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Private Wealth Management

Subjects : personal-finance, business-skills

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1. What are the benefits of an IPS to the adviser?
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 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
HC = PV of future labor income

2. How does the nature of human capital affect the demand for life insurance?
The more equity-like - the less the demand for life insurance
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
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
- cautious - methodical - individualistic - spontaneous

3. What risks must be considered when discussing each concentrated investor category?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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

4. As probability of death increases...
The demand for life insurance increases - regardless of age
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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
- a subjective assessment of financial well-being based on perceived wealth

5. 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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
- cautious - methodical - individualistic - spontaneous
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

6. What are the diffferent types of tax jurisdictions?
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
Demand for life insurance decreases
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
The testator

7. What are the advantages of the monte carlo approach to portfolio construction?
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
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
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)
1) active 2) passive

8. 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
It is expenseive - time consuming - public
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

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

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10. What are the four broad categories of investor personality types (BB&K)?
- cautious - methodical - individualistic - spontaneous
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Taxes paid on the gain (long or short position) when an asset is sold or purchased

11. 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?
Young -Building a foundation for future wealth -above avg risk tolerance
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
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk

12. What are typical characteristics of passive recipients of wealth?
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Extra investment value created by effective tax management
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

13. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Both increase with longer holding periods and higher returns
Implied assets
The decedent's estate

14. What are the disadvantages of completion portfolios for low basis stock?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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)
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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

15. What are the two sources of wealth?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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
- 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) active 2) passive

16. What are the main characteristics of the foundation phase of life?
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
Early career 8accumulating education - developing skills - above-average ability to take risk
1) credit method 2) exemption method 3) deduction method
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either

17. Describe asset segregation in a behavioral finance context.
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
- 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
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

18. What are the equity holding life risk attributes for an entrepreneur?
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Demand for life insurance increases
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
Young -Building a foundation for future wealth -above avg risk tolerance

19. What are the different types of trusts?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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

20. As desire to leave an estate increases...
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
Demand for life insurance increases
Hedged with life insurance - think of the life insurance as a replacement for lost 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

21. 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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer 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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date

22. What is typically considered when imposing an exit tax?
A will (also known as a testament)
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
- 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
- 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

23. Describe a spontaneous investor personality type.
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
Demand for insurance decreases; less human capital to replace
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
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

24. When dealing with low basis stock - emotional issues can arise from what?
Total wealth = financial assets + human capital
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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

25. Any amount above core capital is considered what?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Excess capital

26. 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)
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
Demand for insurance decreases; less human capital to replace
HC = PV of future labor income

27. What are the advantages of an outright sale of low basis stock?
1) active 2) passive
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
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

28. characteristics of methodical investor
Both increase with longer holding periods and higher returns
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
1) credit method 2) exemption method 3) deduction method

29. As probability of death increases...
The demand for life insurance increases - regardless of age
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

30. What is human capital?
Demand for life insurance increases
HC = PV of future labor income
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
1) source of wealth 2) measure of wealth 3) stage of life

31. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
Both increase with longer holding periods and higher returns
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
The demand for life insurance increases - regardless of age
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one

32. What is the most common estate planning tool?
Demand for life insurance increases
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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
A will (also known as a testament)

33. benefits of IPS to client
The demand for life insurance increases - regardless of age
The reduction in return caused by the payment of taxes
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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

34. What are the disadvantages of hedging for low basis stock?
The amount of assets (i.e.present value) necessary to meet all future liabilities
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
HC = PV of future labor income
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

35. situational profiling - considerations
The amount of assets (i.e.present value) necessary to meet all future liabilities
Sources of wealth - measure of wealth - 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
1) active 2) passive

36. What is the eifference in willingness to take risk between active and passive wealth creators?
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
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 higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance

37. What are the different stages of life?
It is expenseive - time consuming - public
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
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

38. Why would someone want to use a valuation discount?
1. foundation 2. accumulation 3. maintenance 4. distribution
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
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

39. When should you use a tax-exempt versus a tax-deferred account?
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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
The risk of a premature death with accompanying loss of future human capital
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

40. What are the 3 categories of investors when discussing concentrated positions?
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
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
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
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)

41. What are typical characteristics of active wealth creators?
- 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
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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)

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

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43. What is loss aversion?
Excess capital
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
Young -Building a foundation for future wealth -above avg risk tolerance

44. What are the benefits of an IPS to the client?
Demand for life insurance decreases
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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
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

45. When should you use a tax-exempt versus a tax-deferred account?
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
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

46. What are the different retirment risks and how can they be hedged?
Young -Building a foundation for future wealth -above avg risk tolerance
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)
- 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) 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

47. When calculating a required return - you typically must identify what?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
- 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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date

48. Investor questionnaires help to determine what?
Risk tolerance and decision-making style
The client's psychological profile
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)
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

49. characteristics of cautious investor

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50. What are the two sources of wealth?
Young -Building a foundation for future wealth -above avg risk tolerance
1) active 2) passive
Demand for insurance decreases; less human capital to replace
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

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Private Wealth Management

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