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Private Wealth Management

Subjects : personal-finance, business-skills

Instructions:

Answer 50 questions in 15 minutes.
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Match each statement with the correct term.
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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. What are the main characteristics of fixed annuities?

2. What are the benefits of an IPS to the client?
Risk tolerance and decision-making style
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
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

3. What are the steps involved in creating an IPS?

4. What are the main characteristics of variable annuities?

5. 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?
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
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital

6. Describe an individualistic investor personality type.
A will (also known as a testament)
1) active 2) passive
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)
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

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

8. What are the 3 categories of investors when discussing concentrated positions?
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
The client's psychological profile
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

9. What is tax alpha?
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Early career 8accumulating education - developing skills - above-average ability to take risk
Extra investment value created by effective tax management
- cautious - methodical - individualistic - spontaneous

10. What risks must be considered when discussing each concentrated investor category?
1) credit method 2) exemption method 3) deduction method
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
When a decedent leaves no will or if the will is deemed invalid
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

11. As wealth increases...
Demand for life insurance decreases
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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

12. What are the four broad categories of investor personality types (BB&K)?
Excess capital
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
- cautious - methodical - individualistic - spontaneous
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely

13. 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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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)
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

14. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
The testator
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
When a decedent leaves no will or if the will is deemed invalid

15. Any amount above core capital is considered what?
When a decedent leaves no will or if the will is deemed invalid
- 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
Excess capital
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk

16. Investor questionnaires help to determine what?
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)
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
Transferring assets directly to a third generation avoids possible double taxation

17. Define capital gains taxes.
Wealth transfer stage - focus on tax min. with trusts and foundations
The risk of a premature death with accompanying loss of future human capital
HC = PV of future labor income
Taxes paid on the gain (long or short position) when an asset is sold or purchased

18. What are the benefits of an IPS to the client?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired 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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
1) credit method 2) exemption method 3) deduction method

19. What are the diversification techniques for low basis stock?
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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) growing the portfolio (capital gains) 2) liquidity needs - total return approach

20. What are the different retirment risks and how can they be hedged?
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
- 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) 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)
The client's psychological profile

21. As wealth increases...
1. foundation 2. accumulation 3. maintenance 4. distribution
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Demand for life insurance decreases

22. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Implied liabilities
The demand for life insurance increases - regardless of age

23. What is the most common estate planning tool?
A will (also known as a testament)
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification

24. 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
- 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 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 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

25. 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
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one

26. Define capital gains taxes.
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Risk tolerance and decision-making style
Demand for insurance decreases; less human capital to replace
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

27. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
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
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
A will (also known as a testament)

28. psychological profiling
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
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
Early career 8accumulating education - developing skills - above-average ability to take risk
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

29. characteristics of accumulation phase
Transferring assets directly to a third generation avoids possible double taxation
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
The risk of a premature death with accompanying loss of future human capital
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

30. What is core 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
Implied liabilities
Income rising - assets growing - long time horizon - above-avg. ability to take risk
The amount of assets (i.e.present value) necessary to meet all future liabilities

31. If human capital is equity-like/fixed-income like - how should you generally allocate financial assets?
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)
Implied assets
The client's psychological profile
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

32. 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
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
The more equity-like - the less the demand for life insurance
Should use accrual-equivalent returns and after-tax risk

33. Equation for total wealth.
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
The government shares in both gains and losses
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Total wealth = financial assets + human capital

34. What are the psychological issues of low basis stock held by an executive?
Demand for life insurance increases
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)
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
- 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

35. What are the equity holding life risk attributes for an investor?
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
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
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) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging

36. template for return objective
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
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n

37. What are typical characteristics of active wealth creators?
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
- 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
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Risk tolerance = as risk tolerance increases - demand for life insurance decreases

38. What are ways that individuals can avoid probate?
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
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
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) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock

39. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n

40. What is typically considered when imposing an exit tax?
- cautious - methodical - individualistic - spontaneous
The reduction in return caused by the payment of taxes
- 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) active 2) passive

41. What are the psychological issues of low basis stock held by an executive?
The more equity-like - the less the demand for life insurance
- 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
The demand for life insurance increases - regardless of age
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses

42. What is human capital?
HC = PV of future labor income
The amount of assets (i.e.present value) necessary to meet all future liabilities
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
Young -Building a foundation for future wealth -above avg risk tolerance

43. Human capital is sometimes referred to as what?
Implied assets
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)
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
- a subjective assessment of financial well-being based on perceived wealth

44. characteristics of individualist investor
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)
- a subjective assessment of financial well-being based on perceived wealth
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Implied liabilities

45. What are ways that individuals can avoid probate?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

46. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Total wealth = financial assets + human capital
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase

47. What are the equity holding life risk attributes for an executive?
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
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
- cautious - methodical - individualistic - spontaneous

48. As probability of death increases...
1. foundation 2. accumulation 3. maintenance 4. distribution
The demand for life insurance increases - regardless of age
The testator
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date

49. What are the main characteristics of chritable gifts?
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
HC = PV of future labor income
1. foundation 2. accumulation 3. maintenance 4. distribution
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

50. What are the steps involved in creating an IPS?