Rate of Return pre-tax calculation with inflation

CFA Level III Portfolio Management
#1

How to calculate pre-tax rate of return? In CFA AM mock, I did see some qns, the pre-tax return is calculated before adding the inflation, but in schweser they add in inflation then calculate the pre-tax.

example: Return required: 5%, tax rate 30%, inflation 3%

the pre-tax return in schweser : 5+3=8% : (1-0.3) = 11.43%

but in CFA answer : 5 : (1-0.3) + 3 = 10.14%

which one should we follow? I guess CFA? Anyone experience the same or I misunderstand the qns?

#2

all questions i came across add inflation BEFORE gross-uping for pre-tax return. If you think about it in practical terms, you are indeed taxed on nominal gains, even though real gains are zero or negative. id go with adding inflation before calculating the pre-tax return.

#3

Depends on the question.

Withdrawals from a taxable account = add inflation first

withdrawals from a tax deferred account = add inflation after tax adjustment.

There’s a few recent threads that discuss this in detail. Scroll back and have a look.

#4

thanks!

#5

Read the vignette!

It will tell you – explicitly – whether the inflation portion (which is not withdrawn from the portfolio, but left in the portfolio to grow) is taxable or not.

(Similarly for real growth of the portfolio, by the way, if they should include that.)

http://finexamhelp123.wpengine.com/inflation-in-required-rate-of-return-to-tax-or-not-to-tax/

#6

Hi Magician ,

Want to understand when it’s mentioned that ‘Income and Expense will grow at inflation’ , we add inflation to pretax return to calculate next year return requirement .

We do this assuming next year’s After Tax Income ( not before tax ) and expense will grow at inflation ?

Thanks

#7

If the after-tax income and expenses grow by inflation, the before-tax income and expenses also grow by inflation (because the tax rate is constant), and vice versa.

#8

Thank you its clear now . Sorry , was late in acknowledging as i could not locate this thread .

Also Request if you can confirm if my below understanding is correct :

Return calculations are usually at the end of the year . We assume all expense / inflow will happen in the end of year and thus our portfolio return will match the next year expense requirments ( end of the next year) ?

Thank you

#9

Yes, typically.

#10

Thank you magician .

#11

My pleasure.