WMCP flashcards
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32 cards. Read the term and the definition here. The deck at the top of this page is optional.
- Goal-based planning
- Goal-based planning links household goals to time-dated cash-flow targets, then determines required saving, asset allocation, and monitoring thresholds to fund each goal.
- Funding ratio
- A goal's funding ratio equals the present value of assets dedicated to that goal divided by the present value of the goal liability; below 1.0 indicates a funding gap.
- Required savings formula
- For level end-of-year deposits, PMT = (FV × r) ÷ ((1 + r)^n − 1) when r > 0; when r = 0, PMT = FV ÷ n.
- Present value of goal
- The present value of a future goal equals its future cost divided by (1 + r)^n; use a real return when the goal and cash flows are stated in today's dollars.
- Risk tolerance
- Risk tolerance is the investor's willingness to accept volatility and loss; it is psychological and may differ from risk capacity, which is the ability to bear risk.
- Risk capacity
- Risk capacity is the financial ability to bear risk based on income stability, liquidity, time horizon, and human capital; allocation is constrained by the lower of capacity and tolerance.
- Human capital
- Human capital is the present value of expected future labor income; it is usually larger for younger households and can support greater growth-asset exposure, all else equal.
- Goal prioritization
- Goal prioritization ranks objectives by essentiality and timing; essential near-term goals generally use lower-volatility funding, while discretionary long-term goals can accept more risk.
- Monte Carlo analysis
- Monte Carlo analysis simulates many return paths to estimate the probability that goals will be funded; results depend on assumptions and are not guarantees.
- Review triggers
- Review triggers include changes in income, health, family status, tax law, spending, or a funded ratio outside its tolerance band.
- Expected portfolio return
- Expected portfolio return is the weighted average of asset expected returns: E(Rp) = Σ wi E(Ri), where the weights sum to one.
- Two-asset portfolio variance
- Variance = w1²σ1² + w2²σ2² + 2w1w2ρ12σ1σ2; lower correlation reduces portfolio variance for given asset volatilities and weights.
- Efficient frontier
- The efficient frontier is the set of portfolios offering the highest expected return for each level of risk; mean-variance investors select a frontier portfolio matching their utility.
- Sharpe ratio
- Sharpe ratio = (Rp − Rf) ÷ σp; it measures excess return per unit of total portfolio risk, including systematic and unsystematic risk.
- Treynor ratio
- Treynor ratio = (Rp − Rf) ÷ βp; it measures excess return per unit of systematic risk and is useful for well-diversified portfolios.
- Jensen's alpha
- Jensen's alpha = Rp − [Rf + βp(Rm − Rf)]; a positive value indicates return above the CAPM-required return for the portfolio's beta.
- CAPM equation
- CAPM: E(Ri) = Rf + βi[E(Rm) − Rf]; beta measures an asset's sensitivity to market risk, and only systematic risk is compensated in equilibrium.
- Diversification effect
- Diversification reduces unsystematic risk through imperfectly correlated assets; systematic market risk remains and is the risk compensated in equilibrium.
- Rebalancing policy
- A rebalancing policy sets trigger rules, such as calendar or threshold bands, to restore target weights; it controls risk drift rather than forecasting returns.
- Asset location
- Asset location places tax-inefficient assets in tax-advantaged accounts when liquidity and tax rules allow, seeking higher after-tax returns for the household.
- Beta
- Beta measures an asset's sensitivity to market movements; a beta of 1.0 implies market-like systematic risk, above 1.0 greater sensitivity, and below 1.0 lower sensitivity.
- Investment policy statement
- An investment policy statement records goals, constraints, risk tolerance, target allocation, allowable ranges, rebalancing rules, and review procedures for a portfolio.
- IPS constraints
- Common investment policy statement constraints are liquidity needs, time horizon, tax circumstances, legal and regulatory requirements, and unique investor circumstances.
- Sustainable withdrawal rate
- A sustainable withdrawal rate is the inflation-adjusted percentage of a portfolio that can be withdrawn over a planned horizon with acceptable probability of not exhausting assets.
- Sequence-of-returns risk
- Sequence-of-returns risk is the danger that poor portfolio returns early in retirement reduce longevity, even if long-run average returns equal the plan assumption.
- Tax diversification
- Tax diversification holds assets across taxable, tax-deferred, and tax-free accounts, increasing flexibility for withdrawals, Roth conversions, and tax-bracket management.
- Estate planning documents
- Estate planning documents coordinate a will, trusts, beneficiary designations, powers of attorney, and health care directives to direct assets and decision-making.
- Insurance risk transfer
- Insurance transfers low-probability, large-loss risks to an insurer; deductibles and coverage limits balance premiums paid against risk retained by the household.
- Family governance
- Family governance clarifies decision rights, communication, philanthropy, and succession processes, supporting wealth transfer and reducing conflict across generations.
- Loss aversion
- Loss aversion is the tendency to feel losses more strongly than equivalent gains, which can lead to excessive risk avoidance or delayed loss realization.
- Recency bias
- Recency bias overweights recent market or economic experience in forecasts; it can cause performance-chasing, misjudged risk, and poorly timed allocation changes.
- Overconfidence bias
- Overconfidence bias is excessive belief in one's forecasts or skill; it can reduce diversification, increase trading, and understate planning risks.