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CFA® Level III · Portfolio Construction · free lesson
An Overview of Private Wealth Management
Private clients bring personal goals, human capital, family dynamics and taxes into every investment decision. This module traces how wealth is created, held and passed on, shows how human capital, financial capital and economic net worth shape risk-taking over a lifetime, turns a client's goals into a required return, risk tolerance and constraints, measures the drag of taxes and inflation, and sets out how a private client's investment policy statement differs from an institution's.
What you will learn
1. Describe how individuals create, hold and distribute wealth, and the structures they use to own and transfer it.
- Wealth is created mainly from earnings (human capital), business ownership, inheritance and investment returns.
- Entrepreneurs' wealth is concentrated and illiquid until a liquidity event, which brings diversification and tax decisions.
- Holding structures (trusts, foundations, holding companies, family offices, insurance wrappers) trade cost for control, tax, privacy and protection benefits.
- Wealth is distributed through spending, lifetime gifts, bequests and philanthropy.
- The source and life-cycle stage of a client's wealth shape their risk attitude and planning needs.
2. Assess how human capital, financial capital and economic net worth evolve over an individual's life and how they shape financial decisions.
- Human capital = PV of expected future earnings, discounted at the risk-free rate plus an occupational risk premium.
- Economic net worth = financial capital + human capital + PV of pensions and other inflows - liabilities.
- HC dominates early in life and is converted into FC through saving; at retirement HC is near zero.
- Bond-like HC supports more equity in the financial portfolio; equity-like or market-correlated HC supports less.
- Avoid concentrating financial wealth in the employer's shares; insure HC against death and disability.
3. Relate a private client's return objective, risk tolerance and constraints to their human and financial capital, and calculate a required return.
- Required pre-tax return for real-value preservation = [(1 + spending rate)(1 + inflation) - 1] / (1 - tax rate).
- Ability to bear risk depends on horizon, wealth relative to needs, human capital and liquidity needs.
- Willingness is psychological; when ability is lower, ability governs; when willingness is lower, respect it while educating.
- Constraints: liquidity, time horizon, taxes, legal and regulatory factors, unique circumstances.
- Human capital raises the ability to bear risk when it is large, stable and uncorrelated with markets.
4. Evaluate how taxes and inflation affect a private client's investment returns and decisions, including the value of tax deferral and real after-tax returns.
- Private clients face income, capital gains, wealth, transfer and consumption taxes.
- Annual taxation: [1 + r(1 - t)]^n; deferred gains taxed at the end: (1 + r)^n(1 - t) + t per unit of basis.
- Accrual-equivalent return = the annual after-tax return giving the same ending value.
- Real after-tax return = [1 + r(1 - t)] / (1 + inflation) - 1.
- Taxing nominal returns raises the effective tax rate on real returns when inflation is high.
5. Contrast private clients with institutional investors and draft the main elements of an investment policy statement for a private client.
- Private clients have multiple, changing goals, finite horizons, varied sophistication, family governance and heavy tax exposure.
- Institutions have defined missions or liabilities, long horizons, professional governance and are often tax-exempt.
- IPS sections: background and objectives, constraints, duties, investment guidelines, rebalancing, evaluation and review.
- An IPS sets policy (allocation ranges, limits, benchmarks, review triggers), not individual security choices.
- Record decision-making responsibilities for couples and families.
Module at a glance
- Wealth is created from earnings, business ownership, inheritance and returns, held directly or through trusts, foundations and family offices, and passed on by gifts, bequests and philanthropy.
- Economic net worth = financial capital + human capital + PV of pensions - liabilities; human capital is converted into financial capital over a career.
- Bond-like human capital supports more equity in the financial portfolio; equity-like or employer-linked human capital supports less.
- Required pre-tax return to spend and preserve real value = [(1 + s)(1 + inflation) - 1] / (1 - t).
- Risk tolerance combines ability and willingness; the lower willingness is usually respected, the lower ability always governs.
- Tax deferral compounds; inflation raises the effective tax rate on real returns.
- A private client's IPS sets objectives, constraints, guidelines, responsibilities and review triggers, not security picks.
This free module has 5 lessons, 18 practice questions with full explanations and 1 essay case with a model answer.