I’ve been facing difficulty with the constraints and what to mention in them.
According to Schweser, we have to mention in the Liquidity section of the constraints:“ongoing, anticipated needs for distribution such as living expenses”.
Yet in one of the blue box examples, The Dubois case(example 2), it is mentioned:“Dubois estimates she will need USD 60,000 her first year in retirement and likes to keep 6 months of her living expenses on hand…”.In th answer on liquidity constraints, Schweser mentions that the only constraint is “none beyond a 6month cash reserve”. I dont understand why we dont mention the living expenses as part of liquidity constraint.
What about if your income/regular inflows didn’t cover your living expenses…I guess that would result in needing to liquidate some of the portfolio if you wanted to maintain standard of living. Would this excess of living expenses over inflows go down as a “liquidity requirement”?
I do not recall having seen that in any previous year’s question - where that number is marked as a liquidity requirement. The excess of expenses over income - and believe me, you will see that all the time - either becomes a “regular” payment (outflow) from your portfolio (if your return req calculation is a multi year period_- or it gets used as a one time outflow to calculate return requirement for NEXT Year.
Usually you will see the liquidity being marked as “needed immediately” or “needed within 6 months” or something like that.
But I don’t think thats the case… As in part the second part of the example, her living expenses decreased. The question then becomes:“has anything changed in her liquidity constraints”? and the answer was, aside from the decrease in her living expenses, nothing major has changed.
Meaning they did mention the regular outflows from the portfolio
aside from the decrease in her living expenses, nothing major has changed.
the key part - nothing major changed.
how would they take the decrease in the living expenses - is that change sustainable? Is it going to be applicable to a considerable time in the future - if yes - then it affects the return requirement on an ongoing basis. you need less returns from your portfolio.
Ok so basically when schweser mentioned the following:“ongoing, anticipated needs for distribution such as living expenses”, they did not mean the normal living expenses over the course of the investment period, but over and above what was stated as needed living expenses in the IPS??
if you have anticipated expenses - over and above your regular - then you need higher liquidity
In this case - your expenses dropped - maybe they were a one-time drop or they may be ongoing. If one time drop - they do not constitute a liquidity impact. Your portfolio return woiuld cover the expense, and you would in fact have some savings left over. If they are an ongoing drop in expenses - then the return requirement would be adjusted with the lower expense.
If expenses increased suddenly - is it a permanent thing? if so - you would need to make sure your portfolio return requirement increases - otherwise you are going to have a shortfall. If not - you have a minor liquidity crunch in the current period - where you need to cover that additional expense.
As always I find the CFAI text to be clearer than Schweser when making judgment calls about these things. They are the unequivocal source.
Hey cpk123, I see you have been actively answering a lot of questions here recently, so thanks for that. I just wanted to clear something up…
I prevously asked:
“What about if your income/regular inflows didn’t cover your living expenses…I guess that would result in needing to liquidate some of the portfolio if you wanted to maintain standard of living. Would this excess of living expenses over inflows go down as a “liquidity requirement”?”
To which you replied:
"I do not recall having seen that in any previous year’s question - where that number is marked as a liquidity requirement. The excess of expenses over income - and believe me, you will see that all the time - either becomes a “regular” payment (outflow) from your portfolio (if your return req calculation is a multi year period_- or it gets used as a one time outflow to calculate return requirement for NEXT Year.
Usually you will see the liquidity being marked as “needed immediately” or “needed within 6 months” or something like that."
But then you go on to cut and paste the CFA explanation of:
Liquidity requirements can arise for any number of reasons but generally fall into one of the following categories: ■ Ongoing Expenses The ongoing costs of daily living create a predictable need for cash and consti- tute one of the investment portfolio’s highest priorities. Because of their high predictability and short time horizon, anticipated expenses must be met using a high degree of liquidity in some portion of the investment portfolio.
Do these two answers not contradict themselves? On the one hand you say ongoing expenses not covered by income etc are NOT usually counted as liquidity requirements and then the CFA mquote seems to suggest they are.
Ok thanks - I’m still far from confident that I really know how to deal with these issues at the moment. I’ve been through the material but am hoping these nuances will start to become clearer once I’ve hit a few AM mocks and see how the problems are framed etc