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Investment portfolio for retirement - time value of money

Finance example with regard to retirement and investment portfolios

Background for Problem:

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 month. 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.

Questions:
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 month?
Assume that the investment portfolio continues to yield a 9 percent rate of return and that the inflation rate will be 4 percent.

Attachments

Solution Preview

See the attached file. Hope this will help you to understand the problem. Thanks

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?

Mr. Roads want to spend $2000 per month ($1500 basic + $500 travel and hobby). His total annual requirement is $24,000
He will receive Social security payments = $750*12=$9000
The real interest rate on the investment is =1.09/1.04 - 1 (assumed inflation is 4%)
=4.808%
Thus his income from the portfolio in real terms = $180000*4.808%=$8654

If he want ...

Solution Summary

The solution advises Mr. Road about how much money he can spend per month. The problems useds concepts such as real interest rate, portfolio income, reinvestment, nominal value of portfolio, real value of portfolio and inflation. It makes use of time value of money concepts to calculate annuity.

$2.19