Hey everyone! For extra credit, I need to answer this question knowing that it is very hard but whoever is closest will get the most credit. Please help me! Here is the question:
Imagine that you have just acquired a new client, Mrs. Brooks. Mrs. Brooks is 75 years old, has a $25 million investment portfolio, and her living expenses are $170 thousand per month. She has no other income source. Her portfolio asset allocation currently is 40% in U.S. large cap equities, 10% in U.S. small cap equities, 10% in international developed markets equities, 10% in emerging markets equities, 25% in 1-year maturity municipal bonds, and 5% in gold. Mrs. Brooks fired her former investment advisor because she was unhappy with her portfolio’s volatility and because the size of her portfolio has decreased significantly over the past three years. Mrs. Brooks had a bad experience with a hedge fund at one point during her life, so she won’t invest in a hedge fund ever again. Mrs. Brooks does not like investments with long lock-ups. Her stated risk tolerance is quite low; in fact she mentioned during the client-intake process that she gets quite upset if her portfolio has a negative return of greater than 0.1% per month. How would you go about building a portfolio for Mrs. Brooks or what investment portfolio/strategy would you recommend for Mrs. Brooks? How would you explain your recommendation to her?
If it’s $170k per month, then that requires a post tax return of just over 8% a year.
With her low risk tolerance and not wanting to lose more than 0.1% a month, this would steer the investments towards money markets or quality corporate & government bonds.
Without the stated returns on the asset classes it makes it impossible to know what asset mix to use that could meet the required return.
At her age, unless she has any bequest requirements, she may as well put the proceeds in Tbills and run the capital down. Again we need a little more background to the IPS to understand her requirements.
Thank you so much for your response and help! I know we need more information to give an asset mix, but can you please help me in coming up with rough numbers? Like how much in corp bonds, gov bonds, money markets, etc? Just a rough breakdown please.
Thank you so much for your response and help! I know we need more information to give an asset mix, but can you please help me in coming up with rough numbers? Like how much in corp bonds, gov bonds, money markets, etc? Just a rough breakdown please.
Your client is essentially asking for an investment to deliver ~8% annual AFTER-TAX return with virtually no downside risk. Not possible, unless you knew Madoff back in the 90s.
Actually, if you assume that she’s going to last only another 25 years and doesn’t need to maintain the corpus, it’s only 6.78% after taxes: an annuity.
Thanks for the answer! Can you give me some more insight though on how you would set up a portfolio to get that return and what percentage in each type of asset? Thanks so much ! This will really help me.
Apart from an annuity (as the magician suggested), it is *impossible* to provide that kind of return without any potential downside risk – no matter what your asset allocation may be.
This Mrs. Brooks sounds like a real piece of work… a selfish, unrealistic old hag who wipes her a$$ with hundred dollar bills, but doesn’t truly understand that you need to take *some* risks in order to earn a rate of return that is materially greater than the rate of inflation. You can tell her that I said that.
I would do more FI than equity in the portfolio 70% Bonds 15% equity, 15% cash (Low Risk Tolerance even though High ability). I know my cash has to be atleast 1.5 year expenditures.
Return objective is maintain income worth 8% + inflation, grossed up to taxes, from the portfolio. The income from the portfolio construction if less than the required return, will have to deplete the investment fund
Based on this question and without the return and standard deviation given. it is also impossible to contruct a portfolio. (Note: we cannot assume the return and standard deviation)
To meet the return objective of $175,000 per month . The investment portfolio will need to meet a after tax return of (175,000 x 12)/ 25,000,000 = 8.16 %( inlfation not given)
Williness to take risk is low given that she was upset when her portfolio suffer a negative return of 0.11%
Ability to take risk: Her financial goal of $ 2million a year is rather large relative to her portfolio and she indicate that she don’t like investment with high lockup period. Thus the ability to take risk is low.
Overall risk tolerance: low
Recommendation: She will need to lower return objective if the parameter of her portfolio risk parameter cannot be violated. Alternatively she can accept a slight less comfortable of risk if she want her objective to be met.
