Individual IPS - Invasion of capital - 1997 exam question

Reading 15 - Question 12 page 204: Looks like the suggested response is invading the principal on the grounds of selecting portfolio B which has less risk than portfolio C. - I was under the impression that prinicipal invasion is a big No No, and one should rely on income from the portfolio. Smiths are 65 yrs old and could possibly live up to 90 or more. Invasion of principle may result in them running out of money. - The suggested response also does not care much about gifting $1MM to the grand daughter even though Smiths state that preservation of assets for grand daughter is important. Comments/Thoughts?

as I see it Smith’s have below-average risk tolerance in many respects because below-average willingness (ability is average). Hence if we understand that we are faced with the problem of capital invasion in long-term I would stress that we need try to convince Smith’s to reconsider their willingness (if their 2nd objective is really important for them) and to make efforts to earn some margin return to settle capital invasion problem (at least partially).

By the way what do you think about liquity requirement in the same question? In the answer they say that Smith’s current expense requirement of $150k is currently being met (by pension income, annuity payment and their portfolio (???)). There already were some discussions on this:,662087,662107#msg-662107 I agreed with MellonC00 it’s seems to be the wrong logic and it differs from CFA answers to other questions (in Liquidity requirement we always calculate the shortfall which should be funded from portfolio).

“objective of giving $1 million to grandaughter may not be fully obtainable” the smiths said this was a secondary objective, therefore this is a desire and not a constraint. Also keep in mind the question says to pick a portfolio taking into account portfolio characteristics OTHER THAN EXPECTED RETURN OR YIELD. therefore B is chosen in that instance

I think we are talking here about ii part of B question where we compare only returns

Both b and c meet the projected disbursements in year 1, but due to rising expeneses, c SEEMS more fitting BUT level of risk is too high given Smiths Risk Tolerance. Principal invasion is a no no ONLY if it dips inot the required capital base needed to obtain the return, like i said before, in this case it’s not really principal invasion but forfeiting their “objective/ Desire” of giving $1 million to their grandaughter"

I have a q about the living expenses-shortfall of 45000 currently. part C ii I do not see the after-tax calculation for 45000? He is taxed at 40 % right ?