FPC008 - Investment Advice Assignment

Assignment Task

Questio 1

Table: Rodney & Sarah Walker’s Balance Sheet

Assets
Assets	Owner	Value ($)
Lifestyle Assets
Principal Residents	Joint	1,000,000
Total
Personal Property
Car	Rodney	50,000
Car	Sarah	45,000
Investment Assets
AMP Super Account	Rodney	250,000
HESTA Super Account	Sarah	200,000
Bank Deposits	Joint	100,000
Total		1,645,000

 

Table 2: Rodney & Sarah Walker’s Cashflow Statement

Income	Year 1 ($)	Year 2 ($)
Combined salaries	$175,000	$175,000
Total Income	$175,000	$175,000
Expenses
Living Expenses	$80,000	$80,000
Loan Repayments	$4,350	$4,350
Tax	$40,059	$40,059
Medicare	$3,500	$3,500
Net Surplus	$47,091.00	$47,091.00

 

c) From analysing the client's balance sheet & cashflow statement as depicted above, planning issues which I identified in being able to minimise tax and maximise retirement savings were:

1. There is no income from either Rodney or Sarah which is outside of their wage. If there is no change to their cash flow, they will be forced to continue working longer than they would like to grow their retirement savings.

2. They possess no equities outside of the AMP & Hesta Super accounts. This will cause an issue for Rodney and Sarah to maximise their retirement savings.

3. They have no liquid assets to their names

4. They have no available tax deductions 5. If they are looking to grow their income and put excess capital into an investment portfolio, it will be very difficult. This will become more difficult if they are looking to have children in the near term future.

6. The surplus capital after expenses should be used to build a portfolio, and grow on their retirement assets for the future.

7. Outside of the home which is still being paid off, the assets they possess are both depreciating assets (cars).

Question 2 

Table : Brett’s Existing Investments

Investments	Value
Bank Account	$25,000.00
Term Deposit	$50,000 matures in 3 months
Term Deposit	$50,000 matures in 12 months
NAB shares	$15,000.00
ANZ shares	$4,800.00
WBC shares	$11,500.00
CBA shares	$10,000.00
Managed Fund	$70000 in Vanguard Balanced Index
Super Fund	$80000 in Vanguard Balanced Index
Total	$316,300.00

 

The breakdown above of Bret’s existing investments outlines four indicators points towards Brett having a moderately conservative risk profile. It is noted that without understanding Bret’s clear goals, objectives, time frame for his investment, his risk profile cannot be assumed.

1) A large portion of the portfolio (31.6%) is made up of term deposits stipulating there is a focus towards income and less risk.

2) Direct Shares make up only 13.1% of the portfolio, indicating volatility from individual equities is minimised by Brett.

3) There is a focus on dividends and income due to the focus on Australian Bank shares and term deposits.

4) The low level of cash (only 7.9% of portfolio) leads me to believe that Brett does have a willingness to take higher risk and he can withstand a higher level of market volatility. Therefore there could be a shift towards a more balanced portfolio.

b) Brett being aged 50 enables him the ability to continue to grow his assets through a more diversified portfolio following a structured meeting to outline his goals, objectives and time frame for his investment . If Brett was 25 years of age, this is a stage of life where an investor can take additional risk as they attempt to accumulate assets. The biggest advantage of investing at a younger age (25) is time and having an increased ability to reap the benefits of long-term investing. In comparison, if Brett was 62 years old, he is either retired, or looking to retire soon (ABS 2023). Therefore, at this stage of life, Brett will subsequently lose his salary, causing him to rely solely on his portfolio to fund his living expenses. This reliance on the portfolio will significantly adjust Bret’s risk profile compared to that of a 25-year-old who can take increased risk.

c) Options Brett has to raise the funds are:

1. Sell direct shares (NAB, ANZ, WBC & CBA) as they are the most volatile and use the $8,700 from the matured term deposit to fund the remaining amount for the car. At the 12 month point, Brett will still have $41,300 from the first term deposit which would now be sitting in his bank account with a total of $66,300 which can be used to fund his $50,000 holiday.

2. Use $25,000 in the bank account and use half of the funds from the first maturing term deposit. This allows for the direct shares to accumulate the dividend amount of $1,874 (excluding franking) over 12 months. At which point $50,000 out of the managed fund can be sold to fund his $50,000 holiday. This also reduces Brett’s exposure to Vanguard’s Balanced Index which currently makes up 47.4% of his total assets.

3. If Brett is looking to not touch ANY of his term deposit funds, another option is to sell the entire $70,000 managed fund, allowing for the car to be paid for. At the 12-month point, $5,000 worth of NAB can be sold, as this has the greatest exposure out of his direct equities, and added to the $45,000 remaining in the bank, to fund his holiday.

Question 3

a) If both Alfonse & Alice were to stop work now, their combined retirement fund will comfortably allow them both to reach their life expectancy. Whilst making 5% p.a. from their combined superannuation, it combats the 3% CPI p.a. and their income needs. See their cash flow forecast below:

Table : Alfonse & Alice’s Cash Flow Forecast

Year	Age	Start Super Balance	Investment Return	Estimated living expenses & Investment Withdraws	End Super Balance
2023	65	$850,000.00	$42,500.00	$66,950.00	$825,550.00
2024	66	$892,500.00	$44,625.00	$68,958.50	$868,166.50
2025	67	$937,125.00	$46,856.25	$71,027.26	$912,954.00
2026	68	$983,981.25	$49,199.06	$73,158.07	$960,022.24
2027	69	$1,033,180.31	$51,659.02	$75,352.81	$1,009,486.51
2028	70	$1,084,839.33	$54,241.97	$77,613.40	$1,061,467.90
2029	71	$1,139,081.29	$56,954.06	$79,941.80	$1,116,093.56
2030	72	$1,196,035.36	$59,801.77	$82,340.06	$1,173,497.07
2031	73	$1,255,837.13	$62,791.86	$84,810.26	$1,233,818.73
2032	74	$1,318,628.98	$65,931.45	$87,354.56	$1,297,205.87
2033	75	$1,384,560.43	$69,228.02	$89,975.20	$1,363,813.25
2034	76	$1,453,788.45	$72,689.42	$92,674.46	$1,433,803.42
2035	77	$1,526,477.88	$76,323.89	$95,454.69	$1,507,347.08
2036	78	$1,602,801.77	$80,140.09	$98,318.33	$1,584,623.53
2037	79	$1,682,941.86	$84,147.09	$101,267.88	$1,665,821.07
2038	80	$1,767,088.95	$88,354.45	$104,305.92	$1,751,137.48
2039	81	$1,855,443.40	$92,772.17	$107,435.10	$1,840,780.47
2040	82	$1,948,215.57	$97,410.78	$110,658.15	$1,934,968.20
2041	83	$2,045,626.35	$102,281.32	$113,977.89	$2,033,929.77
2042	84	$2,147,907.67	$107,395.38	$117,397.23	$2,137,905.82
2043	85	$2,255,303.05	$112,765.15	$120,919.15	$2,247,149.05
Alfonse now reaches his life expectancy, therefore estimated living cost is halved
2044	86	$2,368,068.20	$118,403.41	$62,273.54	$2,424,198.07
2045	87	$2,486,471.61	$124,323.58	$64,141.75	$2,546,653.44
2046	88	$2,610,795.19	$130,539.76	$66,066.00	$2,675,268.95

 

b) Three trade-offs which could be considered to help improve their retirement capacity above the estimated $65,000 p.a. would be:

1. Shift their risk profile from moderate to Growth: this would involve a discussion as to whether Alfonse and Alice would be comfortable investing a greater proportion of their assets into growth investments, specifically international and Australian equities. This would yield a greater potential for growth to help improve their retirement capacity, but it must be noted that with additional risk comes a greater potential for losses.

2. Selling their inner-city terrace valued at $2M, and downsizing to a smaller/cheaper place. For example, if they were to sell their $2M house, which they own outright, and buy a $1M place, they will have the ability to increase their level of funds invested substantially.

3. Continue to work for a longer period. This would allow for additional years of income to be received to boost their retirement capacity. I believe this the most unlikely trade-off they would choose, but it is an option which should be explored.

c) General considerations I would consider when constructing a portfolio for a client in their retirement would be:

1. Risk Tolerance- how much volatility the portfolio can take, whilst still meeting the client’s required expenditure and reach their investment goals.

2. What the Client’s goals will be for retirement- Are they simply looking to fund themselves into retirement, or are they looking to support grandchildren/family with an inheritance?

3. Estimated life expectancy (Time Horizon)- As the longer the life expectancy of a client is, it drastically adjusts their ability for risk.

4. Income requirements (Liquidity) - How much per year will the client need to live their life from funds from the portfolio.

5. Tax Implications- As Alfonse & Alice are in their retirement, tax must be considered to limit capital gains taxes.

6. Diversification of the portfolio- Is there a sustainable allocation of assets in the clients portfolio as they enter retirement.

Question 4

a) To find Jason!s expected return of his share portfolio, we must initially find the share weightings:

Table: Jason’s Share Portfolio Breakdown

Share	Total Investment	% of Portfolio
ARG	$10,000	25%
BHP	$7,000	18%
WOW	$9,000	23%
WES	$6,000	15%
CBA	$8,000	20%
Total	$40,000

 

Therefore, following the discovery of the portfolio breakdown, we can decipher the expected return

= 6.0 x 0.25 + 11 x 0.18 + 4.0 x 0.23 + 5 x 0.15 + 4.5 x 0.20

= 6.05% expected return of the next 12 months from the above share portfolio

 b) The tracking error of Jason!s managed fund over the 12-month period can be found by the following: TE= √∑(PR-B)^2 / (N – 1)

Where:

• TE = tracking error
• PR= Portfolio Return
• B= Benchmark
• N= Total Periods (Months)

Table: 12 Month Performance vs Benchmark

Month	Portfolio Return (PR)	Benchmark (B)
1	5%	1%
2	2%	2%
3	-7%	-1%
4	3%	-1%
5	-1%	3%
6	4%	1%
7	7%	2%
8	8%	3%
9	1%	-3%
10	2%	-4%
11	8%	3%
12	-2%	3%

 

For each month!s returns: (PR – B)

Table: (PR-B)

Month	(PR-B)
1	4%
2	0%
3	-6%
4	4%
5	-4%
6	3%
7	5%
8	5%
9	4%
10	6%
11	5%
12	-5%

 

Following this, each simple tracking error is squared:

Table: : (PR-B)^2

Month	(PR-B)^2
1	0.16%
2	0.00%
3	0.36%
4	0.16%
5	0.16%
6	0.09%
7	0.25%
8	0.25%
9	0.16%
10	0.36%
11	0.25%
12	0.25%
TOTAL	2.45%

 

Therefore, to find the tracking error of Jason!s managed fund over 12 months: TE= √(2.45% / 11) TE (annualised)= 4.719% p.a.

Table: Jason’s Share Portfolio Breakdown

Share	Total Investment	% of Portfolio
ARG	$10,000	25%
BHP	$7,000	18%
WOW	$9,000	23%
WES	$6,000	15%
CBA	$8,000	20%
Total	$40,000

c) In order to find the Beta of Jason’s share portfolio we must find the Beta value for the 5 shares below using the CAPM Model:

ri = rf + (rm – rf) x Bi + e

Argo: 6% = 2.75% + (9.5% - 2.75%) x

Bi 6%= 2.75% + 6.75%

Bi 3.25% = 6.75%Bi

Bi= 3.25%/6.75%

Bi (Argo)= 0.4815

BHP

11%= 2.75% + (9.5% - 2.75%) xBi

11%= 2.75% + 6.75%Bi

8.25%= 6.75%Bi

Bi = 8.25%/6.75%

Therefore: Bi(BHP)= 1.2222

WOW

4%= 2.75% + (9.5% - 2.75%) x Bi

4%= 2.75% + 6.75%Bi

1.25%= 6.75%Bi

Bi= 1.25%/6.75%

Therefore:

WES 

5%= 2.75% + (9.5% - 2.75%) x Bi

5%= 2.75% + 6.75%Bi

2.25%= 6.75%Bi

Bi= 2.25%/6.75%

Therefore: Bi(WES)= 0.3333

CBA

 4.5%= 2.75% + (9.5% - 2.75%) x Bi

4.5%= 2.75% + 6.75%Bi

1.75%= 6.75%Bi

Bi= 1.75%/6.75%

Therefore: Bi(CBA)= 0.259259

In order to establish Jason’s Beta for the entire portfolio we must use the following equation: B(Portfolio) ∑(Bi x P) Where Bi= Beta of stock P= % of total portfolio Therefore: B(Portfolio)= (0.4815 x 0.25) + (1.22 x 0.18) + (0.185185 x 0.23) + (0.333 x 0.15) + (0.259259 x 0

B(Portfolio)= 0.48442

From a portfolio beta of 0.48442 I can infer that the portfolio is anticipated to be roughly half as volatile in comparison to the broader market. This indicates to me that Jasons’s portfolio has been structured with a more conservative view. For example, if the stock market (i.e. ASX All Ordinaries) rose by 15%, I would expect Brett’s portfolio to rise by approximately 7.26%.

d) I would describe Jason’s managed funds as Alpha. This is because there are large differences each month between the benchmark and the portfolio return indicating there is a higher amount of risk taken compared rather than attempting to track the market. This indicates to me that the fund manager is not interested in matching the market index, but would rather try beat it on a consistent note, which was managed for 8 out of the 12 months of the year. Furthermore, as his managed fund is with an active manager I would assume Jason would be paying a fee in order to gain knowledge from a broker into riskier assets.

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