When listing the multiple stages in the “Time Horizon” section of IPS, Schweser says consider a large inflow/outflow as a separate stage. However, in curriculum EOC questions, I see the answers ignoring large inheritances, such as in question 9a for reading 10. Page 216-217.
Can anyone provide clarification on this?
IMO, if the cash flow is large enough to change investor’s situation and requires for a change in IPS then it should be considered as another stage.
Generlany cash flows such as inheritance, signifacant gift, insurance, lottery etc change portfolio significantly (especially risk and return obectives) and create another time stage. Cash flows such as ordinary salary, retirement pension are regular and not so big in their nature thus are included in IPS at the beginning and don’t require further changes.
That is what I thought as well, but in the example, guy w/ $2 mil portfolio receives $2 mil inheritance, effectively doubling the size of portfolio, but the answer does not include that as a separate stage.
Ok, I read the question. His case is quite different, because as you can see he is currently making contributions to the portfolio (not withdrawals), has long stage horizon and high risk tolerance. This $2m cash flow, although large relative to current base, in reality changes nothing in his circumstances. He’s still not depeneden on portfolio, still has high risk-return, long term goal.
I think the rule of thumb here is to think in terms of cash flows changing circumstances of investor. Assumed that if he, initially, was able to cover his annual expenses with his salary (ie. no contributions to portfolio), such cash flow would change a lot. But it’s not the case here.
Sometimes this questions can be interpreted in many ways. I also have problems and often don’t agree with the answer. I hope than CFAI will accept answers like yours in this case.