Reading 10 - IPS - How to deal with inflation

marsilni

The question I have is in regard to Christa’s return requirement; this is in reading 10, questions 1-8.

Christa’s expected return for the portfolio is said to be €82,500, which in the solution is said to include inflation. However, it says her expenses will be €100,000 (or €50,000 more than art sales) which the solution assumes does not include inflation.

How are we to know if a number includes inflation or not? In other words, why are we to assume that her investment return includes inflation and her expenses do not include inflation?

parott

I just want to say "welcome to level 3".

John10

Expenses/capital --> Real required return --> + inflation --> Nominal return
(Expenses + Inflation adjustment) / capital --> Nominal return

So adding inflation to real required return or adding inflation adjustment to expenses to arrive at required return both give you the same nominal required return. In other words, expenses and real required return are one and the same, its the amount you withdraw from your investments every year.