I was under the impression that when asked for a return objective and or requirement, you utilize only what is absolutely needed of the portfolio, and consider secondary wishes such as charity and inheritance as an ancillary factor (do not include the amounts in the return calculation but maybe mention them in unique circumstances.)
In both 2008 #1 D and 2007 #1A, the amount that is requested to be set aside for charity and bequeath to children is included as part of the return calculation… along with the standard annual living expenses.
What is the consensus here? I remember specifically reading that these factors were secondary conditions and not part of a required return, but a “desired” return… yet neither of these two questions use the word “desired”.
My sense would be to view this in terms of overall risk tolerance, i.e. it would be OK to consider charity, bequests and other such factors in required return if an investor has an average to high risk tolerance. But I would exclude them and put them into the secondary or “desired” category if the overall risk tolerance was low.
I get the feeling that there is no hard and fast rule about what to include in required return calculations - it will depend on the circumstances of the particular client. If you justify your choice carefully in terms of how you see the risk tolerance and do the calcs correctly, then you will probably get many or even most of the points.
Yes, my approach would have been the same i.e. not to use amount to charity & bequeath in return calculation. I would have done it this way.
Annual Pre tax income (Required return to maintain the lifestyle) = C$ 200 k.
Asset base = C$ 1000k+2400k+800k= 4200 k. Real req return = 200 / 4200 = 4.762%. So Nominal = 4.762 + 2.50 = 7.26% additive or 1.04762* 1.025 - 1 = 7.38% multipilcative
After looking at answer guidelines they have included for return calculation desired terminal value = 3000k which gives us the return = 7.34% or 7.46% so there are differences in answers. I dun knw whether i would have got a credit for the above answer.
But then it made me think. Since these expenses are already planned these should be treated as required.
Schweser says:
Whether an objective is required or desired will be made clear in the vignette to the question.
"The exam question will sometimes ask for the return the portfolio must generate over the coming year or some other single year. In that case, you will total the client’s required expenditures for the year and divide them by the client’s investable portfolio.
In another common exam question format, the portfolio must meet the client’s retirement living expenses and a planned bequest at death (usually stated as a minimum portfolio value at death). Even though the amount of the bequest is known, you do not reduce the portfolio by the amount. Rather, you incorporate the current value of the investable portfolio, the client’s living expenses, and the value of the bequest into a time-value-of-money return calculation as present value, payment, and future value, respectively."
CFAI deals with IPS questions differently many times leaving us wondering.