“Note 5: Max stated that his investment risk tolerance is “moderately high.” Max asked Depuy: “Beyond simply getting older, how can Jan and I lower our need to purchase life insurance?” Max also asked Depuy to explain the relationship between his job and term life insurance. Tom mentioned that he would like to follow in his mother’s career path and eventually become a tenured finance professor. Jan stated that “Max and I are concerned about outliving our assets and running out of income to fund our retirement needs.” 5. Taking into consideration Comments 1, 2 and 5 and Note 5, Depuy is most likely to recommend that Max and Jan increase their exposure to: A. risky assets. B. risk-free assets. C. lifetime income instruments.” (Institute 366) Institute, CFA. Level III 2013 Volume 2 Behavioral Finance, Individual Investors, and Institutional Investors. John Wiley & Sons (P&T), 6/18/2012. vbk:9781937537340#page(366). Answer given is B risk free assets. Why wouldn’t it be C which is an annuity and will allay concerns about outliving their retirement? This whole reading is full of BS (or unintuitive to me). (As others have pointed out), 80% stock allocation for Lee (in Q.3) makes zero sense no matter how you twist the meaning of human capital. So frustrating.
Agreed, asking us to consider note 5 in addition to comments 1,2 and 5 makes the question vague. My guess is that 3 out of 4 data points indicate increasing financial capital as % of total cap, so rf should be used as a counterweight, making B the best answer.
Thanks Oh.
(Stupid) comment: I didn’t think about this but an annuity would be part of human capital (similar to a pension) because it’s a future stream of payments, right? Whereas to be considered financial capital, you need to own these assets right now. In that case, B makes some sense.
Still, owning a risk-free asset has more risk of outliving your assets than annuity… “3 out of 4” notwithstanding. I just have to let that one go I guess :-))
The discount rate for the liability of lifetime living expenses is considered to be the real risk-free rate ( expenses not market related and beta=0 ) . So if your only goal is to provide living expenses in your lifetime, theoretically you should never run out of funds if you invest in real rate bonds .
Good point janakisri, subtle but correct (theoretically, maybe not in practice.)