The Smiths' Liquidity...

thx FinNinja

How much is small?

I think there is another piece … to this puzzle. Like in Q 13.

There is a 26K excess of Expenses over Inflows. Say it had been 40K instead… If you had mentioned it as liquidity - you would take it off the current Investment Portfolio - so the current portfolio would be lower - and there is an expected required portfolio in 18 years or 20 years (some time in the future). If you used the

PV=, FV=, PMT=, N= and did the I/Y computation after deducting the amount — you would end up with the wrong answer.

I guess the other rule (at least per me) is that if there is a “Portfolio” expected value at the end of N years … the existing portfolio needs to “deduct” what is to go off immediately … like the 30K + 20K - and then look for the inflation growth on income matches expenses. … and then if Income < Expenses - that becomes a required portfolio payout - but is not a liquidity need (by this I mean it does not immediately reduce existing portfolio value).

Like that 26K is due duyring the course of the next year. It is not due IMMEDIATELY. But the 30K and the 20K are DUE IMMEDIATELY (So liquidity).

Wouldn’t that be double counting the 26K for expenses? I usually calc equired return as expenses/portfolio value. since current expenses are partially offset by current income you only have to withdraw a portion of the return.

so required return = total expenses/portfolio assets + Inflation

If, however, you calculated required return as:

Expenses = current needs(portion not offset by income) + future needs(portion offset by income)

Assets = Portfolio value

required return = current needs/portfolio value + future needs/portfolio value + inflation

Even thought you are removing $ from the portfolio returns, the portfolio as a whole is still getting larger and when you retire and start taking all of your expenses from the portfolio the required return would stay the same ( as long as you keep adding inflation into the requred return and your expenses do not change).

look at the example in the book with the 26K expenses…

there are two pieces the 30K and 20K being removed immediately. but the 26K is not specified as liquidity and it is only considered as annual expenses

so PV=-1500K, FV=2000K, PMT=26K, N=18 or so… and I/Y is computed as 4.427% (if I remember the numbers).

cpk, doesn’t annual expense become a liquidity concern if income cannot cover it?..damn…this is supposed to be simple topic…y am i confused???

if you took it as a liquidity constraint - you would reduce it immediately.

then instead of considering 1500 K as PV - it would become 1474K as PV

and your number for I/Y would be wrong.

The 26K is not due immediately - but it is due by the end of Year 1… that is the distinction I am trying to make (and it looks like unsuccessfully)

I understand now. You are correct the immediate liquidity needs would reduce the principle and increase the I/Y

Thanks for clarifying.

angry. I feel like a monkey trying to understand the things that humans take for granted…cpk thx for your patience. So the reason why the 26k is not a liquidity need is because it is due after a year for every year of the 18 years until retirement.

Q11: payment now = 50000, payment for daughter=15000 for the next 5 years, here the recurring expenses of 15000 are insignificant but considered in the liquidity portion

Q13:payment now = 50000,payment for net expenses=26000 for the next 18 years,here the recurring expenses of 26000 are not mentioned.

i m sorry…i still dont see it…the argument that 26000 is not an IMMEDIATE need does not detract fromt the fact that it is needed…

11 - they state that the College expenses have not been considered at all, and should be considered.

13 - looks like this state of 48K after tax salary and 74K in expenses has been going on for some time and the new advisor is trying to build this into the 2 Mill Portfolio required after 18 years.

Yes, there is no light at the end of the tunnel either. However do note that 13 was a past CFA Exam live question - and so it is a little more cut and dry there - since the guideline answer wrote it out in black and blue.

IMO, it also has to do with the age of the client.

For Ongoing expenses

If client is _ retired & dependent on portfolio _ for his ongoing expenses (like living expenses, medical expenses for individual or dependant) is will always be included in the liquidity section. Irrespective of amount (i.e. 2-4% )

However if the client is still working than any excess of expenses against income need to compared against the size of the investable assets. If it is low range i would say 2-4% it need not be mentioned in the liquidity section. Only we need to cash reserve to meet these living expenses as & when required. (My understanding)

Guideline answer for 2009 makes this point where if they retire at 60, living expenses become liquidity constraints. If they are postponing it till age 65, its not.

For immediate/emergency/unusal expenses

Irrespective of client age & status, need to be deducted from the investable asset base & mentioned in the section

ans 10.iv mentions this because Taylor age is 50 & recently retired

12 - Mesa are retired. Hence mention of annual expenses under liquidity, but then it says being met by portfolio (i guess because of large investable asset base)

13 (b) Maclin’s are at working age.

so do you guys think it also had to do with the age of the client in these ques…

angry