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Management of Personal Finances

You have been asked by an elderly relative to take over the management of her finances. She is in reasonably good health, and currently lives in a "life-care" facility that offers a wide range of living arrangements, from independent, assisted living and custodial care. She has total funds of $1.1 million that provide the primary source of her income, about $50,000 yearly. Social Security income is about $10,000 a year. She has invested her funds in the past in money-market funds and / or CDs (certificates of deposit) because she's wary of stocks. However, her recent concern is that the money earned from her funds and Social Security won't be sufficient to meet the rising cost of her living arrangements, now about $30,000 yearly but increasing about 10% yearly. She has asked you to use your best judgment to develop a viable strategy that could reasonably sustain her current living situation for the next ten or more years. Provide her with a viable strategy (identify major asset types only); include your best assessment of estimated rates of return, annual income generated and possible risks.

Solution Preview

First of all let us calculate the actual return earned the elderly relative:

In this case the earning is $50000 on $1.1 million of financial assets. Thus the actual return is
=Earnings/ Financial Assets
= 50000/1100000
=4.54%
Let us first estimate the income desired by the relative in coming years
We will use the formulae:
Future Value (FV) = Present Value (PV) *(1+r)^n
After 1 year her requirement will be
30000*(1+.1)^1= $33000
After 2 years her requirement will be
30000*(1+.1)^2= $36300
After 3 years her requirement will be
30000*(1+.1)^3= $39930
After 4 years her requirement will be
30000*(1+.1)^4= $43923
After 5 years her requirement will be
30000*(1+.1)^5= $48315

After 10 years her requirement will be
30000*(1+.1)^10 = $77812

Investment Strategy
After 10 years the yield must be more than 77812/1100000= around 7.5% to sustain the future rise in income. The various options for the investment are:
Equities: Investment in shares of companies is investing in equities. There are two streams of revenue generation from this form of investment.

1. Dividend: Periodic payments made out of the company's profits are termed as dividends.

2. Growth: The price of a stock appreciates commensurate to the growth posted by the company resulting in capital appreciation.

On an average an investment in equities in has a given higher return with higher risks attached to it.

Bonds: It is a fixed income (debt) instrument issued for a period of more than one year with the purpose of raising capital. The central or state government, corporations and similar institutions sell bonds. A bond is generally a promise to repay the principal along with fixed rate of interest on a specified date, called as the maturity date. Other ...

Solution Summary

This in-depth solution with 1,143 words contains step-by-step calculations to determine the actual return and desired income over 10 years. It also proposes an investment strategy that covers equities, dividend, growth, bonds, certificate of deposits, mutual funds, cash equivalents and others. A analysis of the types of risks are provided along with references.

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