Question

Question 14. John won the lottery on Monday and can take either $50,000 per year for 20 years, or $500,000 today. Bill won the same lottery on Tuesday and has the same options for receiving the cash. A well respected financial advisor is hired by both John and Bill. The advisor recommends that John take the $50,000 per year for 20 years but advises Bill to take the $500,000 up front payment. How is it possible to give different advice to two clients regarding the exact same cash flows?

Answer 1

This is because the financial advisor creates a different investment policy statement for both the clients.

Each client has different investment objectives, risk profiles, need for cash, financial position, etc. The financial advisor considers all attributes before making investment recommendations.

It may be possible that Bill is a younger client with a better risk profile who can take the 500,000 up front payment and earn a return over the market rate by investing in equities and other riskier asset classes.

On the other hand, John might be close to his retirement age and 50,000 payments for 20 years provides a steady source of income over his remaining life. John might not earn a return on his investment income more than what the lottery is offering due to a risk investment portfolio based on his ability to take risk. There might also be a possibility that John might invest in illiquid assets are earn higher return through illiquidity premium since his current liquidity needs might be low.