
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


11. As wealth increases...
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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
Demand for life insurance decreases
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


12. What is intestate?
When a decedent leaves no will or if the will is deemed invalid
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Both increase with longer holding periods and higher returns
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification


13. As desire to leave an estate increases...
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Demand for life insurance increases
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


14. As probability of death increases...
Transferring assets directly to a third generation avoids possible double taxation
- cautious - methodical - individualistic - spontaneous
The demand for life insurance increases - regardless of age
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


15. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
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
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
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


16. characteristics of individualist investor
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase


17. Describe asset segregation in a behavioral finance context.
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
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


18. What is core capital?
The amount of assets (i.e.present value) necessary to meet all future liabilities
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Transferring assets directly to a third generation avoids possible double taxation
Transferring assets directly to a third generation avoids possible double taxation


19. Define tax drag.
The reduction in return caused by the payment of taxes
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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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


20. How is mortality risk typically hedged?
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
Extra investment value created by effective tax management
Risk tolerance and decision-making style
Hedged with life insurance - think of the life insurance as a replacement for lost human capital


21. Why would someone want to use a valuation discount?
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
When a decedent leaves no will or if the will is deemed invalid
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


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

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23. What are the advantages of private exchange funds for low basis stock?
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
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


24. What is the difference b/t a required and desired return objective?

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25. Investor questionnaires help to determine what?
Risk tolerance and decision-making style
1) credit method 2) exemption method 3) deduction method
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Risk tolerance = as risk tolerance increases - demand for life insurance decreases


26. What are the problems that financial advisers can face with low basis stock?
The reduction in return caused by the payment of taxes
Total wealth = financial assets + human capital
The client's psychological profile
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification


27. situational profiling

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28. What are the different stages of life?
1. foundation 2. accumulation 3. maintenance 4. distribution
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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
Transferring assets directly to a third generation avoids possible double taxation


29. characteristics of foundation stage
Young -Building a foundation for future wealth -above avg risk tolerance
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Demand for insurance decreases; less human capital to replace
Demand for life insurance decreases


30. What are the disadvantages of an outright sale of low basis stock?
Demand for insurance decreases; less human capital to replace
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
The government shares in both gains and losses
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


31. What are the disadvantages of private exchange funds for low basis stock?
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 client's psychological profile
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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


32. Describe asset segregation in a behavioral finance context.
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
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
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


33. What is the most common estate planning tool?
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)
A will (also known as a testament)
The decedent's estate
1) credit method 2) exemption method 3) deduction method


34. What are the different types of trusts?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
- 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) 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
Demand for life insurance decreases


35. What is human capital?
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
HC = PV of future labor income
- 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) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification


36. 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
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
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
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase


37. Describe the equity holding life three stages from the perspective of the stock.
The amount of assets (i.e.present value) necessary to meet all future liabilities
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
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool


38. What are the four broad categories of investor personality types (BB&K)?
- a subjective assessment of financial well-being based on perceived wealth
- cautious - methodical - individualistic - spontaneous
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
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)


39. What are the different stages of life?
Should use accrual-equivalent returns and after-tax risk
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale


40. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
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
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
- a subjective assessment of financial well-being based on perceived wealth
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


41. What are the main characteristics of the distribution phase of life?
1) source of wealth 2) measure of wealth 3) stage of life
Wealth transfer stage - focus on tax min. with trusts and foundations
- 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
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


42. What are wealth taxes.
Total wealth = financial assets + human capital
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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


43. What is measure of 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
Excess capital
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
- a subjective assessment of financial well-being based on perceived wealth


44. typical IPS elements
A positive relationship
Implied liabilities
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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


45. Living expenses in retirment can be referred to as what?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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
Implied liabilities
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


46. Describe biased expectations in a behavioral finance context.
- 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
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up


47. situational profiling - considerations
- cautious - methodical - individualistic - spontaneous
Sources of wealth - measure of wealth - stage of life
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) 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)


48. What is tax alpha?
Extra investment value created by effective tax management
- 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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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


49. How is mortality risk typically hedged?
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk


50. What are the main characteristics of fixed annuities?

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