CFA L3 Individual PM

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CFA L3 Individual PM by Mind Map: CFA L3 Individual PM

1. Trusts

1.1. Types

1.1.1. Irrevocable

1.1.2. Revocable

1.1.3. Discretionary

1.1.4. Fixed Trust

1.2. Benefits of

2. Investor Characteristics

2.1. Situational Profiling

2.1.1. Examples of situational profiling approaches Sources of Wealth Earn it through employment Inheritance Entrepenuer Measure of Wealth The client's "perception" of their wealth, in terms of size. Stage of Life Foundation Accumulation Maintenance Distribution

2.2. Psychological Profiling

2.2.1. Traditional Finance Exhibit "risk" aversion Hold rational expectations practice asset "integration"

2.2.2. Behavioral Finance Biased Expectations Asset "Segregation" Exhibit "Loss" aversion

2.2.3. Personality Typing Cautious Investors Methodical Investors Spontaneous Investors Individualist Investors

3. IPS

3.1. Objectives

3.1.1. Risk Above Average, Average, Below Average Willingness Ability Willingness dominates Ability when there is a conflict between average and below average.

3.1.2. Return Spending Needs Analysis When dividing the living expenses by the asset based to come up with the real rate of return. Remove cash reserves or emergency funds from the asset base before computing the required rate of return. Multiple IRR approach Be aware if there are any "in the future" subtractions to what is needed in retirement (aka FV) from things like the sale of a second home in 10 years and using the proceeds from that house sale to subtract from their final number to adjust the FV number the financial advisor said was needed. Changes to Required Return as a result of being retired, living expenses, one-time liquidity needs Notice the question does not ask How "should" his expected return change? Rather, it asks How "has" it changed. If wages will grow at the same rate as expenses then we DON'T need to add inflation to the required return.

3.2. Constraints

3.2.1. Liquidity Ryan Smith (for the upcoming year) ANNUAL college payments for both daughters of 190k Since he is a net spender every year till retirement in 4 years. He will need 170k (200k living expense minus 30k salary) If a clients ongoing expenes are going to be met by after tax income in the coming year and every year going forward and they have set aside a years worth of emergency funds than: Even if a client has enough assets to cover any liquidity needs, you should still list what the liquidity needs are and the amount. (Chris Maclin)

3.2.2. Time Horizon # of stages Single stage 2 stage Multistage 3 stage Long term, short term, Intermediate Term Example of a client retiring in 4 years at age 46. Example of a 75 yr old client who is retired but plans to live for another 10+ years. Inger Family Even though the Dad was 57 and retiring in a year or two, because he was considered financially secure, his time horizon was long term.

3.2.3. Legal/Regulatory

3.2.4. Taxes

3.2.5. Unique Needs

3.2.6. As it relates to Asset Allocation Asset Classes Example of what changes should be made to CURRENT allocation due to clients change in objectives and constraints Real Estate International Equities Cash Domestic Equities Fixed Income

3.2.7. Side notes about IPS and working with clients One way in which a Financial Advisor might seek to reduce the tension between a clients current return requirement in the face of his current risk tolerance. Lower living expenses to allow for the client to be ok with earning a lower return. Client needs to earn a higher return if he wants to have a higher living expenses.

3.3. Good examples of IPS

3.3.1. Susan Fairfax IPS & subsequent asset allocation that is appropriate based on highest utility, shortfall level, safety first Scenario for IPS Return Objective Risk Objective Time Horizon Liquidity Needs Narrowing down the set of portfolio's based on clients IPS

3.3.2. Questions from Ronans essay workshop. (available via email)

3.3.3. 2012 Morning Essay (CALCULATE FV )Calculate the amount that would be needed to buy an annuity in 'x' number of years. The answer Time Horizon Question (Time Horizon & Liquidity) Liquidity Needs

3.3.4. 2013 Morning Essay (I) Tom and Liz Voort Scenario & Return calculation (Less than 2 years) Answer Liquidity Answer Determine the most appropriate portfolio given their objectives & contstraints Answer

3.3.5. 2013 Morning Essay (II) Scenario (community property) How much would first wife be entitle to. Force Heirship question & community Property

3.3.6. 2015 Morning Essay Scenario (calculate minimum amount that should be bequested to Husband to cover his needs). Calculate the minimum bequest from Betty's estate to her husband, Jack, in order to meet his spending needs & taxes. Time Horizon & Liquidity

3.3.7. Inger Family Peter & Hilda (the parents) Risk Tolerance

3.3.8. Christa Inger IPS LIQUIDITY Requirement answer If a client has expenses or lump sum withdrawals in the current year but will also be receiving an inheritance in the current year that EXCEEDS their withdrawals. They do not have any liquidity needs (It is worth mentioning this in my answer) RETURN requirement answer (based on current net annual expenses divided by asset base). (Less than 1 year). Even if the annual required return is .1% higher than the portfolio's expected return, her return requirement will not be met. It must be at least as high as the return requirement if not higher.

3.3.9. Chris Maclin IPS (More than 2 years from retirement) (2004 exam) Formulate a RISK & RETURN objective Risk Objective Answer Return Objective Answer Time Horizon & LIQUIDITY Time Horizon Answer Liquidity Answer

3.3.10. 2016 IPS Multiple IRR approach (TMV on calculator) Less than 2 years away. Return calculation curve ball Scenario Don't add future sales proceeds to today's PV. Duh! Subtract in from FV that is estimated they need in the reading. Also, if in the reading it says that all "cash flows" occur at the end of the month in terms of monthly contributions into a retirement account. You need to divide the annual savings by 12 months and multiply the 10 years by 12 months. Then when you compute I/Y it will give you a MONTHLY return. Just multiply that monthly yield by 12 months to convert it to an annual yield. That is your answer.

4. Taxes

4.1. Tax Regimes

4.1.1. Common Progressive The US is Common Progressive Notice it says that taxation for Interest Income may receive favorable tax treatment or even be exempt.

4.1.2. "Ordinary Income" Tax Rate Structure will either be Progressive or Flat Progressive Flat

4.1.3. What do the different Regimes mean Flat & Light vs. Flat & Heavy Flat & Light Flat & Heavy Heavy Cap gains Cap Gains are taxed at ordinary rates but other sources of INVESTMENT income receive favorable tax treatment. Light Cap Gains ONLY Cap gains receive favorable tax treatment, all other INVESTMENT income is taxed at ordinary tax rates. Heavy Dividend Dividends are the only INVESTMENT income taxed at ordinary tax rates and and every other INVESTMENT income receives favorable interest income.

4.2. Tax Loss Harvesting

4.2.1. The major value of participating in Tax Loss Harvesting is really just the ability to defer taxation into future years. Selling a security at a loss and reinvesting in another security is essentially just RESETTING the cost basis to a lower level & potentially increasing future tax liability. TOTAL Tax savings is 0 when implementing tax loss harvesting (and not reinvesting the tax savings)

4.2.2. TLH: Current Savings

4.2.3. TLH: Tax Deferral

4.2.4. TLH: Adding Net of Tax Principal Realizing a loss saves taxes in the current year. This money that was saved from paying taxes can no be used to invest in the portfolio.

4.3. HIFO & LIFO

4.3.1. An example where HIFO lots would be sold

5. Risk Management for Individuals

5.1. Human Capital & Financial Capital

5.1.1. Human Capital Includes "Unvested" pension benefits, since they are typically contingent on future work and are thus considered to be part of human capital. Formula P(s) = Probability of surviving to year 't'. Wt = the wages from employment in year 't' g = annual growth rate of wages rf = nominal risk free rate y = occupational wage volatility N = number of working years

5.1.2. Financial Capital Personal Assets Investment Assets Subdivided based upon marketability of the asset Non-Marketable Assets Employer Pension Plans (Vested) Government Pensions Account Type

5.1.3. Net Wealth (not to be confused with Net Worth, which is different) Takes "net worth" and adds and subtracts to it/from it.

5.2. A Framework for Individual Risk Management

5.2.1. The Risk Management Strategy for Individuals Specify the Objective Identify Risks Evaluate Risks and Select Appropriate Methods to Manage the Risks Monitor Outcomes and Risk Exposures and Make Appropriate Adjustments in Methods

5.2.2. Financial Stages of Life Education Phase age is when the individual is starting to invest in a trade through education. Early Career age 18 to early 30's Career Development ages 35-50 Peak Accumulation ages 51-60 Maximum earninfa and opportunity for wealth accumulation Increased interest in retirement planning Greater emphasis on stability vs. growth in investment portfolio Greater concern about tax strategies Increased concern about losing employment because it's harder to find at that age. Pre-retirement Early Retirement The first 10 years of retirement Late Retirement

5.2.3. The Individual Balance Sheet Traditional Balance Sheet Economic (Holistic) Balance Sheet EOC#22 Story Determining Net Worth on Econ BS. Changes in Net Wealth

5.2.4. Individual Risk Exposures Earnings Risk Premature Death Risk Longevity Risk Property Risk Liability Risk Health Risk

5.3. Insurance & Annuities

5.3.1. Life Insurance Uses of Life Insurance Tax sheltering Provide for loss of income to dependent beneficiaries Provides asset liquidation in the case of death and equal disbursement to beneficiaries if some assets are not to be sold off/liquidated. Types of Life Insurance Temporary Life Insurance Permanent Life Insurance Basic Elements of a Life Insurance Policy How Life Insurance is Priced Life Insurance needs Consumer Comparisons of Life Insurance Costs (mostly used for WHOLE LIFE policies since they are more difficult for consumers to compare one to another when shopping around.) Calculation of the Net Premium and Gross Premium How much life insurance does one need? Appropriateness of Life Inusrance 2 different methods used to calculate the amount of life insurance needed.

5.3.2. Disability Income Insurance What is meant by "disability" used by insurance providers typically specifies one of the following. Inability to perform the "important" duties of "one's" regular occupation. Inability to perform the "important" duties of "any" occupation for which one is suited by education and experience. Inability to perform the duties of "any" occupation.

5.3.3. Property Insurance Homeowners Insurance Auto Insurnace

5.3.4. Health/Medical Insurance Indemnity Plans The most flexible but also the coverage by the insurance provider is proportionally split % with the insured. Preferred Provider Organization (PPO) More expensive but also more flexible with the doctors you can see (allows for out of network visits to be covered) than an HMO Health Maintenance Organization (HMO) The cheapest of the plans but also the most restrictive in the fact that you must see only doctors within a network.

5.3.5. Liability Insurance

5.3.6. Other Types of Insurance

5.3.7. Annuities Parties to an Annuity Contract Classification of Annuities Deferred Variable Deferred Fixed (SPDA) Immediate Variable Immediate Fixed Advanced Life Deferred Annuity (DIA) Advantages and Disadvantages of Fixed & Variable annuities Payout Methods Annuity Benefit Taxation Appropriateness of Annuities

5.4. Implementation of Risk Management for Individuals

5.4.1. Determining the Optimal Risk Management Strategy "Loss Control" in Risk Management.

5.4.2. Analyzing an Insurance Program

5.4.3. The Effect of Human Capital on Asset Allocation Policy BB Example "Human Capital and Asset Allocation (1). What is the optimal allocation for financial capital, given what the human capital is like? don't over think this problem too much. It's actually easier when I just think it through in my head. Existing life insurance policy is not considered as part of "Financial Capital" Accounting for human capital risk when considering investment strategies Despite having an annuity A family where a husbands volatile income accounts for MORE THAN HALF of family income should consider more conservative investments in their Financial Capital and that are uncorrelated with the sector the husband works in.

5.4.4. Asset Allocation and Risk Reduction BB 17 Comparing two couples employment and income situation against each other to determine how each couple should invest and the relative value of "Human Capital" compared to each other. What's interesting to note is that for the couple with the more volatile (less stable) income, will likely have a lower combined Human Capital vs. the HC of a couple with stable income and jobs.

6. Estate Planning in a Global Context

6.1. Core Capital & Excess Capital

6.1.1. Computing Using Mortality Tables Sample Question Answer to question 1 Answer to question 2 (Capitalized value of their core capital spending needs)

6.1.2. Compute using Monte Carlo Analysis Sample Problem (Solution 1) Someone that wan't to be 98% certain that they will not run out of money if they retire at age 55. (Solution 2) Someone that wants to be 94% certain that they will not run out of money.

6.2. Domestic Estate Planning

6.2.1. Estate, Wills, & Probate Intestate Ways to avoid or reduce burden of probate Living Trusts Joint survivor accounts Life Insurance Retirement accounts

6.2.2. Legal Systems, Forced Heirship, Marital Property Rights Forced Heirship rules (That bratty little son, that you had out of wedlock, is going to be entitled to your estate). Ways to avoid forced heirship rules. So that bratty little kids out of wedlock are not going to get a dime. If forced heirship rule question states that children are entitled to 1/4 of the total estate and their are two children then each child gets 1/2 of the 1/4. How living in a FORCED HEIRSHIP jurisdiction can OVERRIDE what is assumed with COMMUNITY PROPERTY OR SEPARATE PROPERTY. Marital Property Rights/Regimes Community Property (assets accumulated ONLY DURING marriage) Separate Property Civil Law Common Law

6.2.3. Income, Wealth, & Wealth Transfer Taxes Generation Skipping

6.3. Transferring Excess Capital

6.3.1. Lifetime Gifts and Testamentary Bequests RV of tax free gift RV of taxable gift

6.4. Estate Planning Tools

6.4.1. Trusts Two categories of trusts Irrevocable trust Recovable trust Two structures of trusts Fixed Trust Discretionary Trust Spendthrift trust Countries with Forced Heirship rules Many countries prohibit the application of forced heirship rules to trusts, making trusts an especially useful tool in this regard.

6.5. Cross Border Estate Planning

6.5.1. Source Tax systems vs. Residence tax systems

6.5.2. Ways countries claim to have taxing authority over the same income or assets. Residence-residence conflict Source-source conflict Residence-source conflict