So they took the Cashflow needed (493K) and divided it by investable assets to get 1.17% annual return. I get that. But why do they add on 3% to adjust for inflation? That will get you $1.7MM of cashflow every year. Also, they arrived at 493K by adjusting living expense upwards by the inflation rate of 3%, so 493K is the cashflow they need in order to manage the expenses that are already inflation adjusted. Can anyone help?
B/c the 493k is goign to be increasing every year by 3%.
the confusing part is in the next example, on pg 184, they determine that 658K is needed on 13.2MM investable assets, so the return is 5%, no additional adjustment for inflation.
I agree that example on p. 184 is a bit confusing. I think what they are trying to say that at the moment of her retirement, when her investable assets are 13.2M and with her goal to maintain inflation-adjusted living expenses of 658K, she would need to generate a return of 5% at that moment of time (btw they omit to say that the return is “after-tax”). I think that 5% return should be adjusted by adding 4% inflation, to assure that inflation-adjusted living standards are maintained. Otherwise, she can still maintain her living standards on inflation-adjusted basis, but she would need to start depleting her principal balance for the 4% shortfall. I guess such strategy is sensible in a case where total return requirement considering inflation and taxes may not be realistic given certain level of risk investor is willing to tolerate. However, nothing in the case indicates that, and leaves us guessing. My opinion, in absense of any information, we should adjust returns by expected inflation, unless instructed otherwise.
right, I can understand if the client say I want a 3% real return, then you figure out what a 3% return would be then tack on the inflationary adjustment. In the first problem, they don’t know what the required return was, just that they need a nominal 493K. But yea, I think the CFAI wants you to add on inflation to the required return.