Private Wealth Management Flashcards
Traditional Finance
how individuals should behave; efficient markets; utility theory with diminishing marginal returns (convex indiff curves)
REM - risk averse, rational expectations, asset integration
Behavioral Finance
how individuals actually behave and make decisions to realize lifestyle-based objectives - need to consider loss aversion, biased expectations, asset segregation
- micro = decisions of individuals
- macro = why markets deviate from TF expectations
Source of Wealth
Active: created through entrepreneurial activity; more willing to take risk
Passive: created through inheritance, windfall, saving; less willing to take risk
Measure of Wealth
how much wealth client preceives themself to have
positive correlation between preception of wealth an willingness to take investment risk
Stage of Life
- Foundation: generating wealth, long time horizon, risk: higher willingness, lower ability
- Accumulation: accumulated some wealth, long time horizon, higher risk, risk: higher willingness, higher ability
- Maintenance: retirement, lower risk, shorter time horizon
- Distribution: assets > level of need, risk depends on goals
Personality Types
- Cautious investor: risk averse, decisions based on feelings
- Methodical investor: risk averse, decisions based on facts
- Individualistic investor: less risk averse, decisions base on facts
- Spontaneous investor: less risk averse, decisions based on feelings
Client Benefits of IPS
- identify objectives and constraints
- dynamic (can change)
- easily understood, transferable
- educational about themself/ investment process
Manager Benefits of IPS
- know client
- guidance for decisions
- guidance for resolving disputes
IPS Objectives
- return
- risk
IPS Constraints
- time horizon
- taxes
- liquidity
- legal
- unique
Ability to Take Risk
ability to sustain loss without putting goals at risk
- time horizon
- goal size in relation to portfolio size
- liquidity needs
- goals that cannot be deferred
- ability to replace losses in value (portfolio = sole income)
Willingness to Take Risk
psychological profile
Return Objective
- list objectives
- determine asset base
- determine distribution
- calc [real] return (distribution/ base)
- calc nominal return (real + inflation)
Process of Elimination
eliminate asset allocation models that
- violate constraints
- violate risk objective
- fail to diversify
- don’t maximize return to risk (efficency, sharpe ratio)
Deterministic Approach
traditional approach
linear return analysis; single req return, not representative of actual volatility, no insight into risk
Monte Carlo Simulation
calc req return, each variable given prob distribution, thousands of simulations
PROS: considers path dependency, risk/ return trade offs, tax analysis, SR vs LR risk, multiple periods
CONS: GIGO
Tax Drag
money lost to taxes
tax drag$ = gainPT - gainAT
gain = FV - BV
tax drag% = TD$/ gainPT
RAE
accrual equivalent return; hypothetical tax rate if taxed every period
- RAE = (FVAT / PV)1/n - 1
- RAE = r * ( 1 - TAE )
** might not be on exam
Tax Regimes
- Progress: favorable for int, div, cap gains
- Heavy: favorable for int
- Light: favorable for div, cap gains