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Q: Finance Problem ( Answered 5 out of 5 stars,   0 Comments )
Subject: Finance Problem
Category: Business and Money > Finance
Asked by: tomfam18-ga
List Price: $5.00
Posted: 20 Sep 2005 20:47 PDT
Expires: 20 Oct 2005 20:47 PDT
Question ID: 570399
Old Alfred Road, who is well-known to drivers on the Maine
Turnpike, has reached his seventieth birthday and is ready to retire.
Mr. Road has no formal training in finance but has saved his
money and invested carefully.
Mr. Road owns his home?the mortgage is paid off?and
does not want to move. He is a widower, and he wants to bequeath
the house and any remaining assets to his daughter.
He has accumulated savings of $180,000, conservatively invested.
The investments are yielding 9 percent interest. Mr. Road
also has $12,000 in a savings account at 5 percent interest. He
wants to keep the savings account intact for unexpected expenses
or emergencies.
Mr. Road?s basic living expenses now average about $1,500
per month, and he plans to spend $500 per month on travel and
hobbies. To maintain this planned standard of living, he will have
to rely on his investment portfolio. The interest from the portfolio
is $16,200 per year (9 percent of $180,000), or $1,350 per
Mr. Road will also receive $750 per month in social security
payments for the rest of his life. These payments are indexed for
inflation. That is, they will be automatically increased in proportion
to changes in the consumer price index.
Mr. Road?s main concern is with inflation. The inflation rate
has been below 3 percent recently, but a 3 percent rate is unusually
low by historical standards. His social security payments will
increase with inflation, but the interest on his investment portfolio
will not.
What advice do you have for Mr. Road? Can he safely spend
all the interest from his investment portfolio? How much could he
withdraw at year-end from that portfolio if he wants to keep its
real value intact?
Suppose Mr. Road will live for 20 more years and is willing
to use up all of his investment portfolio over that period. He also
wants his monthly spending to increase along with inflation over
that period. In other words, he wants his monthly spending to stay
the same in real terms. How much can he afford to spend per
Assume that the investment portfolio continues to yield a 9
percent rate of return and that the inflation rate will be 4 percent.

Request for Question Clarification by omnivorous-ga on 21 Sep 2005 04:14 PDT
Tomfam18 --

There are 3 questions here.

1.  does he have enough to afford $2,000 per month?  Yes.
2.  what income would he have if he kept the real value of the
portfolio intact?  Does that mean retain the $180,000 -- or provide a
real return of 6% per year on it (9% - 3% is his current real return)?
3.  how much could he make each year if the portfolio goes to zero in
at his 90th birthday?

Best regards,


Clarification of Question by tomfam18-ga on 21 Sep 2005 06:26 PDT
I appreciate your help. I agree that those are the three questions. I
just don't understand how to figure it out. If you need more info, I
will try to help, but as I said, I really don't understand it.

Request for Question Clarification by omnivorous-ga on 21 Sep 2005 08:03 PDT
Tomfam18 --

The reason that I posted the Clarification Request was that the second
question is unclear: "what income would he have if he kept the real
value of the
portfolio intact?"  Does that mean retain the $180,000 -- or provide a
real return of 6% per year on it (9% - 3% is his current real return)?
 They're 2 dramatically different financial issues.

Best regards,

Subject: Re: Finance Problem
Answered By: omnivorous-ga on 21 Sep 2005 11:42 PDT
Rated:5 out of 5 stars
Tomfam18 ?

Mr. Roads is well-set with his financial plan, even with inflation
higher than forecast.

There are 3 questions here:

1.  does he have enough to afford $2,000 per month with inflation at
4% -- assuming that he doesn?t touch savings or his house but can use
the core portfolio?
2.  what spending level would he have if the core $180,000 is
untouched (at 4% inflation)?
3.  how much could he spend each year if the portfolio goes to zero in
at his 90th birthday?

These are all forms of Net Present Value calculations, including the
annuity that he would enjoy from the portfolio (#3).

Now here?s the key data:
?	Social Security is indexed and will provide a real annual return of
$9,000, no matter what the inflation rate will be.
?	Mr. Roads real concern is what happens to income & expenses with the
other $1,250 per month ($15,000 per year).
?	He has a portfolio (9%) and a savings account (5%) to produce the
other $15,000 per year.

So let?s proceed to answer the questions:

1.	Year 1 he has portfolio and savings to try to get the needed $1,250
which is not provided by Social Security:

Income = $16,200 + $600 = $16,800
Expenses: $15,000

Added savings: $1,800

In year 2, savings increase but expenses increase faster:

Income = $16,200 + (.05) * $13,800 = $16,890
Expenses = $15,00- * 1.04 = $15,600

Added savings are down = $1,290

It?s easier to iterative work like this with a spreadsheet:

?Alfred Roads Annual Financials?

Note that savings build through year 4.  Also, that we stay above
$12,000 balance there through year 7 ? then the portfolio withdrawals
have to start.

In the end, he still has $30,000 of his portfolio and all of the
savings ? but inflation?s going to pretty well eliminate the portfolio
in year 21.

2.	Here?s a scenario where we need to know what he can spend without
touching the $180,000 in principal and without touching the $12,000 in
savings.  In this case, we have to reduce the spending not covered by
Social Security ($15,000) enough that interest from growing savings in
the early years can keep an Annual Investment Net that doesn?t drop
savings below $12,000.

You can keep changing the number in cell B26 until you get there ? the
number is $12,019 ? PLUS his inflation-indexed Social Security of
$9,000 = $21,019.

That in contrast to $24,000 per year above but says that reducing
monthly spending from $2,000 per month to about $1,752 will leave the
principal in his portfolio, his savings and his house investment in
place should Roadsie live beyond 90.

3.	Scenario #3 sets up an annuity for his investment portfolio and
adds the Social Security and savings:

In Excel this is calculated with PMT function, the same function that
would be used to calculate a loan.  In this case, it?s an annuity,
with money coming back each month to Mr. Roads:


Rate:   is the interest rate for the loan ? and this has to match the
term (if monthly, then 0.75% or if yearly, then 9%)
Nper   is the total number of payments for the loan, here 20 years
Pv   is the present value or principal -- $180,000.
Fv   is the future value, or a cash balance you want to attain after
the last payment is made. If fv is omitted, it is assumed to be 0
(zero), that is, the future value of a loan is 0.
Type   is the number 0 (zero) or 1 and indicates when payments are
due. We?ll make sure that he has the money at the beginning of each
year, a 1.

The $180,000 paid as an annuity would be $18,090.  With Social
Security and cash from savings he?d have about $27,690 annually.  Note
that he could actually spend a bit more because his $18,090 tucked in
a savings account would earn another $452.25 in savings ? you can add
that or ignore it (I'd add it).

Adding it brings annual spending to $28,142.


Since this is your first experience with Google Answers, please be
sure to use the Clarification Request if any portion of this Answer is

Best regards,


Request for Answer Clarification by tomfam18-ga on 21 Sep 2005 12:35 PDT
Thanks so much.  You are a lifesaver. This is my first experience with
google and it has been great.  My husband has a problem that I am
posting for him shortly as well. It is longer, and he is willing to
pay more, so you might want to look it up.
Thanks again.

Clarification of Answer by omnivorous-ga on 21 Sep 2005 12:52 PDT
Tomfam18 --

Thanks so much for the kind words (and the extra sum!)  These finance
questions, sometimes get a little complicated, so I understand the

Best regards,

tomfam18-ga rated this answer:5 out of 5 stars and gave an additional tip of: $5.00
The researcher was very through, and prompt. Help was wonderful.

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