Reading 28: Overview of Private Wealth Management Flashcards
Private Vs Institutional Investors
Private clients have wide range of objectives some that may not be well defined and may can change over time. Insto clients have well defined objectives based on liabilities that are stable over time, with much longer time frames and some tax benefits. Insto’s are more focused on risk capacity than risk tolerance as they usually accept risk for returns (they have less emotional biases compared to private clients).
Personal Information
Manager should obtain family circumstances, proof of ID, employment information and future career aspirations, retirement plans, source of wealth, specific return or investment objectives, risk tolerance, and investment preference (related to liquidity or unique concerns).
Financial Information
Manger should collect net worth statement that includes assets and liabilities (life insurance, retirement accounts etc). As well as sources of income and expenses. Economic net worth statement includes human capital.
Tax Considerations
Income tax on any form of income including capital gains. Wealth based tax paid on real estate or on inheritances or gifts. Consumption tax like sales tax.
Tax avoidance: utilising investment accounts that are legally exempt from tax.
Tax reduction: being more efficient by investing in tax free securities or investing for capital gains where the jurisdiction has lower capital gains taxes.
Tax deferral: low turnover and capital gains defer tax payments, also 403(b) retirement accounts allow for tax to only be paid on withdrawals.
Planned & Unplanned Goals
Planned are reasonably estimated within a specific time horizon and include retirement goals, specific purchase like primary or secondary residence, funding education or significant family events, charitable giving.
Unplanned are unexpected in terms of amount and timing and include property repairs or unexpected medical.
Formulating Client Goals
Quantifying goals: assisting the client to put a dollar value on goals that may be hard to quantify.
Prioritising goals: a client having goals that are difficult to reconcile, the manager will help client prioritise these. These may not simply be the ones that occur in the short term that the client may think has high priority because of that.
Changing goals: goals may change over time of after changes in financial circumstances.
Risk Tolerance
The client may have different risk tolerance for each goal. Risk tolerance is more subjective than risk capacity which is more objective.
Capital Sufficiency
Enables the managers to determine the likely hood of their client being able to meet financial objectives, this can be based on deterministic forecasting or Monte Carlo simulation. Meeting the capital sufficiency without changing strategy is a goal.
Deterministic Forecasting
Assumes portfolio will achieve a single compounded growth rate across the clients investment horizon. Current value, investment horizon, forward looking annual return assumption, cash flows into the portfolio, and impact of taxes, inflation and fees are all needed. Easy to understand but singular return is not representative of actual market volatility.
Monte Carlo Simulation
Allows the inputs to vary and to be given a probability distribution. Each asset class can be modelled with its own risk and return assumptions along with correlations, instead of using a single portfolio return assumption. Large number of independent trials are done then aggregated to determine probability of client meeting goals. This is more complex. Can cause shortfall magnitude as it doesn’t consider amount by which an investment portfolio may fall short of goals.
Retirement Stages of Life
Education: emphasis on developing human capital rather than saving. Early career: enters workforce, starts family and assumes other responsibilities, saving for retirement begins. Career development: job skills expand, financial obligation increase, financial capital is building if successful. Peak accumulation: financial capital is typically greatest in decade before retirement, liabilities reduce and need for accumulated savings peaks. Preretirement: emphasis on accumulating savings still and reducing liabilities. Early retirement: depending on pension and investment portfolio to fund retirement lifestyle. Late retirement: expenses on leisure activities decrease but uninsured health care costs may rise.
Analysis of Retirement Goals
Mortality tables: shows life expectancy and probability of survival at different ages, the future cash flows required are calculated using these probabilities. It may be underestimated causing longevity risk.
Annuities: a way to determine the PV of future cashflows by pricing an annuity. Can reduce longevity risk. But annuity puzzle can occur where individuals avoid annuities as they are high cost, lock in certain lifestyle, or want to control their assets.
Monte Carlo can also be used, as discussed above.
Behavioural Considerations
Increased loss aversion in retirees, consumption gaps where spending by retirees is lower than economic forecasts due to uncertainty of future income, annuity puzzle previously discussed, lack of self control where clients want more income assets to spend more now.
What the IPS Covers
Client background and investment objectives. Key investment parameters. Portfolio asset allocation. Portfolio management and implementation. Duties and responsibilities of private wealth manager (covered subsequently).
Client Background & Investment Objectives
Obtained from personal, financial, and tax information as discussed earlier. Manager should consider all components of clients investment portfolio as well as any other financial assets. Objectives should be quantified, prioritised, and capital sufficiency should be determined.
