I dont get how they come up with the required return calculation on this. They say it is: Alison’s care = $105,000 Stipend= $50,000 Total= ~154,500/5000000 = 3.1% + 2% inf = 5.1% nominal required return The question states the daughters healthcare costs are rising at 5% per year. How can the nominal be only 2% above the real? Also, what about living expenses once he retires? I calculate needs of $280,734 by year 4, which is 5.6%, + inflation going forward. Can someone explain to me why the qestion and answer ignore the fact that the daughters healthcare costs are rising at 5% a year and the fact that in 3 years the salary that covers living expenses goes away?
my understanding on this: normal living expenses and stipend are to increase at 2% inflation. only medical expenses will increase by 5%. so we better adjust 5% medical increase in calculating annual medical expenses while when calculating the nominal return for portfolio, we need to adjust it by 2% normal inflation. if all expenses had grown by 5% (incl. living expenses), then we would have added 5% to calculate the nominal return,
I dont get that at all. If half of your liabilities are growing at 5%, and half at 2%, how can you only budget for 2% for all? And why no mention of the extra income needed after he retires?
The 2% is added just to protect the real portfolio value, not particular expenses. That’s why you add the overall inflation rate, not healthcare inflation. If you want to see a proof that this is correct (it’s not anywhere in the CFAI readings), check out the answer key to the 2005 exam #7, part A.
Do you know where I can find that exam?
google is your friend… to answer your other question, I believe that the required rate of return is only for the first year. The portfolio should be reassessed on at least an annual basis. But you need to consider the fact that the salary will go away in 3 years to address overall risk tolerance as well as the constraints (such as unique circumstances, liquidity, legal, potential need for life insurance) on the portfolio.
DoubleDip Wrote: ------------------------------------------------------- > google is your friend… > Thanks thats really helpful. I’ll be sure to direct you to google, the search function or your local library if you have any questions and I happen to have the answer.