Private Wealth Management

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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. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
1) credit method 2) exemption method 3) deduction method
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances


2. What is the general relationship b/t a client's perception of wealth and risk willingness?
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
A positive relationship
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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)


3. characteristics of accumulation phase
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
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
- 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
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


4. psychological profiling
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
1) credit method 2) exemption method 3) deduction method
Wealth transfer stage - focus on tax min. with trusts and foundations
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


5. characteristics of spontaneous investor

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6. What is human capital?
HC = PV of future labor income
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
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized


7. situational profiling

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8. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
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
The demand for life insurance increases - regardless of age
Both increase with longer holding periods and higher returns
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


9. Living expenses in retirment can be referred to as what?
Early career 8accumulating education - developing skills - above-average ability to take risk
The government shares in both gains and losses
Implied liabilities
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)


10. characteristics of spontaneous investor

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11. What is intestate?
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
When a decedent leaves no will or if the will is deemed invalid
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


12. What are the equity holding life risk attributes for an entrepreneur?
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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
Implied liabilities


13. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Implied assets
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
The demand for life insurance increases - regardless of age


14. What are the different types of trusts?
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
Both increase with longer holding periods and higher returns
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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


15. typical IPS elements
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Demand for insurance decreases; less human capital to replace
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)
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


16. benefits of IPS to client
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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
- 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
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


17. What are the benefits of an IPS to the adviser?
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)
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
It is expenseive - time consuming - public


18. What are the psychological issues of low basis stock held by an executive?
- a subjective assessment of financial well-being based on perceived wealth
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
A positive relationship
- 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


19. characteristics of methodical investor
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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
Demand for life insurance decreases
Risk tolerance and decision-making style


20. What are the psychological issues of low basis stock held by an executive?
Young -Building a foundation for future wealth -above avg risk tolerance
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
- 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
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


21. 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
Risk tolerance and decision-making style
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
When a decedent leaves no will or if the will is deemed invalid


22. Calculating the required return component is driven by what 2 elements?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
- 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
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) growing the portfolio (capital gains) 2) liquidity needs - total return approach


23. What are the two sources of wealth?
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
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
1) active 2) passive
Demand for life insurance increases


24. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
Income rising - assets growing - long time horizon - above-avg. ability to take risk
- 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
Early career 8accumulating education - developing skills - above-average ability to take risk
Risk tolerance = as risk tolerance increases - demand for life insurance decreases


25. Describe a methodical investor personality type.
Implied liabilities
Should use accrual-equivalent returns and after-tax risk
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)
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


26. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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
Sources of wealth - measure of wealth - stage of life
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase


27. Why do individuals often take steps to avoid probate?
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
It is expenseive - time consuming - public
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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


28. What is HIFO accounting?
The client's psychological profile
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
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either


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

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30. As wealth increases...
When a decedent leaves no will or if the will is deemed invalid
If human capital is equity-like - allocate financial assets more to fixed income - if the human capital is fixed-income like - allocate financial assets more to equities
1) active 2) passive
Demand for life insurance decreases


31. benefits of IPS to manager
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
- 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
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased


32. Describe a cautious investor personality type.
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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


33. What are the problems that financial advisers can face with low basis stock?
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
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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


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

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

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36. Any amount above core capital is considered what?
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
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) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Excess capital


37. What are the main characteristics of the distribution phase of life?
Wealth transfer stage - focus on tax min. with trusts and foundations
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Methodical - cautious - individualist - spontaneous
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


38. Why would an individual try to use generation skipping in estate planning?
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
Transferring assets directly to a third generation avoids possible double taxation
Methodical - cautious - individualist - spontaneous
Methodical - cautious - individualist - spontaneous


39. characteristics of accumulation phase
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
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
Both increase with longer holding periods and higher returns
- 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


40. What are the diversification techniques for low basis stock?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Excess capital
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification


41. stages of life
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
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
1. foundation 2. accumulation 3. maintenance 4. distribution
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


42. Define capital gains taxes.
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) 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


43. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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


44. When should you use a tax-exempt versus a tax-deferred account?
1) active 2) passive
HC = PV of future labor income
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either


45. What are the disadvantages of an outright sale of low basis stock?
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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
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


46. If human capital is equity-like/fixed-income like - how should you generally allocate financial assets?
Implied assets
Wealth transfer stage - focus on tax min. with trusts and foundations
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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


47. What is the person called that transfers assets through a will?
The testator
A positive relationship
Demand for life insurance increases
The government shares in both gains and losses


48. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
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
Both increase with longer holding periods and higher returns
Sources of wealth - measure of wealth - stage of life
Implied liabilities


49. What are the advantages of private exchange funds for low basis stock?
Can borrow and/or use derivatives to diversify - ability to borrow (monetize) increased - owners retain upside potential of the original investment - not required to hodl illiquid assets - partners can change fund composition
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
1) active 2) passive
1) source of wealth 2) measure of wealth 3) stage of life


50. What are the equity holding life risk attributes for an executive?
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
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)
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