8 return on the savings portfolio or 7 nominal after

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10.8% return on the Savings Portfolio (or 7% nominal after-tax return), then, by retirement age, she should accumulate: $10,000,000 + ($2,000,000 × 1.07 7 ) = $13,211,500 To generate $658,000 per year, a 5.0% return on the $13,211,500 would be needed. Risk Tolerance . The information provided indicates that Fairfax is quite risk averse; she does not want to experience a decline of more than 10% in the value of the Savings Portfolio in any given year. This would indicate that the portfolio should have below average risk exposure in order to minimize its downside volatility. In terms of overall wealth, Fairfax could afford to take more than average risk, but because of her preferences and the non-diversified nature of the total portfolio, a below-average risk objective is appropriate for the Savings Portfolio. It should be noted, however, that truly meaningful statements about the risk of Fairfax’s total portfolio are tied to assumptions regarding both the volatility of Reston’s stock (if it is retained) and when and at what price the Reston stock will be sold. Because the Reston holding constitutes 83% of Fairfax’s total portfolio, it will largely determine the risk she actually experiences as long as this holding remains intact. CONSTRAINTS Time Horizon . Two time horizons are applicable to Fairfax’s life. The first time horizon represents the period during which Fairfax should set up her financial situation in preparation for the balance of the second time horizon, her retirement period of indefinite length. Of the two horizons, the longer term to the expected end of her life is the dominant horizon because it is over this period that the assets must fulfill their primary function of funding her expenses, as an annuity, in retirement. Liquidity . With liquidity defined either as income needs or as cash reserves to meet emergency needs, Fairfax’s liquidity requirement is minimal. Five hundred thousand dollars of salary is available annually, health cost concerns are nonexistent, and we know of no planned needs for cash from the portfolio. 28-9
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Chapter 28 - Investment Policy and the Framework of the CFA Institute Taxes . Fairfax’s taxable income (salary, taxable investment income, and realized capital gains on securities) is taxed at a 35% rate. Careful tax planning and coordination with investment planning is required. Investment strategy should include seeking income that is sheltered from taxes and holding securities for lengthy time periods in order to produce larger after-tax returns. Sale of the Reston stock will have sizeable tax consequences because Fairfax’s cost basis is zero; special planning will be needed for this eventuality. Fairfax may want to consider some form of charitable giving, either during her lifetime or at death. She has no immediate family, and we know of no other potential gift or bequest recipients.
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  • Fall '10
  • SMITH
  • investment policy, CFA Institute, risk tolerance, time horizon

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