- When calculating the required before-tax return, why isn’t inflation grossed up by 1-t?
- With regard to the $750k that will be donated “over the coming year,” why isn’t this amount discounted back to PV?
“over the coming year” does not give any indication of the length of time it could take , so treat it as cash , outside the portfolio . Keep it simple.
For #1 isn’t inflation always given as “Before-Tax”? I don’t have the question in front of me so I don’t know how it was asked but for me before tax return = Real return + Inflation. No tax adjustment needed unless specifically asked for AFTER-Tax returns.
Inflation is always considered tax free . Last year there were some posts on AF as to why inflation is shown pre-tax , when it can be argued that you pay taxes on inflated gains as well as real gains . It wasn’t resolved I don’t think. It is just a little scary that CFA never discusses that aspect , or some of us are overthinking it , and missing a point they’re implicitly making
Check this out.
CFAI book 2, page 177, last paragraph before Exhibit 5:
“Note, strickly speaking, the inflation rate should be adjusted upward by the portfolio’s average tax rate.”
CFAI book 2, page 193, last paragraph at the bottom:
“Her (Ms. Fairfax) 3% real, after-tax return…implies a gross total return requirement of ast least 10.8%, assuming her investments are fully taxable and assuming a 4% inflation.”
If you take tax rate of 33% .
( (1+0.03)*(1+0.04)-1 ) /(1-0.33) = 0.1078 ~ 10.8%
(1+ 0.03/(1-0.33)) *( 1+ 0.04/(1-0.33))-1 = .1078 ~ 10.8
Thanks Hank for setting me straight.
they simpilify but they tell you they do , just in this one place . Never seen it in an AM exam, because they never ask for gross total return , only an after tax nominal return
Got caught on a CFAI morning test somewhere – perhaps 2007 – where they stated that taxes apply only upon withdrawal from portfolio. I misssed the point and blew the RR by grossing up inflation.
so CFAI way is to get return first then calculate pre tax? agreeed?
CFAI way is to RTFP very carefully. The exams I’ve seen always specify how to handle taxes.
can you please provide an example or 2 how to treat taxes with different scenarios?