Answer to Question #204918 in Finance for arnold

Question #204918

Amy and Mike, a married couple, are considering retirement; they are both aged 65 and supply the following information:

  • They jointly own their home worth $820,000 and have no debt.  
  • They have a car ($30,000), home contents ($20,000) and savings ($20,000).
  • Amy’s superannuation is $260,000 (tax-free $52,000, balance from a taxed source).
  • Mike’s superannuation is $180,000 (tax-free $36,000, balance from a taxed source).
  • As ‘high growth’ investors, expected return on investments is 4.0% p.a. above the inflation rate (currently 3.0% p.a.).
  • They WANT $44,000 p.a. after tax to meet their living costs.

a)     Explain how Amy and Mike could derive their cash flow for retirement.

a)     Discuss adequacy of capital for retirement and show calculations.

a)     Discuss Amy and Mike’s risk tolerance relative to the ‘draw-down’ phase.


Expert's answer

(a)Preparing a retirement cash flow can help us to alleviate our concern and can help us from the rainy days in the future. This involves assessing our current income and future estimated wealth along with expenditure to be incurred in the future and rates of investment growth, inflation, among others.

(b)Since both of them do not have any liability to pay till now therefore there total net worth from the assets they are holding and retirement amount before and after tax is $ 13,19,440. From the above table we can conclude that both of them have $ 4,49,440 for expenses in the future. Below is the table showing forecasted expenses to be incurred by them. 

Both of them can incur $ 1,290 per month for living in this way their expense in a year will be $15,480. If they continue to work according to the estimated cash flow of expenses then they can save more then $ 44,000 in a year and can use their savings and assets for the next 29 years i.e. till the age of 94 years. Besides this both of them also get a return of 4% on the investment that they have done. This return is added as a income from investment. 

(c)Since future is uncertain. Therefore there is 100% chance either a person can earn profit or can lose the entire amount due to market risk, inflation rate, interest rate risk and volatility in the market. Therefore, in the case given above both of them show come under low risk tolerance. It is also advised to take aggressive risk at an early age i.e. when the person is young or young and married. As the age is increasing and it reached above 60 years the person should come under lower risk tolerance category. 

Below is the step that lower risk tolerance investor should follow:

  • The investor should diversity their portfolio. As diversification will help them not to lose their entire investment. 
  • The investor should do a proper analysis before investing in a plan and should select a plan with low risk and low return after attaining the age of 60.
  • The investor should invest in different plans like pension plan, stocks, retirement benefits and insurance plan. 

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