The Barretts are a very wealthy family (husband and wife are both 39 years old) with one child aged 11 and they currently have investable assets of $18,000,000. They hope to maintain their current lifestyle with average annual after-tax expenses of $200,000 which they want to come entirely from bond interest (they are in the 40% income tax bracket). They want to purchase a vacation home in Hawaii worth $3.5M while setting aside $250,000 for their child’s college education; the Barretts want to set aside these funds immediately. They also have placed the following constraints on the portfolio:
The bond funds are of equal risk and the Barretts don’t have a particular preference; they just want to get the highest after-tax return when choosing between the two funds with no funds in cash/money markets because the returns are too low to be interesting. They want the bond investment(s) to be determined and separated from the rest of the portfolio; remaining funds will then be invested in different risk-oriented asset classes available to them.
They believe that investments in US stocks should range anywhere from equal to double the amount of any investments in international stocks. They also want to have only a single investment in US stocks and a single investment in international stocks.
They don’t want more than 15% of the portfolio or less than 7.5% either in private equity or hedge funds or more than 25% in the total of these two alternative investment asset classes.
First determine an amount that will provide their income needs from bond interest and separate these funds from the rest of the portfolio. Then determine an allocation for the remaining portfolio that will provide a return of 5% annualized growth above inflation which they expect to be 3.0% annually (i.e. calculate the expected return for the portfolio assuming the bond investments and interest from the bond investments are not counted in the portfolio return).