Q14. Corri Morgan is an investment advisor for Izaguirre Investment Management (IIM). Morgan is reviewing the account for Brian and Nicole Herbster.
Brian and Nicole are both age 65, and have one daughter, Andrea, age 18. The Herbsters are recently retired from Tucker Technology Inc., a large manufacturer of microprocessors for a variety of applications. Andrea is an aspiring finance student and would like to attend a prestigious university to pursue a degree in finance. The tuition at the University costs $40,000 per year, but Andrea’s strong academic performance in high school allowed her to earn a scholarship covering half of the tuition. The Herbsters have expressed a desire to fund the amount of the college education not covered by the scholarship, as well as leave a large inheritance to Andrea at their death. During their careers, the Herbsters earned relatively high incomes, and were able to save approximately 10% of their income each year. With regard to their portfolio, they say they prefer investments that have minimal volatility. Their current investment portfolio is valued at $1.2 million.
The investment policy statement for the Herbsters is shown below:
|
Return Objective |
The Herbster’s income requirement is $6,000 monthly. Total return requirement is $72,000 / $1,200,000 = 6%. |
|
Risk Tolerance |
Ability to take on risk: average. Willingness to take risk: below average |
|
Liquidity |
Need cash each year for the next four years to fund college education. |
|
Time Horizon |
3 stages. Stage 1, funding daughter’s college tuition. Stage 2, retirement. Stage 3, after death – inheritance for daughter. |
|
Legal/Regulatory |
N/A |
|
Taxes |
Little need to defer income. |
|
Unique Considerations |
Desire to fund daughter’s college education. |
The Herbster’s current portfolio is shown below:
|
Asset/Fund |
Allocation |
Expected |
Expected |
Expected Standard |
|
Tucker Technology Common Stock |
32% |
19.0% |
0.5% |
28% |
|
Money Market Fund |
2% |
2.5% |
2.5% |
2% |
|
Diversified Bond Fund |
30% |
6.5% |
5.5% |
8% |
|
Large capitalization equities |
15% |
9.5% |
2.0% |
16% |
|
Emerging market equities |
15% |
16.0% |
1.0% |
26% |
|
Undeveloped commercial land |
6% |
19.0% |
0% |
N/A |
After reviewing the notes on the Herbster’s, Morgan reviews recommendations complied by Todd Irons, a fellow portfolio manager with IIM. Irons’ recommendations include the following:
Recommendation 1: Reduce the weighting in Tucker Technology common stock – the large position exposes the portfolio to unnecessary security specific risk.
Recommendation 2: Increase the allocation to the Diversified Bond Fund in order to increase income and decrease volatility.
Recommendation 3: Increase the allocation to Large Capitalization Equities to provide growth.
Recommendation 4: Maintain the allocation to emerging market equities due to their high returns.
Recommendation 5: Maintain the allocation the undeveloped commercial land due to its low correlation with other assets in the portfolio.
After reviewing Irons’ recommendations, Morgan should agree with:
A) Recommendations 1, 2 and 4 only.
B) Recommendations 1, 3 and 5 only.
C) Recommendations 1, 2 and 3 only.
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