I was wondering if I could get any advice on the IPS questions. Namely, 1) Question on adding the inflation component to the required nominal after tax return. Say they give you an asset base of $1,000,000 and say net expenses were $100,000 last year with inflation of 2% for the expenses and in general. So, your required nominal after tax return would be $102,000/1,000,000=10.2% if you wanted to maintain the NOMINAL value of your portfolio, but to maintain the real value of your portfolio the required return would be 10.2+2=12.2%, because your portfolio must increase just to break even with inflation. Am I approaching this right? 2) Anyone have any tips on how to tell if someone’s ability to take risk is above, average, or below average. I know the basic one’s like start at average and adjust, and willingness trumps ability, but I still seem to get this wrong a lot. For example, if your required nominal after tax return is 8% is that consdiered high or low? Thanks.
As my understanging, just for your reference 1) the return on portfolio need to be specified. If it is 0%, the answer is 10.2%, not 12.2%. 2) risk tolerance = min(willingness, ability), if willingness
- Yes, they will ask you for expensing that will be forth coming and you will need to account for future expenses that will increase with inflation, in a forward looking sense as they have not occurred yet. Then you concern yourself with purchasing power maintenance, which in general is where the second adjustment comes into play. 2) It would be typically obvious. For instance a long time horizon is a big one as well as a large asset base, these will increase the ability to assume risk. Things like extensive expenses (which are a high proportion of assets), liquidity requirements that might be high, need to maintain purchasing power, shorter horizon or small asset base would be negatives. 2006 had a good IPS questions about the soccer player on pluses and minuses of abiltiy.
Further to question 1, if expense are do very shortly, then they would factor more into immediate liquidity needs and should be deduced from assets.