Before-Tax or After-Tax Adjustment? (Return Objective)

CFA Level III
#1

Hi all,

I was wondering if anybody could enlighten me with this question.

Specifically, Schweser, SS4, (book 1, pg 246). Return Objective calculation Before-tax.

-It says her marginal tax-rate is 25% on pg 244.

The calculation = “Expenses/Portfolio value + inflation rate” (Not adjusted for Taxes).

-Another case in CFAI has the inflation adjusted return divided by ( 1-Tax), which assumes that to grow her portfolio (she is still actively working), she needs adjust the returns for her active tax rate.

So:

  1. Is it likely, since she is a retiree, there are no taxes (ie. she is in a 0% tax bracket)? Even though she is receiving investment income?

  2. Or is it the way the question is worded, as it specifically asks for the “Before-Tax” calculation? So basically, just match the inflaction adjusted nominal figure, and ignore that the Investment Income return “After-Tax” will fall short of meeting expenses and fail maintain the Portfolio’s purchasing power?

#2

Before tax means before paying tax. If the tax rate is 25% and you want to grow the portfolio at 20% rate, you should earn 20/(1-25%). That is you should earn 26.67% on portfolio before paying tax. So 20% is the after tax return requirement and 26.67% is the before tax return requirement.

This is my understanding.