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Private Wealth Management

Subjects : personal-finance, business-skills

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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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1. Equation for total wealth.
Total wealth = financial assets + human capital
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Wealth transfer stage - focus on tax min. with trusts and foundations
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)

2. When dealing with low basis stock - emotional issues can arise from what?
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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)

3. What are the main characteristics of chritable gifts?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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
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

4. What are ways that individuals can avoid probate?
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
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
The government shares in both gains and losses
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will

5. What are the main characteristics of the maintenance phase of life?
Implied assets
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Both increase with longer holding periods and higher returns

6. What is loss aversion?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
Early career 8accumulating education - developing skills - above-average ability to take risk
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

7. What are wealth taxes.
A positive relationship
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
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)

8. As probability of death increases...
The testator
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
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

9. What are wealth taxes.
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
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
- 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
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

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

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11. What are the advantages of the monte carlo approach to portfolio construction?
- cautious - methodical - individualistic - spontaneous
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
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases

12. What are the equity holding life risk attributes for an entrepreneur?
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
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
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

13. Any amount above core capital is considered what?
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
Excess capital
When a decedent leaves no will or if the will is deemed invalid

14. What are the 3 categories of investors when discussing concentrated positions?
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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)

15. What are the two sources of wealth?
1) active 2) passive
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
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

16. What are the four broad categories of investor personality types (BB&K)?
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
- cautious - methodical - individualistic - spontaneous
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Methodical - cautious - individualist - spontaneous

17. What are the disadvantages of an outright sale of low basis stock?
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification

18. What is human capital?
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
The risk of a premature death with accompanying loss of future human capital
HC = PV of future labor income
The risk of a premature death with accompanying loss of future human capital

19. What is mortality risk?
Earnings start to accelerate -Expenses increase - but so do savings -Long time horizon over which to recover from short-term losses -above-average risk tolerance
The risk of a premature death with accompanying loss of future human capital
- 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
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

20. four types of investors
Methodical - cautious - individualist - spontaneous
The risk of a premature death with accompanying loss of future 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
1. foundation 2. accumulation 3. maintenance 4. distribution

21. As wealth increases...
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
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
Demand for life insurance decreases
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)

22. What are the different types of trusts?
Implied assets
The government shares in both gains and losses
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
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

23. What are the psychological issues of low basis stock held by an executive?
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
- 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

24. As age increases..
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Demand for insurance decreases; less human capital to replace
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
Early career 8accumulating education - developing skills - above-average ability to take risk

25. When should you use a tax-exempt versus a tax-deferred account?
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
- 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
The reduction in return caused by the payment of taxes

26. Investor questionnaires help to determine what?
Risk tolerance and decision-making style
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Demand for life insurance 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

27. Describe asset segregation in a behavioral finance context.
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
The client's psychological profile
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
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

28. characteristics of cautious investor

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29. What are typical characteristics of active wealth creators?
When a decedent leaves no will or if the will is deemed invalid
The demand for life insurance increases - regardless of age
- 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
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

30. What are the advantages of public exchange funds for low basis stock?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
The amount of assets (i.e.present value) necessary to meet all future liabilities

31. What are the main characteristics of variable annuities?

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32. 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
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
Young -Building a foundation for future wealth -above avg risk tolerance
The decedent's estate

33. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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

34. Describe an individualistic investor personality type.
Implied assets
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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)
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

35. What should an investor use in mean-variance optimization
When a decedent leaves no will or if the will is deemed invalid
Young -Building a foundation for future wealth -above avg risk tolerance
Should use accrual-equivalent returns and after-tax risk
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

36. What are typical characteristics of passive recipients of wealth?
Both increase with longer holding periods and higher returns
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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education

37. Describe biased expectations in a behavioral finance context.
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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
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
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

38. What are the benefits of an IPS to the client?
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
The risk of a premature death with accompanying loss of future human capital
- 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
Should use accrual-equivalent returns and after-tax risk

39. What are the disadvantages of public exchange funds 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
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)
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis

40. characteristics of foundation stage
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
Young -Building a foundation for future wealth -above avg risk tolerance
Both increase with longer holding periods and higher returns
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either

41. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Taxes paid on the gain (long or short position) when an asset is sold or purchased
The risk of a premature death with accompanying loss of future human capital
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

42. 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?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
The government shares in both gains and losses
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
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

43. Describe asset segregation in a behavioral finance context.
The government shares in both gains and losses
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
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one

44. What are the four broad categories of investor personality types (BB&K)?
Excess capital
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital

45. What is HIFO accounting?
It is expenseive - time consuming - public
The testator
Young -Building a foundation for future wealth -above avg risk tolerance
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

46. What is core capital?
The amount of assets (i.e.present value) necessary to meet all future liabilities
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased

47. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
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
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
A positive relationship
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase

48. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely

49. What are the advantages of completion portfolios for low basis stock?
Demand for life insurance increases
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
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

50. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Both increase with longer holding periods and higher returns
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) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging