Private Client Flashcards
goal of private wealth management
help investors seek the benefits as well as navigate the complexities of financial market
private client
inv. objective:
objective may not be clearly defined or quantified.
Constraints:
Time horizon: relatively short (lifelong)
Scale: smaller (more limitations)
taxes: significant and complex
investment governance less formal
distinction
Inv. sophistication:
emotional, subject to behavioral biases
regulation: separate regulation or shared regulatory structure
uniqueness and complexity:
similar objective may have different inv. strategies
institutional clients
inv. objective:
specified, clearly defined
Constraints:
Time horizon: theoretically infinite
Scale: larger
taxes: depends on institutions
investment governance: formal
distinction
Inv. sophistication:
a higher degree, professionals
regulation: separate regulation or shared regulatory structure
uniqueness and complexity:
similar objective may have different inv. strategies
information needed in advising private client
- personal info
- financial information
- tax considerations
basic tax strategies
tax avoidance
tax reduction
tax deferral
tax avoidance: TEA
tax exempt account TEA that investor are allowed to contribute a limit account
- various wealth transfer techniques
tax reduction
tax exempt bonds
tax efficient asset classes (stock paying a high dividend)
tax deferral
same investor in a progressive tax system seek to defer taxes because they anticipate lower futures tax rates
the wealth manager rols
goal quantification
goal prioritization
goal changes
private client risk tolerance
willingness to tolerate risk
risk aversion
unwillingness to tolerate risk
risk capacity
ability to accept financial risk, more obligate in nature
risk perception
subjective assessment of the risk involved in the outcome of an investment decision
- questionnaire for risk tolerance score
- risk tolerance conversion
capital sufficiency analysis/ capital needs analysis
process by wealth manager determines likely to accumulate, sufficient financial resources to meet his/her objectives
2 methods
- deterministic forecasting
- monte carlo simulation
- deterministic forecasting
portfolio growth occurs in a straight line
wealth manger must specify: portfolio return assumption current value of the portfolio anticipated future contribution CF the portfolio that represent client needs
disadvantage:
the use of single return assumption is not representative of the actual market volatility
2 monte carlo simulation
allows a wealth manager to model the uncertainty of several key variable and therefore the uncertainty or variability in the future outcome
- assume a simple average (arithmetic mean) return and a std of YoY returns for the portfolio
- forward looking assumption should be the foundation for the analysis
when the probability of success falls below the acceptable range, potential solution include:
- increase the amount of contribution
- reduce the goal amount
- adoption an investment strategy with higher expected return
deterministic planing
retirement stage of life
education: develop human capital
early career: save for retirement goal starts
career development:
35-50 career development: financial obligation and accumulate financial capital
51-60 peek accumulation : financial capital is greatest
early retirement: lnv. portfolio fund their lifestyle
retirement: accurate financial capital
late retirement: medical expense increase
(face longevity risk)
analyzing relevant goals
- mortality table
indicate individual life expectation at specific ages
potential drawback: individual clients pro. of living to a certain age may exceed that of the general population
- ammunities lump sum
provide a series of fixed pmt, entire for life or for a specific period in exchange for a lump sum payment.
It helps to mitigate the longevity risk. - monte carlo simulation
adv: applicability to the client, actual asset allocation
It can flexibly model different scenario and explore issues that are important to clients
disadvantage:
it cannot predict the future due to the limitation of use of historical data
- the output is highly sensitive to small changes in input assumption
- the output indicates the prob. of reaching a good but not accessary the “shortfall magnitude”
immediate annuity
pay an initial lump sum in return for a guarantee of specific future monthly payment, beginning immediately over a specific period of time
deferred annuity
the specific future monthly payment begin at a later date
longevity risk
use annuity
risk of outliving one’s financial resources
life annuities hep mitigate it.
behavioral consideration in retirement planning
- heightened loss aversion
- consumption gap between actual and potential consumption
- the annuity puzzle: not prefer to invest in annuity
- invest’s reluctance to give up hope of substantial life style
- the dislike of losing control of assets
- high cost of annuities - preference for investment income over capital appreciation
spending only the interest and not the principal is a self-control mechanism
spending dividend rather then selling stock
IPS
ADV:
- encourage investment discipline and reinforces client’s commitment to fall out the strategy
- focus on LT goals rather than ST performance
for individual:
1. return: variable objectives
may conflict internally and change over time
return maybe titled toward income
- risk: difficult to determine
subject to behavioral influences
smaller asset based increases sensitivity of risk - constraint
- liquidity
may be variable and subject to period shortfall - time horizon:
long >10 years
but short than pension plan - tax
fully taxable with some tax advantaged and tax-exempt accounts - legal/regulatory
ordinarily very few
portfolio traditional approach
- identify asset clases
- developed CME
- determine portfolio allocation
- asset constraint
- implement the portfolio
- determine asset allocation
goal-based
optimized with stated max level of volatility of % of success
adv: it may be easier for clients to express their risk tolerance on a goal -specific basis rather than at the overall portfolio level
disadv:
the combination of goal portfolio allocations may not be sufficient
Ethic consideration
fiduciary duty and suitability
know your customer
confidentiality
conflict of interest
private client segments
-robo-advisor
automated advisors, lower fees use questionnaire
-mass affluent segment asset levels between $250,000 and $1 million
serves clients who are focused on building their portfolios and want help with financial planning needs.
greater technology, no customization
- high net worth client
smaller # of customer, tailored investment solution, tax planning, estate planing, contain sophisticated strategy
asset levels between $1 million and $10 million and can provide a team of specialized advisers that supports more customized strategies for more sophisticated investments with longer time horizons, greater risk, and less liquidity.
- ultra high net work segment:
low client to manager ratio
luxury service
multi-genration family member
asset levels over $50 million for clients with multi-generational time horizons and provides a wider range of services for complex tax situations, estate planning, bill payment, concierge services, travel planning, and advice on acquiring high-end assets.
tax aware investment model are valuable:
- tax codes change over time
can be applied in a broad range of circumstance representing diff. taxing justifications, asset classes, and account types
- can provide a framework with which advisor can better communicate the impact to taxes of portfolio returns to private clients and develop techniques to improve their after tax performance
tax structure
tax on:
income
wealth-based
consumption
common progressive regime:
progressive tax rates for ordinary income,
favorable treatment in interest, dividend, capital gain
most common
heavy dividend tax regimes
progressive tax system for ordinary income and favorable treatment for some int. capital gains but dividends at ordinary rates
heavy capital gain tax regimes
favorite treatment for interest dividend
progressive tax system for ordinary income
capital gains tax at ordinary rates
heavy interest tax regime
interest income at ordinary rate
light capital gain tax regime
second most common observed
progressive for income, int, dividend,
fav or capital gains
flat and light regime
favorable for int, dividend and capital gains
flat tax system and treats interest, dividend and capital gains favorably
flat and heavy regime
favorite for interest income
flat tax system for ordinary income
dividends and capital gains
no favorable treatment for dividend and capital gains
but favorable treatment for interest income
TDA tax deferred account
Deferred tax for capital gain is: (1+r)^n(1-tcg)+tcg
Deferred tax account is :(1+r)^n(1-T)
defers taxation on investment return
may permit a deduction for contribution
may occasionally permit tax free distribution
single tax environment FV
= (1+r(1-rt))^n
tax drag: gain lost to taxes = gain without tax - gain after taxes
tax drag % = tax drag $/gaini without taxes
tax drag% > tax rates due to compounding
R & T increase both tax drag and tax drag %
deferred capital gains (deferred until realized)
FV
FVcg = (1+r)^n *( 1-tcg)+tcg
no lost compounding of return
tax drag $ increase with time horizon and rate of return
if B=0( non initial unrealized g/l)
tax drag %= tax rate
if b <1 (initial unrealized gain) tax drag % > tax rate
if b >1 (unrealized loss) tax drag% < tax rate
wealth based taxes
applied annually to a specific capital base
FV =[ (1+r)(1-tw)]^n
inv. horizon increase lead to tax drag % $ both increase
inv. horizon decrease lead to tax % decrease, $ increase
blended taxing environment
interest
dividend
capital gains
weighed avg realized tax rate (WARTR)
WARTR = %w%R
Riti +Rdtd+Rcgtcg
return after realized taxes r*=
r(1-awrtr)
r* = r(1 – %w%t)
overstates true after-tax return because there’s no unrealized gain an a potential future tax liability to be paid on this gain.
Effective capital gains tax T*
TAE
TAE T* =
Tcg(1- sum of %weight)
/(1-wartr)
= 1- R*/R
WARTR = sum of %w%t
FV* taxbable =
b= basis cost/ current investment value
there already capital appreciation
FVIFTaxable = (1 + r)^n(1 – T) + T* – (1 – B)tcg, B = 1
(1 + r)^n(1 – T) + T* – (1 – B)tcg, B = 1
accrual equivalent tax Rate=
r(1-TAE)
initial investment value * (1+RAE)^n = AFTER TAX investment value
- used to measure tax efficiency of different asset class or pm styles
- illustrates to clients the tax impact of lengthening the average holding periods of stocks they own
- assess the impact of futures tax law changes
taxable account
gove’t bear part of investment risk
after tax income invested
taxed return
TDA deferred account
before tax income
taxed when withdraw
FV = (1+r)^n(1-tn)
TEA exempt account
inter bear all investment risk
has no future tax liabilities
=(1+r)^n
tax loss harvesting
= loss * t
realize a loss to offset gain
mean- variance optimization
use accrual equivalent after-tax return
and af tax std
estate planing in a global context
- can be applied in a variety of jurisdiction
- provides an international perspective that advisors can use to counsel clients with a multi-jurisdiction foot print
- provides a framework advisors can use to communicate tax and succession planning consideration to private clients to develop technique to address the need and objectives of such clients
- inheritance laws and tax codes in many jurisdictions are fluid over time
Estate planning
process of preparing for the disposition of one’s estate upon death and during one’s lifetime
Will: outlines the rights others sill have over one’s party after death
probate:
legal process to confirm the validity of the will so that executors hires and other interest parties can rely on it authenticity
intestate: a decedent outline a valid will or with a will that does not dispose to their property
civil law
roman low
developed primary through legislative status or executive action
common law
Britain
developed primary through decisions of the courts
forced heirship rule
- children have the right to a fixed share
- may reduce a forced heirship claim by gifting of denoting assets
- may move asset into a offshore trust governed by a different domicile to avoid forced heirship rule
- clawback provisions bring such lifetime gifts back into the estate to calculate the child’s share
common property regimes
each spouse has an indivisible 1/2 interest in income earned during marriage
separate property regime
prevalent in civil law countries, each spouse is able to own and control property as an individual which enables each to dispose of property as they wish, subject to spouse’s other rights
estimate core capital with mortality table
- incorporate inflation effet over long-time horizon
- forecast nominal speeding need and discount to pv using nominal rates
survival prob= p( joint survival) =
use mortality table
subject to longevity risk
to mitigate, can incorporate safety reserve
p(husband survives) +p(wife survives)
-p(h)*p(W)
pv(spending needs) =
sum or p(survival)*spending /(1+r)^n
r= 1+r/1+g
safety reserve
- provide a capital cushion if capital produce s sequence of unusually poor return that jeopardize the sustainability of the planned spending program
- allows the 1st generation to increase their spending beyond that explicit articulated in the spending program
est. core capital with monte carlo analysis
- incorporate recurring spending needs, irregular liquidity needs, taxes, inflation, and other factors in to the analysis
- exp(r) derived from the market expectations of the assets
capture the interaction of distribution and the sequence of returns, a form of path dependency
probability or ruin
reaching a zero portfolio value
based on different start date for retirement and distribution %.
delay retirement or lowering distribution % make it less likely the portfolio can be exhausted.
transferring excess capital
lifetime gifts and testamentary bequests
gifting now likely give up control and cannot be revoked if circumstances change with tax issues
relative value >1 tax perspective is favorable to gift
relative value <1 bequest if more favorable 遗嘱
Relative value RV=
RV = FVg/FVb
FV after tax to the receiver if gifted now
/ fv after tax to the receiver if bequested
tax free gift
RV = FVg/FVb
=[1+rg(1-tig)]^n
/[1+rb(1-tib)]^n (1-tb)
taxable gifts (tax paid by receiver)
FVg changes
RV=
[1+rg(1-tig)]^n * (1-tg)
/[1+re(1-tie)]^n (1-te)
taxable gifts (tax paid by giver)
FVg changes
RV=
[1+rg(1-tig)]^n * (1-tg + TgTe)
/[1+re(1-tie)]^n (1-te)
TgTe = tax benefit from reducing the value of the taxable estate
location of the gift tax liability
- a cross broader gift could return in both the donor and the recipient being taxes in their home counters
- if the tax liabilities is imposed on the donor’s taxable estate rather than on the recipient, the tax benefit of the lifetime gift vs. the bequest increase
more attractive when the gift tax is paid by the donor
if tax rates are the same, gifting reducing the size of the taxable estate which is better to gift
Generation skipping
benefit from skipping by 1/(1-t)
1st to 2rd generation in 15 year tax =40%
3rd in 30 years
after tax return =5% on asset
FVno skipping = pv( (1.05)^15 *(1-0.4) * (1.05)^30)(1-0.4)) =pv(3.2344)
FV skipping:
=pv(
(1.05)^45(1-0.4))
=pv(5.3910)
by 1/(1-t) = 1/(1-0.4)=1.6667
5.3910/3.2344 = 1.6667
Spousal exemptions
most jurisdiction with estate or inheritance also allow dependent to make bequest and gift to their spouses without transfer tax liability
it’s advisable to transfer the exclusion amount to someone other than the spouse, child tax free
