Question

Elizabeth Yeo,aged 60, is managing director of USX and plans to retire in one year. Yeo will receive a lump sum severance payment of $500,000 from the company and plans to close out her company 401K which is entirely invested in USX stock where she has currently about 35,000 shares. Yeo is widowed and has a son who is married and who has a high-level position at investment bank. Yeo maintain a money market fund currently value at 1.1 million and earns about 1.2% annually. she has a home, zero mortgage, currently valued at about 1 million and plans to continue living there , she also plans to begin to collect social security at the age of 62. her living expenses including maintaining the home, are about 80,000.00 a year. her living expenses are expected to grow at an annual rate of 3 % throughout her retirement period, which is expected to be 25 years given her families mortality history. you are requested to prepare an investment policy statement for yeo and make some investment recommendations.

Answer 1

A) Preparing an investment policy statement requires understanding about objectives (risk and return) and constraints of clients.

Investment objectives of Yeo

Return: Yeo is in maintenance stage of her life cycle (almost retirement). Her objectives are

1) Maintain real value of portfoliio

2) Provide for her living expenses after retirement

Her return requirement are given below

Living expenses required :$80,000 per year

Income through money market fund: 1.1 Million*1.2%=$13,200 per year

Income required=80,000-13,200=$66,800

Return required=66,800/500,000=13.36 percent

So she required 13.36 percent return on $500,000 which she has recieved from her company

When we consider inflation she requires 13.36%+3%=16.36% Nominal rate of return

Risk:

  Yeo is in maintenance stage of her life cycle. Although she has no more responsibilities she has to meet her living expenses whic increase with inflation. So her risk taking ability is average

Constraints:

Liquidity: As discussed she need 80,000-13,200=$66,800 per year 66,800/12=5,566.6

that is $5,567 per month is her liquidity requirement

Time period: Time period is 25 years as per mortality history (can change). We can say its a multi time horizon of 1 year up to retirement and 25 years after retirement.

Taxes: She is a taxable investor

She has no Legal and other constraints

Recommendation:

She requires 13.36 percent real rate of return to meet her living expenses and she is in retirement stage. So she should invest in fixed income instruments such as bonds and money market funds (80 percent) to meet her living expenses which guarantee the income. She can invest other 20 percent to low risky mutual funds and other low risky investments.