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. As wealth increases...
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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
Demand for life insurance decreases
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


2. characteristics of distribution phase
- 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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
A positive relationship
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


3. What are typical characteristics of active wealth creators?
The government shares in both gains and losses
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting 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
- 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


4. What is HIFO accounting?
Excess capital
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
Transferring assets directly to a third generation avoids possible double taxation
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift


5. What is the general relationship b/t a client's perception of wealth and risk willingness?
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
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
A positive relationship
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification


6. 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
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
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


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

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8. What are the main characteristics of variable annuities?

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9. What are the benefits of an IPS to the client?
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
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
Young -Building a foundation for future wealth -above avg 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


10. characteristics of methodical investor
A positive relationship
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
The reduction in return caused by the payment of taxes


11. What are the disadvantages of hedging for low basis stock?
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
A will (also known as a testament)
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)
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)


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

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13. What is tax alpha?
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Extra investment value created by effective tax management
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Total wealth = financial assets + human capital


14. When should you use a tax-exempt versus a tax-deferred account?
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
The decedent's estate
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either


15. Living expenses in retirment can be referred to as what?
Implied liabilities
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
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


16. What is loss aversion?
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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
The government shares in both gains and losses
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


17. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
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
1) active 2) passive
- 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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases


18. What are the main characteristics of variable annuities?

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19. Describe asset segregation in a behavioral finance context.
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
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Income rising - assets growing - long time horizon - above-avg. ability to take risk


20. What is typically considered when imposing an exit tax?
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
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
- 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
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


21. Equation for total wealth.
Wealth transfer stage - focus on tax min. with trusts and foundations
Total wealth = financial assets + human capital
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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


22. What are the equity holding life risk attributes for an investor?
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
The testator


23. Describe a methodical investor personality type.
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Sources of wealth - measure of wealth - stage of life
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


24. When calculating a required return - you typically must identify what?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
1) credit method 2) exemption method 3) deduction method
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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)


25. Why would someone want to use a valuation discount?
Early career 8accumulating education - developing skills - above-average ability to take risk
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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)


26. Define capital gains taxes.
Implied liabilities
Wealth transfer stage - focus on tax min. with trusts and foundations
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Demand for life insurance decreases


27. As wealth increases...
Entrepreneurial activity (likely to have highly concentrated portfolio) -inheritance - one-time windfalls (may be more willing to diversify) -built up over long periods of safe employment (e.g. middle mgr - easier to divest than huge entrepreneurial
Demand for life insurance decreases
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis


28. What is the most common estate planning tool?
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
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
A will (also known as a testament)
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


29. Why would an individual try to use generation skipping in estate planning?
Transferring assets directly to a third generation avoids possible double taxation
A will (also known as a testament)
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital


30. What are the main types of investors?
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)
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
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
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


31. What are the advantages of the monte carlo approach to portfolio construction?
1) active 2) passive
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift


32. As age increases..
The government shares in both gains and losses
Demand for insurance decreases; less human capital to replace
Excess capital
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase


33. What are the disadvantages of completion portfolios for low basis stock?
- a subjective assessment of financial well-being based on perceived wealth
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
The testator


34. What are the main characteristics of the maintenance phase of life?
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)
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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


35. As desire to leave an estate increases...
Demand for life insurance increases
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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


36. What are typical characteristics of passive recipients of wealth?
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) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)


37. Describe biased expectations in a behavioral finance context.
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
Demand for life insurance increases
More subjective than situational profiling -helps to understand how an investor perceives risk and return. -Bridges the differences between traditional finance and behavioral finance -Methodical - cautious - individualist - spontaneous
Tax 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


38. Define tax drag.
The reduction in return caused by the payment of taxes
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
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


39. situational profiling - considerations
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
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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
Sources of wealth - measure of wealth - stage of life


40. template for return objective
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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
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


41. characteristics of individualist investor
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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


42. What are the diversification techniques for low basis stock?
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
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
Implied liabilities
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging


43. What is measure of wealth?
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
Should use accrual-equivalent returns and after-tax risk
- a subjective assessment of financial well-being based on perceived 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


44. Equation for total wealth.
Total wealth = financial assets + human capital
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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
Demand for insurance decreases; less human capital to replace


45. Living expenses in retirment can be referred to as what?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Implied liabilities
Total wealth = financial assets + human capital
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)


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

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47. What are the different global tax regimes and their respective ordinary income tax structure?
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
- 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
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)


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


49. What are the different types of trusts?
The more equity-like - the less the demand for life insurance
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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) 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


50. characteristics of spontaneous investor

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