Hi All, couldn’t find any definitive answer on this. Schweser example has a woman who just retired with a $2M portfolio. She estimates she will need $60,000 after-tax in living expenses/year, and likes to keep six months of living expenses on hand. She also wants to continue to provide $30,000/year after tax every year to her adult son. Both living expenses & supporting her useless son expenses are expected to increase with inflation, 3%. They calculate required return as ($60K + $30K) / $2M = 4.5%, then add inflation to get 7.5%.
The question states that she wants to keep 6 months of living expenses on hand, why wouldn’t you remove $30K (=$60K/2) from the investable base? Thanks for any input.
Hmm hadn’t thought about it. Thought it was just a liquidity requirement, and didn’t eat up the investable asset base therefore. But the living expenses in and of itself are liquidity requirement already… hmm…
Cash on hand will still earn RFR and will be part of liquidity needs but pat of asset base. Keep a look out for it in Asset Allocation though if the questions asks to pick the best choice form a list. Cheers
This isn’t part of the investable asset base because she mentions that she wants to keep it in hand. I think it’s safe to assume that she does not want to invest it in anything and would just prefer to keep it in a savings/checking account in a bank. Therefore, this has to be removed from the investable base since the investment manager cannot invest that in any productive assets.
Think of it like how most questions treat the house in which the client lives in. The house DOES earn by way of value appreciation. Doesn’t mean that we consider it as part of the investable base because you can’t really make use the capital appreciation to satisfy liquidity needs (unless you go for a mortgage loan or some similarly complex arrangement).
It isn’t part of the liquidity needs since it isn’t a recurring expense.
Emergency reserve is part of investable assets. It might be more difficult to generate a high return with a portfolio with much cash on hands but that is another matter. Cash is more of a constraint that will be reflected in SAA
There was a year where there was a similar question. CFA gave 2 answers. You could keep the reserve in the investable base or you could take it out. Both are right ( according to CFA)
In every past exam I have done, they either give you cash to add to the base, or tell you the cash needed to subtract from it…sounds like this was a goof on their end and it should have been removed in the answer…either way, shouldn’t cost you too much if you show the work.
