Question from Scheser:

Jane Smith has an investment portfolio of $5 million. She is 68 years old, retired, and has no children. After her death, she wishes to leave her portfolio to a local art museum that has given her relatively free access to art exhibits over the past decade. Her health is better than average, and she maintains an active lifestyle consisting of frequent swimming, biking, and playing tennis with friends at her country club. Smith estimates that to maintain her standard of living, she needs approximately $250,000 per year. Expenses are expected to grow at an expected inflation rate of 2%. She states that as a retiree, her tolerance for risk is “below average.” Smith has come to you for assistance in investing her assets.

  1. Smith’s return objective is closest to:

    a. 3%
    b. 5%
    c. 7%.

The answer is 7% because $250k is 5% of 5M, and they added on another 2% for inflation.

However, isn’t the question ambiguous? It doesnt say the client Jane wants to preserve the principle completely and only live off growth? It doesnt say Jane wants to give at least $5M to the museum. It also doesnt say how long Jane is expected to live (only her health is good)… Based on the asset amount, she could live on 0% growth for 25 years and still maintain her standard of living and then give the balance of the portfolio to the museum. 

What’s the best way to handle such a question that lacks so much information? I was being prudent and picked 3% because the Jane doesnt need to take the risk, since she has principle that can draw down for her retirement and still keep up with inflation.