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Question 116478This question is from textbook Personal Finance
: Please assist me with the following question...thank you
Cliff Swatner is single, 33, and owns a condominium in New York City worth $250,000. Cliff is an attorney and doing well financially. His income last year exceeded $90,000, and he has sufficient liquid assets to supplement his condominium and other tangible assets. Several years ago, Cliff began investing in stocks and bonds. He made his selections on the basis of articles he read describing good investment opportunities. Some have worked well for Cliff, but others have not. Cliff has never taken the time to evaluate his portfolio performance, but he feels it isn't very good. Cliff currently has about $90,000 invested. He has been dating a woman lately and hopes to marry her in three years, at which time he will need $20,000 for marriage expenses and a honeymoon. Cliff's only other objective is to accumulate funds for retirement, but he does not have a specific dollar target for this goal. Cliff feels that he has a moderate risk-tolerance level.
Explain some disadvantages of Cliff's current investment approach.
Construct a portfolio for Cliff, limiting your selections to mutual funds (assume that he sells his current stock and bond holdings). Make sure your plan indicates specific dollar amounts for each portfolio component. Make sure your plan also explains your selections for each portfolio component.
Explain how Cliff should periodically rebalance his portfolio, indicating how frequently rebalancing should be done.
SHOW ALL WORK FOR EACH ASSIGNMENT AND EXPLAIN EACH STEP CAREFULLY.
This question is from textbook Personal Finance
Answer by bucky(2189)   (Show Source):
You can put this solution on YOUR website! This problem is probably beyond the scope of the problems you normally find in this forum.
Not that it's a trivial problem ... just not the ordinary math problems posted here.
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I doubt if you will get an answer for that reason, but here's a little food for thought
that you may want to consider before you develop any positions on the answer.
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A. The problem does not say whether Cliff owns his condo outright. If he has a mortgage on a
$250,000 condo (cheap for New York City) his payments become a factor that influences
what he can do with money.
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B. A $90,000+ salary sounds like a lot. It's not for New York City. New York has a high state income
tax, and the city also adds an income tax as I recall. The cost personal transportation
(car) is enhanced by the high cost of renting a place to park. And the general cost of
living in New York City is pretty steep ... especially for a professional person who probably
has lots of "necessary" expenses such as entertaining clients, running in social circles for the
sake of appearances, belonging to a health club, etc. In short, Cliff is not necessarily a
high income earner considering that he lives in New York City.
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C. Although Cliff has "sufficient liquid assets" (whatever "sufficient" means) to supplement his
tangible assets he has not necessarily positioned himself well. Most financial advisors
recommend that you have in the range of 4 to 6 months of liquid assets available for unforeseen
events such a medical emergencies, loss of job, business down-turns (a fall in billable
legal hours), loss of clients, etc. To provide this baseline, Cliff should probably have
$45,000 or so in ready reserve. (If he has mortgage payments he may even want more. No
sense in losing your house to foreclosure because your job is down-sized and it takes you a
year to find comparable employment.)
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D. Cliff also needs $20,000 for an upcoming wedding. Add that to the $45,000 in reserve and
you see a sizable portion of his $90,000 reserves obligated. That means that he has a limited
amount of funds to invest.
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E. There is no mention as to the extent that Cliff's wife-to-be will be able to contribute to
the family well-being. If she is not going to work, or if she can at best provide income
from low-level employment, the picture changes. There is an element of truth in two sayings
applicable to Cliff. One is, "Think about this ... you can marry more in 10 minutes than
you can earn in a lifetime." And two is, "Two can live as cheaply as one, it just costs
twice as much." Some food for Cliff to think about before taking the plunge.
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F. As far as re-balancing the portfolio, you may want to check out Scott Burns' Couch Potato
method for investing in stocks and bonds. It's a simple scheme that seems to work well, costs
no brokers' fees, and is available for essentially free. It is ideal for the person who
likes to manage his own money with little actual work involved. Just Google Scott Burns Couch
Potato and you will find lots of articles by Scott that are brutally honest about the
performance of his idea ... which seems to out-perform the majority of market gurus in
the long run. (It is based on low cost S&P 500 index funds for stocks and index funds for
corporate bonds.) It involves re-balancing between stock and bond funds once or twice a year.
Enuff said ... just research it and see what you think. (Scott Burns is an MIT graduate
who drifted into finance way back when. He writes finance columns that are syndicated
and printed in newspapers throughout the country. His last employer was the Dallas Morning News.
They hired him away from the Northeast US - Boston, MA as I recall.)
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G. Cliff really needs to set some intermediate goals -- yardsticks by which he can measure
his progress toward reaching his goal. I read recently that most people who reach retirement
now have only in the range of $50,000 to $70,000 saved up. That plus social security (if
it still exists) really means a meager existence in old age. At a 5% rate of return when
he reaches 65 years old, Cliff will need about $2 million to replace his $90,000+ salary,
(assuming he doesn't want to spend down the principal) and 30 years from now when he retires
that $90,000 won't buy what it does today.
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H. At the current age of 33 Cliff needs to be working hard at saving for retirement.
The power of compounding of interest and growth depends on having a pretty long time to
allow the compounding to boost your savings big time. Using the rule of 72 (your money will
approximately double in the number of years found by dividing the rate of return into 72) tells
you that at a rate of return of 7.2% your money will double in 10 years. Money you invest
at age 18 will double (neglecting taxes on it) by the time you are 28 and double again (i.e.,
become 4 times as much) by the time you are 38. The lesson being, the earlier you start
to save the better off you will be. Unless you hit the lottery (Plan A for lots of people)
if you start thinking about this when you reach 60 years of age ... it's almost too late.
Normally you will be too late to enjoy the benefits of compound interest and the only money
you will be able to tuck away during retirement will come from using those famous one line
financial security sentences ... "Welcome to WalMart" and "You want fries with that?"
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Anyhow, good luck with your analysis. Hope this gives you a little food for thought.
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