Reading 17: Excerpts from Invest....ivate Investors－LOS b average, expected, Investment

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 4: Private Wealth Management
Reading 17: Excerpts from Investment Management for Taxable Private Investors
LOS b: Explain the expected effects of shrinking time horizons, as investors grow older, on (1) the risk tolerance for average investors and that of very wealthy investors with bequest goals, and (2) the desirability of realizing taxable gains.

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The rationale for changing risk tolerance is that:

A) for most investors, a shorter time horizon implies more ability to tolerate risk, but for wealthy investors, the focus often shifts to the recipients of the estate.

B) for wealthy investors, a shorter time horizon implies less ability to tolerate risk, but for most investors, the focus often shifts to the recipients of the estate.

C) for wealthy investors, a shorter time horizon implies more ability to tolerate risk, but for most investors, the focus often shifts to the recipients of the estate.

D) for most investors, a shorter time horizon implies less ability to tolerate risk, but for wealthy investors, the focus often shifts to the recipients of the estate.

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Answer and Explanation

The rationale for changing risk tolerance is that for most investors, a shorter time horizon implies less ability to tolerate risk, but for wealthy investors, the focus often shifts to the recipients of the estate.

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As investors grow older, their time horizons shorten, and:

A) a minority of all investors have decreasing levels of risk tolerance.

B) most investors have decreasing levels of risk tolerance, but wealthy investors with bequest goals may have increasing risk tolerance.

C) most investors have increasing levels of risk tolerance, but wealthy investors with bequest goals may have decreasing risk tolerance.

D) most investors have increasing levels of risk tolerance.

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Answer and Explanation

Most investors have decreasing levels of risk tolerance, but wealthy investors with bequest goals may have increasing risk tolerance as the focus shifts to the time horizon of the recipient of the bequest.

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The desirability of realizing taxable capital gains:

A) often becomes greater as the investors time horizon shrinks.

B) often becomes less as the investors time horizon shrinks.

C) is not affected by changes in the investors time horizon.

D) is greatest immediately before the investors death.

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Answer and Explanation

The desirability often becomes less as the investors time horizon shrinks. This is because the cost basis will be reset to current fair market value upon date of death, so capital gains taxes are drastically reduced or eliminated at that point.