Private Wealth Management

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• Answer 50 questions in 15 minutes.
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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. All costs associated with probate are born by whom?

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2. 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
- 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
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
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. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Implied liabilities
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification


4. 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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Sources of wealth - measure of wealth - stage of life
The more equity-like - the less the demand for life insurance


5. What are the diffferent types of tax jurisdictions?
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
Both increase with longer holding periods and higher returns
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


6. What is an equity collar? What is the purpose of the underlying positions
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
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
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis


7. psychological profiling
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
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
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
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)


8. characteristics of spontaneous investor

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9. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
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
1) source of wealth 2) measure of wealth 3) stage of life
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


10. What are the main characteristics of variable annuities?

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11. Who is responsible for gains/losses in a taxable (accrual taxation) account?
Young -Building a foundation for future wealth -above avg risk tolerance
Excess capital
The government shares in both gains and losses
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


12. Calculating the required return component is driven by what 2 elements?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
- 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) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
A positive relationship


13. characteristics of distribution phase
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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
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


14. What are the different stages of life?
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


15. 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
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
Implied assets
Young -Building a foundation for future wealth -above avg risk tolerance


16. What are the psychological issues of low basis stock held by an entrepreneur?
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
Typically very loyal to the firm - views the concentrated position as a positive - does not desire diversification - b/c feels in control of the future - as entrepreneurs delegate more and more control to others - they strive for more and more divers
- cautious - methodical - individualistic - spontaneous
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date


17. What are the 3 categories of investors when discussing concentrated positions?
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
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
Risk tolerance and decision-making style
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


18. What are the disadvantages of hedging for low basis stock?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis


19. Describe asset segregation in a behavioral finance context.
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
Transferring assets directly to a third generation avoids possible double taxation
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


20. Any amount above core capital is considered what?
The risk of a premature death with accompanying loss of future human capital
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Excess capital
Income rising - assets growing - long time horizon - above-avg. ability to take risk


21. What are the different stages of life?
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) 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)
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase


22. What are the different retirment risks and how can they be hedged?
Demand for life insurance decreases
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 decedent's estate
1) credit method 2) exemption method 3) deduction method


23. What are the different types of trusts?
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
The amount of assets (i.e.present value) necessary to meet all future liabilities
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
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


24. What are the different global tax regimes and their respective ordinary income tax structure?
Demand for insurance decreases; less human capital to replace
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
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
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)


25. As age increases..
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Demand for insurance decreases; less human capital to replace
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances


26. characteristics of individualist investor
Implied liabilities
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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)
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


27. 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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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


28. What is the reinvestment caveat when considering tax loss harvesting?
- 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
The reduction in return caused by the payment of taxes
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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


29. What are the benefits of an IPS to the client?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale


30. 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
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
A positive relationship
Excess capital


31. What is measure of wealth?
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
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
- a subjective assessment of financial well-being based on perceived wealth
Hedged with life insurance - think of the life insurance as a replacement for lost human capital


32. When dealing with low basis stock - emotional issues can arise from what?
1) source of wealth 2) measure of wealth 3) stage of life
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)
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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


33. template for return objective
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
Demand for life insurance decreases
1. foundation 2. accumulation 3. maintenance 4. distribution
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n


34. What are the main characteristics of fixed annuities?

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35. four types of investors
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Methodical - cautious - individualist - spontaneous
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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized


36. typical IPS elements
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
A positive relationship
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
Extra investment value created by effective tax management


37. Human capital is sometimes referred to as what?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Implied assets


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

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39. 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
Active wealth creators typically have an above-avg. willingness to take risk - passive recipients of wealth typically have an average or below-average willingness to take risk
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses


40. situational profiling

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41. What is human capital?
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
HC = PV of future labor income


42. As wealth increases...
Implied liabilities
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Young -Building a foundation for future wealth -above avg risk tolerance
Demand for life insurance decreases


43. stages of life
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
1. foundation 2. accumulation 3. maintenance 4. distribution
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
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


44. characteristics of cautious investor

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45. Describe a methodical investor personality type.
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
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
Sources of wealth - measure of wealth - stage of life


46. What is mortality risk?
The risk of a premature death with accompanying loss of future human capital
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
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


47. Living expenses in retirment can be referred to as what?
Implied liabilities
1. foundation 2. accumulation 3. maintenance 4. distribution
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
It is expenseive - time consuming - public


48. characteristics of accumulation phase
A positive relationship
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
The client's psychological profile
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


49. What is loss aversion?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
The government shares in both gains and losses


50. Define capital gains taxes.
It is expenseive - time consuming - public
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely