PWM Flashcards
Calculation for Real After-tax rate of return
pre-tax nominal return * (1-T) - inflation
basically just the after-tax return less inflation, just note to calculate AT return FIRST
Calculate Shortfall Risk
Looking to see if the portfolio shortfall risk is less than the risk objective – if so, it DOES meet the objective.
Formula:
Pre-tax nominal return - (2 x stdev)
NOTE: this is for a 2-stdev approach - can be other multipliers to (ie replace the 2 above)
E.g.:
suppose some folks have a pre-tax nominal return of 12.8% on their portfolio, with a stdev of 13.2%. If they want to have a small probability of declining more than 14% within two standard deviations, it’s:
12.8% - (2 x 13.2%) = -13.6%
since 13.6% is less than the 14% risk objective, it meets their objective
Benefits of establishing an irrevocable / revocable trust
irrevocable (forever):
provides greater protection from claims coming from outside the family against the settlor
avoids disputes within the family
transfer of assets without potential publicity of a probate (better for keeping affairs private)
Revocable (donor can revoke / regain title –> not considered a true transfer to trust):
settlor retains the right to rescind the strust relationship and regain title of trust assets
DISADVANTAGE –> makes sturst assets vulnerable to reach of creditors having claims against the settlor
ADVANTAGE: –> settlor retains more control
Stages of Life
Types of Tax System:
Tax Haven
Territorial Tax System
Worldwide Tax System (mostly dealing w this on exam)
Tax Location Formulas:
Taxable Accounts
Tax-exempt Accounts
Tax-deferred accounts
Relative Value of a Gift or Bequest
it’s the relative value of gifting now vs. waiting for the bequest / death
denominator is always the same –> the numerator is what changes between two examples depending if gift tax or not
standalone: if gift tax rate > estate tax rate, better to wait
but still need to figure out if donor or recipient has higher or lower tax rate
if >1, advantageous to give now
Fixed Vs. Discretionary Trust
Fixed:
- distributions specified in certain times / certain amounts
Discretionary:
- trustee can determine what and how much and when to distribute to beneficiaries –> better for if beneficiaries are irresponsible –> also might provide better protection to trust assets from beneficiaries’ creditors, since the trustee decides what to distribute to the beneficiaries
3 benefits of a trust
1) retain control while giving beneficial interest
2) asset protection: from external claims / creditors, espcialyl for irrevocable, discretionary can be used to protect from claims against beneficiaries
3) reducing taxes
3 Benefits of using Life Insurance for estate planning purposes
Revocable vs. Irrevocable Trust
Revocable = settlor keeps right to rescind the trust relationship, regain title to the trust assets
Irrevocable = can’t do that; generally provides more asset protection from claims against settlor –> if settlor is debt-free, doesn’t matter, so revocable trust is better
UNLESS the tax rates for the jursidiction are different for a revocable vs irrevocable trust
Completion Portfolio
Staged Diversification
Exchange Fund
if you have a concentrated position in one company, ways to manage the concentrated position / get more diversification:
completion portfolio = an index-based portfolio that, when added to the concentrated position, creates an overall portfolio with exposures similar to the investor’s benchmark. It allows the investor to retain ownership of the concentrated position.
staged diversification strategy (e.g., selling stock over several years) is good in that it spreads the tax liability out over time, but it means losing ownership of the concentrated position, (was against example objective of wanting to retain control).
exchange fund involves numerous investors (each with a concentrated position in a single stock with a low cost basis) contributing their holdings into a newly formed exchange fund and then each owning a pro rata share of the new fund. As a result, it involves giving up most of the ownership of the initial concentrated position, which is against Stone’s objective from example.
Benefits of MCS for individual
from exam:
It can quantify the probability that Guthrie will have sufficient assets to last for her expected lifetime; in other words, it can determine probability of ruin.
It can incorporate path dependency issues such as how a change in inflation would affect her portfolio value and the need for distributions.
It can help Guthrie focus on her primary risk, which is outliving her assets, instead of short-term risk analysis focusing on volatility of return.
