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Hello, I need help with my project for wealth management. We are asked to create an Investment Policy Statement for a client. I have attached a copy of the requirements as well as some course material.
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Asset Allocation I
Wealth Management
Economic Balance Sheet
• An accounting balance sheet reflects a point-in-time snapshot of an
organization’s financial condition and shows the assets, liabilities, and
owners’ equity recognized by accountants.
• An economic balance sheet includes conventional assets and liabilities as
well as additional assets and liabilities—known as extended portfolio
assets and liabilities—that are relevant in making asset allocation
decisions but do not appear on conventional balance sheets.
• For individual investors, extended portfolio assets include human capital
(the present value of future earnings), the present value of pension
income, and the present value of expected inheritances. Likewise, the
present value of future consumption is an extended portfolio liability.
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Asset Allocation Process
• Asset allocation should consider the full range of assets
and liabilities—both the financial portfolio and extended
portfolio assets and liabilities—to arrive at an
appropriate asset allocation choice.
• For example, an asset allocation process that considers
the extended balance sheet, including the sensitivity of
an individual investor’s earnings to equity market risk
(and that of the industry in which the individual is
working), may result in a more appropriate allocation to
equities than one that does not.
Asset Allocation Approaches
• We can identify three broad approaches to asset allocation: (1) asset-only, (2)
liability-relative, and (3) goals-based. These are decision-making frameworks that
take account of or emphasize different aspects of the investment problem.
• Asset-only approaches to asset allocation focus solely on the asset side of the
investor’s balance sheet. Mean–variance optimization (MVO) considers only the
expected returns, risks, and correlations of the asset classes in the opportunity
set.
• Liability-relative approaches to asset allocation choose an asset allocation in
relation to the objective of funding liabilities. Liability-driven investing (LDI) is an
investment industry term that generally encompasses asset allocation that is
focused on funding an investor’s liabilities
• Goals-based approaches to asset allocation are used primarily for individuals and
families, involve specifying asset allocations for sub-portfolios, each of which is
aligned to specified goals ranging from supporting lifestyle needs to aspirational.
Goal Based Approach
• Each goal is associated with regular, irregular, or bulleted cash flows; a distinct
time horizon; and a risk tolerance level expressed as a required probability of
achieving the goal.
• For example, a middle-aged individual might specify a goal of maintaining his
current lifestyle and require a high level of confidence that this goal will be
attained.
• That same individual might express a goal of leaving a bequest to his alma mater.
This would be a very long-term goal and might have a low required probability.
• Each goal is assigned to its own sub-portfolio, and an asset allocation strategy
specific to that sub-portfolio is derived. The sum of all sub-portfolio asset
allocations results in an overall strategic asset allocation for the total portfolio.
Goal Based Approach
• Goals-based asset allocation builds on several insights from behavioral
finance.
• The approach’s characteristic use of sub-portfolios is grounded in the
behavioral finance insight that investors tend to ignore money’s
fungibility and assign specific dollars to specific uses—a phenomenon
known as mental accounting.
• Goals-based asset allocation, as described here, systemizes the fruitful use
of mental accounts. This approach may help investors embrace moreoptimal portfolios (as defined in an asset-only or asset–liability framework)
by adding higher risk assets—that, without context, might frighten the
investor—to longer-term, aspirational sub-portfolios while adopting a more
conservative allocation for sub-portfolios that address lifestyle preservation.
Goal Based Approach
• Types of Goals
• As goals-based asset allocation has advanced, various classification systems for goals have
been proposed. Two of those classification systems are as follows.
• Personal goals—to meet current lifestyle requirements and unanticipated financial needs
• Dynastic goals—to meet descendants’ needs
• Philanthropic goals
• Personal risk bucket—to provide protection from a dramatic decrease in lifestyle (i.e.,
safe-haven investments)
• Market risk bucket—to ensure the current lifestyle can be maintained (allocations for
average risk-adjusted market returns)
• Aspirational risk bucket—to increase wealth substantially (greater than average risk is
accepted)
Asset Classes
• Asset classes can be defined as “a set of assets that bear some
fundamental economic similarities to each other, and that have
characteristics that make them distinct from other assets that are not
part of that class.”
• Capital assets. An ongoing source of something of value (such as
interest or dividends); capital assets can be valued by net present value.
• Consumable/transformable assets. Assets, such as commodities, that
can be consumed or transformed, as part of the production process,
into something else of economic value, but which do not yield an
ongoing stream of value.
• Store of value assets. Neither income generating nor valuable as a
consumable or an economic input; examples include currencies and art,
whose economic value is realized through sale or exchange.
Specifying Asset Classes
• Assets within an asset class should be relatively homogeneous. Assets within
an asset class should have similar attributes.
• Asset classes should be mutually exclusive. Overlapping asset classes will
reduce the effectiveness of strategic asset allocation in controlling risk and
could introduce problems in developing asset class return expectations. For
example, if one asset class for a US investor is domestic common equities,
then world equities ex-US is more appropriate as another asset class rather
than global equities, which include US equities.
• Asset classes should be diversifying. For risk control purposes, an included
asset class should not have extremely high expected correlations with other
asset classes or with a linear combination of other asset classes. Otherwise,
the included asset class will be effectively redundant in a portfolio because it
will duplicate risk exposures already present
Specifying Asset Classes
• The asset classes as a group should make up a preponderance of
world investable wealth. From the perspective of portfolio theory,
selecting an asset allocation from a group of asset classes satisfying
this criterion should tend to increase expected return for a given level
of risk. Furthermore, the inclusion of more markets expands the
opportunities for applying active investment strategies, assuming the
decision to invest actively has been made.
• Asset classes selected for investment should have the capacity to
absorb a meaningful proportion of an investor’s portfolio. Liquidity
and transaction costs are both significant considerations. If liquidity
and expected transaction costs for an investment of a size meaningful
for an investor are unfavorable, an asset class may not be practically
suitable for investment.
Asset Classes in Practice
• Global public equity—composed of developed, emerging, and sometimes
frontier markets and large-, mid-, and small-cap asset classes; sometimes treated
as several sub-asset classes (e.g., domestic and non-domestic).
• Global private equity—includes venture capital, growth capital, and leveraged
buyouts (investment in special situations and distressed securities often occurs
within private equity structures too).
• Global fixed income—composed of developed and emerging market debt and
further divided into sovereign, investment-grade, and high-yield sub-asset
classes, and sometimes inflation-linked bonds (unless included in real assets; see
the following bullet). Cash and short-duration securities can be included here.
• Real assets—includes assets that provide sensitivity to inflation, such as private
real estate equity, private infrastructure, and commodities. Sometimes, global
inflation-linked bonds are included as a real asset rather than fixed income
because of their sensitivity to inflation.
Asset Class Levels
Risk Factors
• Modeling using asset classes as the unit of analysis tends to obscure the
portfolio’s sensitivity to overlapping risk factors, such as inflation risk.
• As a result, controlling risk exposures may be problematic.
• Multifactor risk models, which have a history of use in individual asset
selection, have been brought to bear on the issue of controlling
systematic risk exposures in asset allocation.
• In broad terms, when using factors as the units of analysis, we begin with
specifying risk factors and the desired exposure to each factor. Asset
classes can be described with respect to their sensitivities to each of the
factors.
• Factors, however, are not directly investable. On that basis, asset class
portfolios that isolate exposure to the risk factor are constructed; these
factor portfolios involve both long and short positions.
Risk Factors
Risk Factors: Implementation
• The following are a few examples of how risk factor
exposures can be achieved.
• .
• Real interest rates. Inflation-linked bonds provide a proxy for
real interest rates.
• US volatility. VIX (Chicago Board Options Exchange Volatility
Index) futures provide a proxy for implied volatility.
• Credit spread. Going long high-quality credit and short
Treasuries/government bonds isolates credit exposure.
Asset Allocation: Steps
1. Determine and quantify the investor’s objectives.
2. Determine the investor’s risk tolerance and how
risk should be expressed and measured.
3. Determine the investment horizon(s).
4. Determine other constraints and the
requirements they impose on asset allocation
choices. (Tax status ,ESG issues,legal and
regulatory factors, political sensitivities).
Asset Allocation Steps
5. Determine the approach to asset allocation that is most suitable for
the investor.
6. Specify asset classes, and develop a set of capital market expectations
for the specified asset classes.
7. Develop a range of potential asset allocation choices for consideration.
These choices are often developed through optimization exercises.
Specifics depend on the approach taken to asset allocation.
8. Test the robustness of the potential choices. This testing often involves
conducting simulations to evaluate potential results in relation to
investment objectives and risk tolerance over appropriate planning
horizon(s) for the different asset allocations developed in Step 7. The
sensitivity of the outcomes to changes in capital market expectations
is also tested.
The Global Portfolio
• Financial theory suggests that investors should consider the global marketvalue weighted portfolio as a baseline asset allocation.
• This portfolio, which sums all investable assets (global stocks, bonds, real
estate, and so forth) held by investors, reflects the balancing of supply and
demand across world markets. In financial theory, it is the portfolio that
minimizes non-diversifiable risk, which in principle is uncompensated.
• Because of that characteristic, theory indicates that the global market
portfolio should be the available portfolio that makes the most efficient use
of the risk budget.
• Other arguments for using it as a baseline include its position as a
reference point for a highly diversified portfolio and the discipline it
provides in relation to mitigating any investment biases, such as homecountry bias
The Global Portfolio
• The global market portfolio is expressed in two phases. The first phase
allocates assets in proportion to the global portfolio of stocks, bonds,
and real assets.
• The second phase disaggregates each of these broad asset classes into
regional, country, and security weights using capitalization weights.
The second phase is typically used within a global equity portfolio
where an asset owner will examine the global capitalization market
weights and either accept them or alter them.
• Common tilts (biases) include overweighting the home-country
market, value, size (small cap), and emerging markets.
• For many investors, allocations to foreign fixed income have been
adopted more slowly than allocations to foreign equity. Most investors
have at least some amount in non-home-country equity.
The Global Portfolio
• Investing in a global market portfolio faces several implementation hurdles.
• First, estimating the size of each asset class on a global basis is an
imprecise exercise given the uneven availability of information on nonpublicly traded assets.
• Second, the practicality of investing proportionately in residential real
estate, much of which is held in individual homeowners’ hands, has been
questioned.
• Third, private commercial real estate and global private equity assets are
not easily carved into pieces of a size that is accessible to most investors.
• Practically, proxies for the global market portfolio are often based only on
traded assets, such as portfolios of exchange-traded funds (ETFs).
Furthermore, some investors have implemented alternative weighting
schemes, such as GDP weight or equal weight.
Passive/Active
• Having established the strategic asset allocation policy, the
asset owner must address additional strategic
considerations before moving to implementation. One of
these is the passive/active choice.
• There are two dimensions of passive/active choices. One
dimension relates to the management of the strategic
asset allocation itself—for example, whether to deviate
from it tactically or not.
• The second dimension relates to passive and active
implementation choices in investing the allocation to a
given asset class.
Tactical Asset Allocation
• Tactical Asset Allocation (TAA) involves deliberate short-term deviations from the
strategic asset allocation.
• Whereas the strategic asset allocation incorporates an investor’s long-term, equilibrium
market expectations, tactical asset allocation involves short-term tilts away from the
strategic asset mix that reflect short-term views—for example, to exploit perceived
deviations from equilibrium.
• Tactical asset allocation is active management at the asset class level because it involves
intentional deviations from the strategic asset mix to exploit perceived opportunities in
capital markets to improve the portfolio’s risk–return trade-off.
• TAA mandates are often specified to keep deviations from the strategic asset allocation
within rebalancing ranges or within risk budgets. Tactical asset allocation decisions
might be responsive to price momentum, perceived asset class valuation, or the
particular stage of the business cycle.
• Tactical asset allocation may be limited to tactical changes in domestic stock–bond or
stock–bond–cash allocations or may be a more comprehensive multi-asset approach, as
in a global tactical asset allocation
Tactical Asset Allocation
• Tactical asset allocation inherently involves market timing as it involves buying
and selling in anticipation of short-term changes in market direction; however,
TAA usually involves smaller allocation tilts than an invested-or-not-invested
market timing strategy.
• Tactical asset allocation is a source of risk when calibrated against the strategic
asset mix. An informed approach to tactical asset allocation recognizes the
trade-off of any potential outperformance against this tracking error.
• Key barriers to successful tactical asset allocation are monitoring and trading
costs. For some investors, higher short-term capital gains taxes will prove a
significant obstacle because taxes are an additional trading cost.
• A program of tactical asset allocation must be evaluated through a cost–
benefit lens. The relevant cost comparisons include the expected costs of
simply following a rebalancing policy (without deliberate tactical deviations).
Active/Passive within asset classes
• In addition to active and passive decisions about the asset class mix, there are active
and passive decisions about how to implement the individual allocations within asset
classes.
• An allocation can be managed passively or actively or incorporate both active and
passive sub-allocations.
• With a passive management approach, portfolio composition does not react to changes
in the investor’s capital market expectations or to information on or insights into
individual investments.
• For example, a portfolio constructed to track the returns of an index of European
equities might add or drop a holding in response to a change in the index composition
but not in response to changes in the manager’s expectations concerning the security’s
investment value.
• In contrast, a portfolio manager for an active management strategy will respond to
changing capital market expectations or to investment insights resulting in changes to
portfolio composition. The objective of active management is to achieve, after
expenses, positive excess risk-adjusted returns relative to a passive benchmark.
• Some strategies use both passive and active elements. In financial theory,
the pure model of a passive approach is indexing to a broad market-capweighted index of risky assets—in particular, the global market portfolio
• . However, consider an investor who indexes an equity allocation to a
broad-based value equity style index. The investment could be said to
reflect an active decision in tilting an allocation toward value but be
passive in implementation because it involves indexing.
• An even more active approach would be investing the equity allocation
with managers who have a value investing approach and attempt to
enhance returns through security selection.
• Unconstrained active investment would be one that is “go anywhere” or
not managed with consideration of any traditional asset class benchmark
(i.e., “benchmark agnostic”).
Rebalancing
• Normal changes in asset prices cause the portfolio asset mix to deviate from
target weights. Industry practice defines “rebalancing” as portfolio
adjustments triggered by such price changes. Other portfolio adjustments,
even systematic ones, are not rebalancing.
• Ordinary price changes cause the assets with a high forecast return to grow
faster than the portfolio as a whole. Because high-return assets are typically
also higher risk, in the absence of rebalancing, overall portfolio risk rises.
• The mix of risks within the portfolio becomes more concentrated as well.
Systematic rebalancing maintains the original strategic risk exposures. The
discipline of rebalancing serves to control portfolio risks that have become
different from what the investor originally intended.
Rebalancing
• The simplest approach to rebalancing is calendar rebalancing, which involves
rebalancing a portfolio to target weights on a periodic basis—for example,
monthly, quarterly, semiannually, or annually.
• Percent-range rebalancing permits tighter control of the asset mix compared
with calendar rebalancing. Percent-range approach involves setting
rebalancing thresholds or trigger points, stated as a percentage of the
portfolio’s value, around target values.
• For example, if the target allocation to an asset class is 50% of portfolio
value, trigger points at 45% and 55% of portfolio value define a 10
percentage point range (or corridor) for the value of that asset class.
• The rebalancing range creates a no-trade region. The portfolio is rebalanced
when an asset class’s weight first passes through one of its trigger points.
Focusing on percent-range rebalancing, the following questions are relevant:
Rebalancing
• Higher transaction costs for an asset class imply wider
rebalancing ranges.
• More risk-averse investors will have tighter rebalancing
ranges.
• Beliefs in momentum favor wider rebalancing ranges,
whereas mean reversion encourages tighter ranges.
• Illiquid investments complicate rebalancing.
• Derivatives create the possibility of synthetic rebalancing.
• Taxes, which are a cost, discourage rebalancing and
encourage asymmetric and wider rebalancing ranges.
Investment Policy Statement
• The investment policy statement is a client-specific summation of the
circumstances, objectives, constraints, and policies that govern the
relationship between advisor and investor.
• A well-constructed IPS presents the investor’s financial objectives, the
degree of risk he or she is willing to take, and any relevant investment
constraints that the advisor must consider.
• It also sets operational guidelines for constructing a portfolio that can be
expected to best meet these objectives while remaining in compliance
with any constraints. Finally, the IPS establishes a mutually agreed-upon
basis for portfolio monitoring and review.
• Constructing an IPS is a dynamic process in which an individual and his
investment advisor must identify and then reconcile investment
objectives, portfolio constraints, and risk tolerance.
• If management practices or investor directions are subsequently
questioned, both parties can refer to the policy statement for clarification
or support. Ideally, the review process set forth in the IPS will identify such
issues before they become serious.
Return Objective
• The process of identifying an investor’s desired and
required returns should take place concurrently with the
discussion of risk tolerance. In the end, the IPS must
present a return objective that is attainable given the
portfolio’s risk constraints.
• It is important at the outset to distinguish between a return
requirement and a return desire. The former refers to a
return level necessary to achieve the investor’s primary or
critical long-term financial objectives; the latter denotes a
return level associated with the investor’s secondary goals.
• Return requirements are generally driven by annual
spending and relatively long-term saving goals. Historically,
these goals have often been classified as income
requirements and growth requirements
Return Objectives
• When an investor’s return objectives are inconsistent with her risk
tolerance, a resolution must be found. If the investor’s return objectives
cannot be met without violating the portfolio’s parameters for risk
tolerance, she may need to modify her low- and intermediate-priority
goals.
• Alternatively, she may have to accept a slightly less comfortable level of
risk, assuming that she has the “ability” to take additional risk.
• An individual, for example, who discovers that his retirement goals are
inconsistent with current assets and risk tolerance may have to defer the
planned date of retirement, accept a reduced standard of living in
retirement, or increase current savings (a reduction in the current
standard of living).
• To calculate the required return and to fully understand the cumulative
effects of anticipated changes in income, living expenses, and various
stage-of-life events, an advisor may wish to incorporate a cash flow
analysis.
Risk Objectives
• An individual’s risk objective, or overall risk tolerance, is a function
of both ability to take risk and willingness to take risk.
• An investor’s ability to take risk is determined by his financial goals
relative to resources and the time frame within which these goals
must be met. If the investor’s financial goals are modest relative to
the investment portfolio, clearly he has greater ability, all else
equal, to accommodate volatility and negative short-term returns.
• As the investment portfolio grows or as its time horizon lengthens,
the ability to recover from intermediate investment shortfalls also
increases. All else equal, longer-term objectives allow the investor
greater opportunity to consider more-volatile investments, with
correspondingly higher expected returns.
Risk Objectives
• Critical goals allow lower margin for error and reduce the portfolio’s
ability to accommodate volatile investments. Financial security and
the ability to maintain current lifestyle are generally among the
investor’s highest priorities; luxury spending, however defined, is
least critical.
• How large an investment shortfall can the investor’s portfolio bear
before jeopardizing its ability to meet major short-term and longterm investment goals?
• The limit of a portfolio’s ability to accept risk is reached when the
probability of failing to meet a high-priority objective becomes
unacceptably high. The investment advisor can provide guidance
with probability estimates and identify clearly unrealistic
expectations, but the ultimate determination of “acceptable” will
also depend on the investor’s general willingness to accept risk
Risk Objectives
• Willingness to Take Risk
• In contrast to ability to take risk, investor
willingness involves a more subjective
assessment. No absolute measure of willingness
exists, nor does any assurance that willingness
will remain constant through time.
• Psychological profiling provides estimates of an
individual’s willingness to take risk, but final
determination remains an imprecise science
Constraints
• The IPS should identify all economic and
operational constraints on the investment
portfolio. Portfolio constraints generally fall into
one of five categories:
• liquidity;
• time horizon;
• taxes;
• legal and regulatory environment;
• unique circumstances.
Liquidity
•
Liquidity refers generally to the investment portfolio’s ability to efficiently meet an
investor’s anticipated and unanticipated demands for cash distributions. Two
trading characteristics of its holdings determine a portfolio’s liquidity:
•
•
Transaction Costs
Transaction costs may include brokerage fees, bid–ask spread, price impact
(resulting, for example, from a large sale in a thinly traded asset), or simply the
time and opportunity cost of finding a buyer. As transaction costs increase, assets
become less “liquid” and less appropriate as a funding source for cash flows.
•
•
Price Volatility
An asset that can be bought or sold at fair value with minimal transaction costs is
said to trade in a highly liquid market. If the market itself is inherently volatile,
however, the asset’s contribution to portfolio liquidity (the ability to meet cash
flow needs) is limited. Price volatility compromises portfolio liquidity by lowering
the certainty with which cash can be realized.
Liquidity
• Significant liquidity requirements constrain the investor’s ability to
bear risk. Liquidity requirements can arise for any number of
reasons but generally fall into one of the following categories:
• Ongoing Expenses
• The ongoing costs of daily living create a predictable need for cash
and constitute one of the investment portfolio’s highest priorities.
• Emergency Reserves
• As a precaution against unanticipated events such as sudden
unemployment or uninsured losses, keeping an emergency reserve
is highly advisable
• Negative Liquidity Events
• Liquidity events involve discrete future cash flows or major changes
in ongoing expenses. Examples might include a significant
charitable gift, anticipated home repairs, or a change in cash needs
brought on by retirement.
Illiquid Holdings
• The IPS should specifically identify significant holdings of illiquid
assets and describe their role in the investment portfolio. Examples
might include real estate, limited partnerships, common stock with
trading restrictions, and assets burdened by pending litigation.
• The home or primary residence, often an individual investor’s
largest and most illiquid asset, presents difficult diversification and
asset allocation issues. This asset defies easy classification, having
investment returns in the form of psychological and lifestyle
benefits as well as the economic benefits of shelter and potential
price appreciation.
• It is not uncommon to exclude the residence from the asset
allocation decision, under the premise that the home is a “sunk
cost,” a “legacy” or “private use” asset that is not actively managed
as an investment.
Time horizon
• . In many planning contexts, time horizons greater than 15 to 20 years can
be viewed as relatively long term, and horizons of less than 3 years as
relatively short term.
• Investor may face a single- or multistage horizon.
• Certain investor circumstances, such as an elderly investor with limited
financial resources, are consistent with a single-stage time horizon. Given
the unique nature and complexity of most individual investors’
circumstances, however, the time horizon constraint most often takes a
multistage form.
• “Stage-of-life” classifications, as discussed earlier, often assume that the
investment time horizon shortens gradually as investors move through the
various stages of life.
• Once the primary investors’ needs and financial security are secure, the
process of setting risk and return objectives may take place in the context
of multigenerational estate planning.
Taxation
• Taxation of income or property is a global
reality and poses a significant challenge to
wealth accumulation and transfer. Tax codes
are necessarily country specific.
• Income Tax
• Capital Gains Tax
• Wealth Transfer Tax
• Property Tax
Legal environment
• In the context of portfolio management for individual
investors, legal and regulatory constraints most
frequently involve taxation and the transfer of personal
property ownership.
• Achieving investment objectives within the constraints
of a given jurisdiction frequently requires consultation
with local experts, including tax accountants and estate
planning attorneys.
• Whatever a portfolio manager’s level of legal and
regulatory understanding, she must be careful to avoid
giving advice that would constitute the practice of law
(the role of a licensed attorney
Asset allocation
• In establishing a strategic asset allocation policy, the
advisor’s challenge is to find a set of asset-class weights
that produce a portfolio consistent with the individual
investor’s return objective, risk tolerance, and constraints.
• This task must be completed from a taxable perspective,
taking into consideration 1) after-tax returns, 2) the tax
consequences of any shift from current portfolio
allocations, 3) the impact of future rebalancing, and 4)
asset “location.”
• The issue of asset location results from the individual
investor’s ownership of both taxable and tax-deferred
investment accounts—clearly, nontaxable investments
should not be “located” in tax-exempt accounts.
Asset Allocation
• Determine the asset allocations that meet the investor’s return
requirements. In carrying out this step, the investment advisor should
compare expected returns for the different asset allocations on a basis
consistent with the IPS.
• Eliminate asset allocations that fail to meet quantitative risk objectives or
are otherwise inconsistent with the investor’s risk tolerance. For example,
an investor may have risk objectives related to the expected standard
deviation of return, worst-case return, or any of several other downside
risk concepts (as is true for Fairfax).
• Eliminate asset allocations that fail to satisfy the investor’s stated
constraints. For example, an investor may have a liquidity requirement
that is appropriately met by holding a certain level of cash equivalents,
and allocations must satisfy that constraint.
• Evaluate the expected risk-adjusted performance and diversification
attributes of the asset allocations that remain after Steps 1 through 3 to
select the allocation that is expected to be most rewarding for the
investor.
The financial liabilities shown are legal liabilities. The extended liabilities include funding
needs that the Lees want to meet. The balance sheet includes an estimate of the present value
of future consumption, which is sometimes called the “consumption liability.” The amount
shown reflects expected values over their life expectancy given their ages. If they live longer,
consumption needs will exceed the $20 million in the case facts and erode the $18 million in
equity. If their life span is shorter, $18 million plus whatever they do not consume of the $20
million in PV of future consumption becomes part of their estate. Note that for the Lees, the
value of assets exceeds the value of liabilities, resulting in a positive economic net worth (a
positive difference between economic assets and economic liabilities); this is analogous to a
positive owners’ equity on a company’s financial balance sheet.
From Exhibit 11, we can identify four goals totaling $24 million in present value terms: a
lifestyle goal (assessed as a need for $20 million in present value terms), an education goal
($0.25 million), a charitable goal ($0.75 million), and the special
