CFA Level III · Private Wealth Pathway

Working With the Wealthy: formula sheet

Full chapter guide

Key formulas

Ability versus willingness to take risk: Overall risk tolerance = the lower of ability and willingness (when they conflict); Standard exam approach: when ability and willingness differ, the more conservative one usually governs the risk objective. Explain why.
Concentration share: Concentration % = Value of single position ÷ Total investable (or total) wealth; Use it to show how dominant one holding is. State which wealth base you use.
After-tax return: After-tax return ≈ Pre-tax return × (1 − tax rate); Simple case where the whole return is taxed at one rate. Adjust if income and gains are taxed differently.
Liquidity coverage: Liquid assets ÷ Expected near-term cash needs; A result below 1 signals a liquidity shortfall. Include taxes, spending and commitments.
Active versus passive wealth: Active wealth = created by the client's own effort (business, career). Passive wealth = received without effort (inheritance, gift).; Active creators tend to show more confidence and willingness to take risk; passive recipients tend toward preservation.
Source-to-risk link: Source of wealth → concentration, liquidity, willingness to take risk → planning needs; Use as the reasoning chain in any essay answer.
Economic net worth: Economic net worth = financial capital + human capital + other (e.g. pension, social benefits) − liabilities; Useful when an employee's wealth is mostly future earnings. Treat it as a framework, not a fixed formula for every case.
Risk tolerance: Risk tolerance = ability to take risk (objective) combined with willingness to take risk (subjective); When the two conflict, the lower one generally governs the risk the portfolio should take.
Discovery to IPS link: Client information → objectives (return, risk) + constraints (liquidity, time horizon, taxes, legal/regulatory, unique circumstances); Use this chain to turn facts in a vignette into IPS content.
Risk tolerance: Risk tolerance = ability to take risk + willingness to take risk; Ability is objective (finances, horizon). Willingness is subjective (attitude). When they conflict, the lower one usually governs the risk taken.
Information types: Quantitative facts (balance sheet, cash flows, taxes) + qualitative facts (goals, values, attitudes, family); A complete discovery needs both.
Human capital: HC = Σ [ expected after-tax labour income(t) ÷ (1 + r)^t ], summed to expected end of working life; Discount at a rate that reflects income risk and the chance of death, disability or job loss. Stable income uses a lower rate.
Economic net worth: Economic net worth = financial capital + human capital + other non-traded assets (e.g. pensions) − liabilities (including PV of future spending); Also called total wealth. Not the same as the net worth on a conventional balance sheet.
Excess capital: Excess capital = total financial wealth − core capital; Core capital is the PV of lifestyle needs plus a safety margin. If the result is negative, the client has a shortfall.
Core capital needed: Core capital = PV of required spending and other must-pay liabilities, discounted at a conservative (low-risk) rate, plus a safety margin; A lower discount rate gives a higher core capital. This reflects the demand for high confidence.
Overall risk tolerance rule: Risk tolerance = lower of (ability, willingness); Where ability and willingness conflict, the more conservative one generally governs. The advisor may try to educate the client on willingness, but ability is a hard limit.
Personal (protective) bucket: Goal = essential needs; risk = low; required probability of success = high; Fund first. Typical assets: cash, high-quality short-term bonds, annuity-like or insured solutions.
Market (middle) bucket: Goal = important but flexible; risk and return ≈ diversified market; Typically a diversified portfolio using strategic asset allocation.
Aspirational bucket: Goal = wishes beyond lifestyle; risk = high; return target = high; Surplus money only. Failure would not change lifestyle. Concentrated, private or growth-oriented assets may fit.
Funding order: Personal → Market → Aspirational; Fund the most important goals first. What is left supports the higher-risk bucket.

Quick revision

Start every case with the client's objectives and constraints.
Source and stage of wealth shape attitudes, needs and behaviour.
Discovery means gathering both facts and the client's values and concerns.
Trust and clear communication are part of the advisor's work, not extras.
The holistic balance sheet includes business, property, human capital and liabilities, not only the portfolio.
Risk tolerance has two parts: willingness and ability. Do not mix them up.
When willingness and ability conflict, the lower one usually limits the risk you can reasonably recommend.
Goals-based planning ranks goals by priority and funds them accordingly.
Family members can hold different goals, so governance and communication matter.
The advisor must manage conflicts of interest and apply the Code and Standards.
In essays, answer exactly what the command word asks and no more.
There is no penalty for wrong answers, so never leave an item blank.

Common mistakes

Treating high net worth as meaning high risk tolerance. Fix: Assess ability and willingness separately. Use the lower one when they conflict and say why.
Ignoring that the client's job or business ties to the concentrated holding. Fix: Include human capital and business income. If both depend on one company, total risk is higher than the portfolio shows.
Assuming all entrepreneurs have high ability to take risk. Fix: Separate willingness from ability. A founder with most wealth in one illiquid company may have high willingness but limited ability.
Treating inherited wealth as always low risk tolerance. Fix: Say 'often' and check the vignette. Inherited clients may be cautious, but the facts of the case decide.
Treating discovery as only collecting financial numbers. Fix: Always include goals, values, family dynamics and attitudes. Name both quantitative and qualitative information.
Confusing ability and willingness to take risk. Fix: Ability comes from wealth, income, horizon and liabilities. Willingness comes from attitude and experience. State each separately, then say which governs.
Treating human capital as a financial asset that can be sold or rebalanced. Fix: Treat it as a non-tradable asset. Use it to judge how much risk the financial portfolio can carry, not as something you can reallocate.
Using a high discount rate for stable income. Fix: Match the rate to income risk. Stable income such as a tenured role gets a lower rate and a higher human capital value. Volatile income gets a higher rate.
Treating willingness and ability as the same thing. Fix: Ability is about finances and circumstances. Willingness is about attitude and emotion. Always label which one each case fact supports.
Letting high willingness raise overall risk when ability is low. Fix: Use the lower of the two. A confident client with a tight budget has low ability, so overall risk stays low.

Exam tips

Always tie the characteristic to an objective or constraint. A bare label earns little.
Quote the client's words when you name a bias. It proves you applied the vignette.
When asked to justify, give the feature and its effect in one sentence each. Do not write essays.
Show every calculation, even simple ones, and label the final number.
Check for conflicts between ability and willingness. They are a common exam trap.
Write the source of wealth and the stage in your first line of any essay answer. It anchors every later point.
Use the vignette's facts as evidence. Quote the detail (illiquid, single company, inexperienced) next to each recommendation.
Check the command word. 'Identify' needs a label; 'explain' needs a reason; 'recommend' needs an action plus a justification.