It has become apparent to me that the order in which the return components are taken into consideration effects the solution calculated under both the (1+r)(1+i)-1 framework, and the r+i framework. For example, first, adding inflation/fees (either additively or multiplicatively), then grossing the return up for taxes, or conversely, gross up the return for taxes, then adding inflation/fees (either additively or multiplicatively), yield very different solutions that are outside of what would be called a rounding error. Is one methodology more correct than the other? The Q1 on the 2009 exam grosses the return up for taxes, and then adds inflation, however, most of the solutions to Schweser study problems adjust for inflation/fees first. Any insight is appreciated. Thanks and good luck.
I think you have to think about what makes sense. For example, taxes and fees are paid on nominal returns, etc. For example, if you required real after-tax return is 2%, inflation is 3%, then after-tax nominal return should be (1+2%)*(1+3%)-1 = around 5%. Then add taxes and fees and you will get before-tax and fees nominal required return. does that help?
I have a related question on college expenses. Sometimes we put them in ongoing expenses and sometimes we discount them and subtract from investment base ? Lets say for the next 4 years we will pay our sons college , when calculating next years required return do we discount them and subtract form our asset base and then divide that our other income needs to tht number or we just add the college expense to our other expenses and then divide by investment base ? Thanks
My guess on college expenses PLEASE correct me if you disagree. 1) If the required return is for next years college expense then I wud treat as an expense and NOT subtract from asset base. 2) If the required return is for my sons college expenses in 18 years time then I wud get the discounted amount and SUBTRACT from the asset base. What u think?
Xtra, with the second one, you should incorporate the late college expense into the time horizon. A large colleg expense expectted to occur 18 years later justifies a multistage IPS.