If we have an investor that has a large portfolio but no current income to cover their annual expenses, is that considered a below-average ability to take on risk? The reason I ask is in CFAI in the EOC questions, one guy has a portfolio of about $800k, no income, and annual expenses of about $50k. In the answer they specify “high personal expenses versus income” as a risk factor. I know the ability depends on a number of things, but all else equal, if there is no income, then that means below average risk? What if his portfolio was $10million, would “high personal expenses versus income” still be a factor in decreasing his risk ability?
If the portfolio was 10mm and his expenses stayed at 50k, i don’t think it would be a factor that would decrease his ability to take risk… 50K is 6.25% after tax in a 800k portfolio… at 10mm, it would a half percent, a very different story.
I realize the 10m vs. 800k is a very different story. But since the cfai stated “expenses versus income” and not “expenses versus portfolio size” I thought their point was more about the guy not working rather than his asset size.
sorry wandering, i misread your question… but i still think with a large enough asset base, the fact that the guy isn’t working shouldn’t make much of a difference.
If the assets basis is $1 million, annual spending still $50k. Is it a “high personal expense”? Personally, I think 5% after tax is a low rate, but I am not sure if CFAI also think so.
In the real world (not CFAI land) 5% is probably not sustainable over the long term.
If he has 10,000,000 in assets, a 1% dividend yield would provide 2x what is needed for annual expenses. So liquidity constraint would be low and risk tolerance would be high. Overall, as long as he’s able to keep pace with inflation while covering expenses his risk tolerance is above average.