Specificity of RR calculations in Individual Investor Portoflio

CFA Level III
#1

Curious as to how specific they are on the exams with regards to Return requirement calculations. In EOC Q1 (Page 202) Volume 2, the individual meets their annual expenses(132500) with a combination of her Income and Portfolio return. Also states in the passage that she requires an emergency reserve = to those same annual expenses = 132 500

Then they talk about the liquidity requirements and some of the portfolio Value from the portfolio(1,120,000) that could be used to meet those expectation of 132 500 for the emergency reserve.

The portfolio value is 1,120,000. When they do the RR calculation they use the 1,120,000 in the denominator. I would subtract the 132 500 required from the emergency reserve from that 1,120,000 then calculate the RR(Use 1,120,000 – 132 500).

In question 11 part IV. Question doesn’t explicitly ask for the RR but they go thru a similar type thing. In this question the first year of a students education 50000 is paid for by the portfolio value(600 000). Then when calculating the RR they use 550 000 in the denominator.

I don’t know if this stuff is a big deal but these type of discrepancies always bother me. Do I need to be concerned about this?

#2

The difference in those two examples is a matter of holding a portion in liquid reserves versus an actual expense within year 1. The emergency liquidity funds will still be a part of the portfolio, but they will likely be held as cash. You still need to consider it as part of the investable portfolio.

Schweser’s guidance is to subtract outflows that will occur soon (i.e., less than one year) from the investable base, which is what you saw in question 11.

Bottom line: A portion of the portfolio being held in liquidity reserves should not be treated as an outflow.

#3

Thanks. Much appreciated.