Case 2. The Bruckner’s Asset Allocation (P892).
You have new clients, Erik and Senta Bruckner. They are in
their mid-30s and have two
children, Stella and Chloe, ages 6 and 8. The Brucknersâ
primary financial objective is to
provide for their childrenâs college education. Their
secondary objective is to plan for
retirement. They own a home with a mortgage and have total
family income of $100,000.
Sentaâs employer provides medical insurance and life
insurance. She participates in her
employerâs 401(k) retirement plan and currently has $40,000
in the plan. The funds are
invested in her companyâs stock. Erik is self-employed and
works from their home. He
has not established a retirement plan. After deducting the
amount of the mortgage, the
family has total assets of $200,000 available for investing
in addition to the $40,000 in
the retirement account.
The Bruckners want sufficient liquid assets to cover six
monthsâ income as a precaution
(0.5Ã$100,000=$50,000). At least 20 percent of the $50,000
should be in exceedingly
liquid assets, but the remaining 80 percent may be invested
elsewhere provided that the
assets meet the objective to provide sufficient liquidity.
The remaining assets ($150,000) are available for other
investments. These funds could
be allocated in numerous ways. Since the couple is
generating income, you expect the
Bruckners to conclude that income-producing bonds are not a
necessary component of
their portfolio. That conclusion, however, is not
necessarily correct. Bonds do offer
potential diversification and may be included as part of any
tax-deferred retirement
account. The interest income will not be taxed until the
proceeds are removed from the
retirement account and the flow of interest income will
compound over time. If Sentaâs
employer offers a bond fund as part of the retirement plan,
selecting the bond fund
instead of the companyâs stock makes sense from an overall
asset allocation perspective.
You decide to develop a sample asset allocation
illustration. Once the Bruckners have
grasped the concept, you can further subdivide the
allocation. The starting amount is
$240,000: the $40,000 in the retirement account, the $50,000
needed for liquid assets,
and the $150,000 balance. You decide that the retirement
account should be invested in
bonds and liquid assets should be in a money market mutual
fund that stresses federal
government Treasury bills. The balance should be divided
equally between large cap and
smaller cap stocks. To illustrate the allocation and its
possible results over time, prepare
answers to the following questions.
1. How much is allocated to each class of assets?
2. Based on the historical returns in Exhibit 10.2 in the
textbook, how much will be in
each account when the girls approach college age ten years
from now?
3. Since historical
returns are averages, how much will be in each account assuming that
the worst- and best-case scenarios based on Exhibit 10.4 in
the textbook were to occur?
(Be careful to select the appropriate time horizon for the
comparisons.)
4. What would have been the impact on the terminal amounts
in Question 3 if the
allocation had been 40 percent large cap companies and 60
percent small cap companies?
5. Given the values in Question 3, what is the portfolioâs
asset allocation after ten years
have passed? What steps should be taken?
6. If the Bruckners do not need the funds to finance their
daughtersâ college education,
how much will be in each account when they approach
retirement in their mid-60s under
the original allocation?
7. Based on the rate of inflation in Exhibit 10.2, goods and
services costing $100 will cost
how much at their retirement? How much annual income is
necessary to maintain their
standard of living?
8. If their combined life expectancy is 15 years at
retirement, can they maintain their
standard of living if their funds as a whole earn 7 percent
after they retire? What is the
future rate of inflation assumed in your answer to the
previous question? Is that
assumption reasonable?
9. Based on the above answers, what are some suggested
courses of actions the Bruckners
should consider taking?
