AWMA flashcards

32 cards. Read the term and the definition here. The deck at the top of this page is optional.

Real after-tax return

Nominal return adjusted for taxes and inflation: nominal return × (1 − marginal tax rate) − inflation rate. Used to compare purchasing power across taxable and tax-advantaged accounts.

Sharpe ratio

Risk-adjusted performance measure: (portfolio return − risk-free rate) ÷ portfolio standard deviation. Higher values indicate better return per unit of total risk.

Beta

Measure of a security's sensitivity to market movements. Beta of 1 moves with the market; above 1 is more volatile; below 1 is less volatile. Only systematic risk is captured.

Duration

Weighted average time to receive a bond's cash flows; modified duration estimates percentage price change for a 1% yield change. Longer duration means greater interest rate sensitivity.

Gordon growth model

Stock valuation formula: intrinsic value = next dividend ÷ (required return − dividend growth rate). Assumes constant growth and growth rate below required return.

Asset allocation

Distribution of a portfolio among asset classes such as stocks, bonds, and cash. It is the primary determinant of long-term return variability and risk.

Portability election

Allows a surviving spouse to use the deceased spouse's unused estate tax exclusion amount, provided a timely estate tax return is filed. Reduces estate tax for surviving spouse.

Charitable remainder trust

Irrevocable trust paying income to donor or beneficiaries for a term, with remainder to charity. Donor receives a charitable deduction for the present value of the remainder interest.

Standard deviation

Statistical measure of dispersion of returns around the mean. Higher standard deviation indicates greater volatility and total risk of an investment or portfolio.

Correlation coefficient

Measures the strength and direction of linear relationship between two assets' returns, ranging from −1 to +1. Lower correlation improves diversification benefits.

Efficient frontier

Set of portfolios offering the highest expected return for each level of risk, or lowest risk for each return. Portfolios below the frontier are inefficient.

Tax-loss harvesting

Selling investments at a loss to offset capital gains or ordinary income, then replacing with a similar but not substantially identical security to maintain market exposure.

Required minimum distribution

Minimum amount that must be withdrawn annually from tax-deferred retirement accounts after a certain age, calculated by dividing account balance by IRS life expectancy factor.

Bond convexity

Measure of the curvature of the relationship between bond prices and yields. Positive convexity means price gains exceed losses for equal yield changes, improving duration estimates.

Fiduciary duty

Legal obligation to act in the client's best interest, disclose conflicts of interest, and place client interests above the advisor's or firm's own interests.

Regulation Best Interest

SEC rule requiring broker-dealers to act in the retail customer's best interest when recommending securities, with obligations of care, disclosure, conflict of interest, and compliance.

Know-your-customer rule

Requirement for financial professionals to collect and verify client identity, financial situation, investment objectives, risk tolerance, and time horizon before making recommendations.

Risk tolerance

Combination of a client's ability to bear risk (financial capacity) and willingness to bear risk (psychological attitude). Both must be assessed and reconciled before recommending a portfolio.

Investment policy statement

Written document defining investment objectives, constraints, risk tolerance, asset allocation targets, and review procedures. Serves as the governing framework for portfolio decisions.

Anchoring bias

Cognitive bias where a client fixates on an initial reference point, such as a purchase price, and makes decisions relative to it rather than current fundamentals.

Loss aversion

Behavioral tendency where losses feel more painful than equivalent gains feel pleasurable, leading clients to hold losing investments too long or avoid necessary rebalancing.

Overconfidence bias

Tendency to overestimate one's knowledge, skill, or ability to predict market outcomes, often resulting in excessive trading or concentrated positions.

AUM fee

Advisory fee calculated as a percentage of assets under management, typically billed quarterly. Aligns advisor compensation with portfolio growth but may create conflicts with small accounts.

Suitability standard

Requirement that a recommendation be consistent with the client's financial situation, objectives, risk tolerance, and needs. Applies to broker-dealers under FINRA rules.

Client risk profile

Summary of a client's risk capacity, willingness, time horizon, liquidity needs, and experience. Used to match recommendations to appropriate investment strategies.

Conflict of interest

Situation where an advisor's personal or firm interests could influence recommendations. Must be disclosed and managed to protect client interests.

Recency bias

Tendency to give recent events more weight than historical data, such as assuming recent market performance will continue, leading to poor timing decisions.

Client communication documentation

Written record of meetings, recommendations, and client instructions. Supports compliance, protects against disputes, and ensures continuity of service.

Performance-based fee

Compensation tied to investment performance, often a percentage of profits. Can align interests but may encourage excessive risk-taking; must comply with regulatory limits.

Financial goal analysis

Process of quantifying client goals, time frames, and required savings or returns. Forms the basis for recommendations and progress reviews.

Client onboarding

Initial process of gathering client information, verifying identity, assessing risk tolerance, and establishing service agreements. Sets the foundation for the advisory relationship.

Periodic portfolio review

Scheduled evaluation of portfolio performance, alignment with objectives, and changes in client circumstances. Ensures recommendations remain suitable over time.