Wealth Management Flashcards
Private Wealth Manager Skills
Technical Skills:
* Financial planning knowledge
* Capital markets proficiency
* Portfolio construction ability
* Quantitative skills
* Technology skills
* Language (bilingual) skills.
Soft Skills:
* Communication skills
* Social skills
* Education and coaching skills
* Business development and sales skills
Ethical Considerations for Private Wealth Managers
- Fiduciary duty and suitability
- Know your customer (KYC)
- Conflicts of interest
- Confidentiality
Private Client Segmentations
Robo-Advisors:
* The less affluent
* Work in a similar way to normal advisors;
Mass affluent:
* Highest number of clients per manager
* Less-personalized investment service
* Charged brokerage based on AUM.
* Likely have other financial planning needs
High-net-wealth (HNW):
* Fewer clients per manager
* Greater customization of investment services
* Likely have other financial planning needs
Ultra-high-net-wealth (UHNW):
* Few clients per manager
* Highly customized investment services
* Generally multigenerational in nature
* Likely to have complicated estate planning needs
* Likely have other financial planning needs
Some Personal Information Needed from a Client
Information Needed:
* Family situation
* Identification
* Additional career information
* Investment Background More details on financial goals and risk tolerance
* Current employment
* Experience with market volatility
* Interest in meeting specific goals or a particular return objective
* Liquidity needs
* Investment preferences based on his environmental and social concerns
* Background Information
* Investment Objectives
Types of Finanical Statements
Net Worth Statement: (personal balance sheet) It lists and values their assets and liabilities. Net worth
Holistic (Economic) Balance Sheet: is “Economic Net Worth” which includes the present value of non-marketable human capital and non-vested pensions (assets), and the present value of lifetime consumption and bequests (liabilities).
Statement of Cash Flows
Basic Tax Strategies
- Tax avoidance: Is the minimization of tax through mechanisms like tax-exempt accounts or gifting rules
- Tax reduction: This involves minimizing tax by investing in tax-effective investments
- Tax deferral: This involves minimizing tax by deferring tax liabilities
Types of Goals
Planned Goals: Can be reasonably estimated in terms of size and timing, and typically include
* Retirement
* Education
* Specific purchases
* Family events
* Wealth transfer
* Philanthropy
Unplanned Goals: Are more difficult to predict, but that are still very important, include
* Uninsured medical expenses, or care for elderly relatives
* Uninsured property repairs
* Other unforeseen expenses
The Wealth Manager’s Role
Plays a key role at clearly identifying and defining their:
* Quantifying financial goals
* Prioritizing financial goals
* Changing client goals
Types of Risks
Risk Tolerance: A client’s willingness and ability to take on investment risk.
Risk Capacity: A client’s ability to take on investment risk.
Risk Perception: How client assesses investment risk.
Risk Aversion: How the individual behaves when faced with negative outcomes.
Capital Sufficiency Analysis
Steps: Evaluate capital sufficiency in relation to client goals.
* Assess whether a client has the capital required to meet their financial goals (capital sufficiency or needs analysis).
* Deterministic forecasting: Uses the expected return to calculate whether the portfolio will meet their objectives
* Monte Carlo simulation: Allows to simulate many potential future outcomes based on assumed probability distributions.
* Other inputs include correlations, taxes, interest, and fees.
Types of Retirement Needs Analysis
How much capital an individual needs in retirement:
* Mortality tables
* Annuities
* Monte-Carlo simulation
Retiree Behavioral Tendencies
- Heightened loss aversion
- Consumption gap
- Annuity puzzle
- Investment income preference
Components of an IPS
The main components are:
* Background and investment objectives
* Investment parameters
* Portfolio asset allocation
* Portfolio management
* Duties and responsibilities
* IPS appendix
Background and Investment Objectives
Section of the IPS that details the client’s relevant details and their investment needs. This is the “why” and “what” of the IPS.
The client’s background information is likely to include:
* Market values of, accounts, and portfolios
* The client’s tax status
* Expected cash flows
Common financial objectives include:
* Retirement income needs
* Supporting family members
* Funding philanthropic activities
* Meeting bequest goals
Investment Parameters
Key investment preferences and includes:
* Risk tolerance
* Investment time horizon
* Asset class preference
* Other investment preferences
* Liquidity preferences
* Constraints.
Portfolio Asset Allocation and Management
Details the target asset allocation for the client based on their investment objectives and parameters:
* Discretionary authority: Full discretion, Partial discretion, or Non-discretionary
* Rebalancing
* Tactical changes
* Implementation
Duties and Responsibilities
Outlines the responsibilities of those implementing:
* Drafting and maintaining the IPS
* Developing, monitoring, and rebalancing an appropriate asset allocation
* Recommending or selecting investment options
* Monitoring costs and third-party service providers
* Reporting performance and taxes
* Voting proxies
* Assisting with private fund offerings
IPS Appendix
Additional information related to the management of the client’s objectives:
* Modeled portfolio behavior
* Capital market expectations
Portfolio Construction Aprroaches
The 2 main approaches are:
* Traditional approach
* Goals-based approach
Traditional Portfolio Construction Approach
The steps are as follows:
1. Identify asset classes
2. Develop capital market expectations
3. Determine portfolio allocations
4. Asset constraints
5. Implement the portfolio
6. Determine asset location
Goals-Based Portfolio Construction Approach
Step 3 Determine portfolio allocations of the traditional approach is where the goals-based approach is different.
* Involves allocating the client investments to each of the client’s goals (goal buckets).
* Looks to set maximum volatility levels or minimum probabilities of success for each bucket.
* Advantage: Helps the client to determine and monitor different investment objectives with more ease.
* Disadvantage: The resulting combined portfolio might not be mean-variance efficient.
Items in a Portfolio Report
Items to put in a Portfolio Report:
* An asset allocation report that reflects strategic asset allocation targets
* A detailed performance report
* A year-to-date performance summary report and a historical performance report
* A transaction details report showing contributions, withdrawals, interest and dividends, and capital appreciation for the current period
* A purchase and sale report for the current period
* Currency exposure report detailing the effects of exchange rate fluctuations
* A benchmark report that shows the performance of the portfolios asset classes
* An accompanying letter that provides market commentary, investment context, education, and other advice
Investment Plan Evaluation
Evaluating the success of client investment program might be expressed in either:
* Absolute (real return)
* Relative terms (return above a benchmark)
* Relative risk-adjusted return or downside risk.
Ways to Mitigate Double Taxation
Tax authorities can recognize this issue through various means:
* Franking credits: investors only pay any surplus of their income tax rate over the corporate tax rate.
* Qualified dividends: Lowering the tax rate for dividends on shares that are held for a minimum time
Types of Accounts
- Taxable account: Normal tax rules apply
- Tax-deferred account: Contributions are made on a pre-tax basis, returns are tax-free. Withdrawals are taxed at ordinary income tax rates.
- Tax-exempt: No taxes are applied to contributions, returns, or withdrawals.
Tax Systems
Tax havens: are a region/country with very low or zero tax rates for foreign investors.
Territorial tax systems: Tax locally generated returns. Returns earned outside of the locality are not taxed.
Worldwide tax systems:
* Tax all income of residents regardless of where in the world it is earned.
* This could give rise to double taxation.
* Tax credits or treaties can mitigate the effect of this double taxation.
* Usually based on the residence of the investor, but USA tax rules, is based on citizenship.
Asset Location
Is the process of assessing which asset classes should be held in which types of account.
The general rule, tax-efficient assets are less impacted by taxation, they should be held in taxable accounts, leaving less tax-efficient assets to benefit from tax-exempt or tax-deferred account status.
Potential Capital Gain Exposure (PCGE)
- A specific issue with mutual funds new investors in the fund buys into any unrealized capital gains tax liabilities of the fund without benefitting from the historic price appreciation.
- In order to investors to assess these unrealized capital gains, mutual fund data providers publish metrics
- A fund with a high PCGE has high potential capital gains tax liability for new investors
- This measure can be negative for funds with embedded net capital losses, which implies the ability to offset these capital losses against future capital gains.
Quantitative Approach to Tax Management
Can be used to carry out the following 3 tasks:
* Transitioning: From their existing portfolio to a new portfolio in a tax-aware and risk-controlled way.
* Tax-optimized loss harvesting: Systematically analyzing opportunities for tax loss harvesting that present themselves during the year.
* Gain-loss matching optimization: Assessing the optimal strategy with respect to realizing gains in order to avoid risk imbalances in the portfolio verses the portfolio objectives.
General Risk and Tax Considerations Relating to Concentrated Positions
- The level of company-specific risk inherent in the concentrated position. This is likely to be greater for private companies than for larger, more established public companies.
- The reduction in portfolio efficiency due to the lack of diversification.
- The liquidity risk inherent in the position. This is likely to be higher for privately held positions
- Any capital gains tax liability realized should the asset be sold. It is highly likely the concentrated position has seen long-term price appreciation and has a very low tax basis.
Appropriate Strategies for Dealing with Concentrated Positions
6 Approaches:
1. Outright sale
2. Staged diversification
3. Hedging and monetization
4. Tax-free exchanges
5. Charitable giving
6. Tax-avoidance and deferral strategies
Strategies to Equity Monetization
- Sell the security short while maintaining the original concentrated position.
- Sell a forward contract on the concentrated position.
- Enter a total return swap, paying the return on the concentrated stock; receive a fixed or floating rate
- Construct a zero-cost collar
Exchange Fund
Tax-Free Exchanges using a Partnership:
* Allows investors to contribute their low-basis stock position in exchange for a share in the fund.
* The exchange itself is not a taxable event
* When the investor redeems from the fund, they receive securities equal in value to their share
* The investor cedes control of the investment to the manager of the exchange fund who has discretion
* The fund also must hold at least 20% of the portfolio in “qualified assets” such as REITs
* Fees for redemption and management
Charitable Remainder Trust (CRAT)
- Irrevocable donation of to a trust and receive a tax deduction for the gift.
- Within the trust, the securities could be sold and reinvested in a diversified portfolio.
- The trust would provide income for the life of its named beneficiaries
- When the last-named beneficiary dies, any assets remaining in the trust would be distributed to the charity named in the trust.
- Could be used as a strategy to reduce concentrated positions.
Strategies for Raising Liquidity from a Concentrated Positions in Privately Owned Business:
- Initial public offerings
- Sale to a third-party investor, or an insider
- Divesture of non-core assets
- Personal line of credit
- Leveraged recapitalization
- Employee stock ownership plan (ESOP)
Strategies for Managing Concentrated Positions in Real Estate
- Outright sale
- Mortgage financing
- Donor-Advised fund (DAF)
Objectives of Gift and Estate Planning
- Income and liquidity
- Control
- Protection
- Tax-awareness
- Family wealth preservation
- Business succession
- Charitable goals
Personal Holding Companies (PHCs)
Controlled Foreign Corporations (CFCs)
Wealthy individuals often typically established in jurisdictions with low or no corporate income tax, allowing taxation to be deferred until profits are distributed from the corporation back to the owner.
Most countries are now restricting such practices to prevent aggressive tax avoidance.
Legal Systems
Common law countries: Allow testators to dispose of their estate as they choose.
Civil law countries: Tend to impose rules on how an estate should be transferred.
Wills
(Testament) is a legal document outlining how the author of the will (the testator) wishes their estate to be transferred to others on the event of their death.
Intestate
A decedent (person who has died) without a valid will, their assets are subject to distribution according to prevailing law.
Probate
On the testator’s death, the will undergoes probate, which is the legal process of establishing the authenticity of the will before its execution.
The probate process can delay transfer of assets, expose family secrets, and create large fees against the estate, especially if challenged.
Testamentary Bequest
Testamentary Gratuitous Transfer
Transferring assets after the donor’s death and taxes here may be paid by the estate (estate taxes) or by the recipient (inheritance taxes) depending on the rules of the jurisdiction.
It is common for transfers to spouses to be exempt from taxation.
Trusts
Is a structure in which a trustee holds and manages assets donated by the grantor (or settlor) for the benefit of the beneficiaries. Offers grantors the ability to transfer assets without the publicity associated with a probated bequest.
Key Motivations for Using a Trust Structure:
* Control
* Asset protection
* Tax considerations
Irrevocable vs. Revocable Trusts
Irrevocable trust: Cannot be changed by the grantor, and the trustee files tax-related documents and pays relevant tax from trust assets. Typically provide better protection from legal claims.
Revocable trust: May be dissolved by the grantor and the assets returned, but the grantor, rather than the trustee, will be responsible for filing tax-related documents and paying relevant tax from the assets.
Fixed vs. Discretionary Trusts
Fixed trusts: Distribute assets to beneficiaries according to a specified fixed schedule or formula.
Discretionary trusts: Allow the trustees discretion as to the timing and size of distributions to beneficiaries and are seen as less of a legal right to the beneficiary.
Foundations
- Are legal structures set up for a certain spending purpose, and can be set up to outlive the donor.
- When set up by a wealthy family or individual they are referred to as private foundations.
- These structures generally allow the grantor to maintain some level of control over decision-making
- Minimum level of spending required each year to maintain foundation status (must spend annually at least 5% of the prior year’s investment assets).
- It is usually the case that a gift to a foundation is tax deductible, investment returns in the foundation are taxed favorably, and assets held in a foundation are not subject to estate taxes.
Life Insurance
- Allows the donor to transfer assets (of paying premiums) to an insurer who promises to make a payment to a trust or individual(s) on the donor’s death.
- Many jurisdictions allow tax-free transfer of death benefits. Other tax efficiencies come from premiums not being subject to gratuitous transfer taxes and the payment reducing the donor’s estate,
- Life insurance could be taken out on the grantor on behalf of a trust, which would transfer proceeds directly to beneficiaries without going through the process of probate.
Common Family Governance Structures
- The board of directors, responsible for establishing the goals of the business and protecting the interests of shareholders of larger family businesses.
- The family council: A group of family members which liaises with the board
- The family assembly: A meeting of all family members at least annually to discuss the direction of the family-owned business and encourage contribution of intellectual and human capital.
- The family office: The investment and administration team that works on behalf of the family.
- A family foundation: set up to achieve the family’s charitable goals.
Family Business Succession/Exit
Options for business succession include:
* Transition of the business to the next generation
* Sale of the business
Other Considerations when Transferring Control:
* Timing of a business sale
* Selection of trustees
* Post-sale considerations
Planning for the Unexpected
- Anti-avoidance tax rules: Many jurisdictions penalize structures such as trusts that have been set up with the main motive of avoiding tax.
- Divorce: The impact depends on the marital laws of the jurisdiction that applies to family assets.
- Incapacity: The 2 major risks are the delay it causes in decisions being made, and the risk that decision-making power is transferred to a guardian who does not fully understand.
Living Will
Sets out the legally binding wishes of the founder regarding their medical care should they become incapacitated.
Power of Attorney
Allocates decision-making powers on either financial or medical issues to a third party which is “durable” in the sense it still applies even if the grantor becomes incapacitated.
Primary Components of an Individual’s Wealth
Human capital: This is the present value of the individual’s future expected labor income. The goal is to view human capital as its own asset with risk and return characteristics.
Financial capital: This consists of bank accounts, individual securities, pooled funds, retirement accounts, the family home, and any other assets owned by the individual.
Difference in Human Capital
- Professions with stable growth of future earnings would have a low discount rate to reflect low risk
- Professions with higher-risk cash flows higher discount rate
Key Steps in the Risk Management Process
The 4 Key Steps:
1. Specify the objective: The goal is to maximize household welfare through a balance of risk taking and safety.
2. Identify risks: There are 6 risks (earnings, premature death, longevity, property, liability, and health).
3. Evaluate risks and select appropriate methods to manage the risks.
4. Monitor outcomes and risk exposures and make appropriate adjustments in methods: Review the client’s risk management plan at major life changes.
Methods to Manage Risks
- Risk Avoidance: by not engaging in the risky activity
- Risk Reduction: by lowering the likelihood that a risk will occur or decreasing the severity of the loss
- Risk Transfer: through the purchase of insurance and annuities
- Risk Retention: (self-insuring) by keeping the risk and setting aside money to cover losses.
Education phase
Description and Age Range: Investing in knowledge through formal education or skill development
Key Characteristics:
* Financially dependent on parents
* Very little financial capital
* Almost no focus on savings or risk management
Financial advisor Can Help With: Those with dependents might need life insurance.
Early career
Description and Age Range: Completes education and enters workforce (age 18 to 20s or early 30s)
Key Characteristics:
* Gets married, has children, buys home
* High family and housing expenses may not allow for retirement savings
Financial advisor Can Help With: Life insurance can supplement lack of sufficient financial and human capital.
Career development
Description and Age Range: Specific skill development within a given field (age 35 to 50)
Key Characteristics:
* Accumulation for children’s college education
* Large purchases such as vacation home, travel
Financial advisor Can Help With: Retirement saving
Peak accumulation
Description and Age Range: Moving toward maximum earnings and greatest opportunity for wealth accumulation (age 51 to 60)
Key Characteristics:
* Retirement planning and travel
* High career risk as high-paying job might not be replaced
Financial advisor Can Help With:
* Reducing investment risk
* Developing retirement income strategies
Pre-retirement
Description and Age Range: A few years before planned retirement age
Key Characteristics: Income often at career highs
Financial advisor Can Help With:
* Decreasing investment risk
* Tax planning for retirement distributions
Early retirement
Description and Age Range: Period of comfortable income and enough assets to cover living expenses (at least first 10 years of retirement)
Key Characteristics:
* Use savings for enjoyment
* Most active period of retirement
* Less likely to suffer from cognitive or mobility impairments
Financial advisor Can Help With: Still a need for asset growth as this phase could last 20 years
Late retirement
Description and Age Range: Unknown duration
Key Characteristics:
* Physical activity declines
* Cognitive or physical problems may deplete savings
* May need long-term health care
Financial advisor Can Help With: Annuities to reduce or eliminate longevity risk
When Determining the Discount Rate for Vested Employer Pensions
Consider the Following:
1. Plan’s financial health, such as its funded status
2. Credit quality of the sponsoring company
3. Additional credit support
Risks to Human and Financial Capital
The 6-Risks:
1. Earnings risk
2. Premature death (mortality risk)
3. Longevity risk
4. Property risK
5. Liability risk
6. Health risk
Primary Purpose of Life Insurance
Is to help replace the economic value of an individual to a family or a business in the event of that individual’s death.
The family’s need for life insurance is related to the potential loss associated with the future earnings power of that individual.
Temporary Life Insurance
- Insurance for a certain period of time specified at purchase, known as a term.
- If the individual survives for the entire term, the policy will terminate unless it automatically renews.
- Premiums can either remain fixed (or level) or increase over the term as the mortality risk increases.
- There is no cash value for term life insurance.
Permanent Insurance
- Lifetime coverage, assuming the premiums are paid over the entire period.
- Policy premiums are fixed, and there is generally a cash value associated with the policy.
There are 2 basic types of permanent insurance:
* Whole life: remains in force for the entire life of the insured.
* Universal life: has more flexibility than whole life to vary the face amount of insurance, pay higher or lower premiums, and invest the cash value.
Participating/Non-Participating Life Insurance
Participating: allows for the cash value to grow at a higher rate than the guaranteed value based on the profits of the insurance company.
Non-Participating: Fixed growth values
Non-forfeiture Clause of Life Insurance
The option to receive a portion of benefits if payments are missed and the policy lapses.
1. cash surrender option, where the cash value is paid
2. paid-up option, where the cash value is used to purchase a single-premium whole life policy
3. extended term option, where the cash value is used to purchase a term life policy
Riders
: Provide protection beyond the basic policy or other modification to a basic policy provision. Examples
* Accidental death and dismemberment (AD&D)
* Accelerated death benefit
* Guaranteed insurability
* Waiver of premium
The Basic Elements of a Life Insurance Policy
- Term and type of insurance
- Amount of benefits
- Limitations under which death benefit could be withheld (suicide of the insured within 2-years, material misrepresentations)
- Contestability period: The period when the insurance company can investigate and deny claims.
- Premium schedule: Specifying the amount and frequency of premiums to be paid
- Riders: Modifications to basic coverage.
Parties Involved in Every Life Insurance Policy
There are 4 Parties Involved which are also considered basic elements:
* Insured
* Policy owner
* Beneficiary (or beneficiaries):
* Insurer
Main Considerations in Pricing a Life Insurance Policy
There are 3 Main Considerations:
1. Mortality expectations: Probability that the insured will die during the term of the policy.
2. Discount rate (or interest factor): Represents the insurance company’s assumed rate of return
3. Loading: Life insurance company expenses and profits, if any.
Load
The Gross Premium Equals the Net Premium Plus a Load Representing Costs to the Life Insurance Company:
1. Underwriting costs: Sales commission to the agent plus the cost of a physical exam, if required.
2. Ongoing expenses: Overhead and administration expenses, monitoring the policy, and verifying death claims. Renewal commissions are paid to the selling agent for the first years of the policy as an incentive.
Methods used to Compare the Prices of Whole Life Insurance Policies
There are 2 Methods:
1. Net payment cost index: This assumes that the insured person will die at the end of a specified period
2. Surrender cost index: This assumes that the policy will be surrendered at the end of the period and that the policyholder will receive the projected cash value.
Types of Life Insurance Companies
Stock companies: Owned by shareholders and have a profit motive, adds a projected profit to the load.
Mutual companies:
* These are owned by the policyholders themselves, so there is no profit motive
* Gross premium is typically higher than the net premium plus expenses.
* If mortality outcomes and investment returns are > expected, the policyholders receive a non-taxable return equal to the difference between the gross premium and net premium plus expenses.
Definitions of Full Disability
There are 3 definitions of full disability that address inability to perform the duties of:
1. One’s regular occupation
2. Any occupation for which one is suited by education and experience
3. Any occupation
Disability Contract Terms
- Benefit period: How long the payments will be made, typically until retirement.
- Elimination period (waiting period): The number of days that the insured must be disabled before payments begin.
- Rehabilitation clause: Benefits for physical therapy to get the insured back to work ASAP
- Waiver of premium: May suspend premiums during a disability period
- Option to purchase additional insurance rider: May increase coverage without further proof of insurability.
- Cost of living rider: Benefits will be increased by an accepted cost of living index or some specified percentage each year.
- Non-cancelable and guaranteed renewable: The insurance company must renew the policy annually provided premiums are paid.
- Non-cancelable: The insurance company must renew the policy annually provided that premiums are paid.
Homeowner’s Insurance
A homeowner’s policy can be specified as:
* All risks: All risks are included except those specified as being excluded.
* Named risks: Only risks specifically listed are covered by the policy
Claims can be Settled in one of 2 ways:
* Replacement cost: The benefit pays the amount required to repair or replace an item with a new item of similar quality
* Actual cash value: The benefit equals replacement cost less depreciation.
Automobile Insurance
Are based on the value of the vehicle and are underwritten on the primary driver’s age and driving record.
There are 2 types of coverage:
* Collision: Covers damage from an accident.
* Comprehensive: Covers damage from other causes, such as fire, hail, glass breakage, and theft.
Health/Medical Insurance
There are 3- kinds of health insurance:
1. Indemnity plan
2. Preferred provider organization (PPO)
3. Health maintenance organization (HMO)
Parties to an Annuity
There are 4 Parties:
* Annuitant
* Contract owner
* Beneficiary (or beneficiaries)
* Insurer
Annuity Types
There are 5 Annuity Types:
1. Immediate fixed annuity
2. Immediate variable annuity
3. Deferred fixed annuity
4. Deferred variable annuity
5. Advanced life deferred annuity (ALDA)
Payout Methods of an Annuity
There are 5-Payout Methods:
1. Life annuity: Payments are made until the death of the annuitant.
2. Period-certain annuity: Payments are made for a specific number of periods, regardless of life span.
3. Life annuity with period certain: Payments are made for the entire life of the annuitant or a minimum number of years (10 years) even if the annuitant dies (payments continue to the beneficiary for the remainder of the period certain).
4. Life annuity with refund: This annuity guarantees that the annuitant or beneficiary receives payments equal to the total amount paid into the contract.
5. Joint life annuity: Payments continue for 2 or more annuitants.
Factors that Would Increase Demand for any Annuity
There are 5-Factors:
1. Longer-than-average life expectancy
2. Greater preference for lifetime income
3. Less concern for leaving money to heirs
4. More conservative investing preferences
5. Lower guaranteed income from other sources (such as pensions)
Life Insurance Sufficiency
There are 2 techniques:
* Human life value method: Estimates the present value of earnings that must be replaced.
* Needs analysis method: Estimates the financial needs of the dependents.
Constraints
L – Liquidity
L – Legal Considerations
T – Tax Consequences
T – Time Horizons
U – Unique needs and Circumstances
Liquidity Requirement
- Ongoing expenses are not included as a component.
- Is only additional expense that are due in a years’ time or less.
Can Time Horizons for Goals be Multistaged
Yes, time horizons can be multi-staged and should be if there are different goals and periods.
