Christopher Maclin, aged 40, is a supervisor at Barnett Co. and earns an annual salary of £80,000 before taxes. Louise Maclin, aged 38, stays home to care for their newborn twins. She recently inherited £900,000 (after wealth-transfer taxes) in cash from her father’s estate. In addition, the Maclins have accumulated the following assets (current market value):
• £5,000 in cash.
• £160,000 in stocks and bonds.
• £220,000 in Barnett common stock.
The value of their holdings in Barnett stock has appreciated substantially as a result of the company’s growth in sales and profits during the past 10 years. Christopher Maclin is confident that the company and its stock will continue to perform well.
The Maclins need £30,000 for a down payment on the purchase of a house and plan to make a £20,000 non–tax deductible donation to a local charity in memory of Louise Maclin’s father. The Maclins’ annual living expenses are £74,000. After-tax salary increases will offset any future increases in their living expenses.
During their discussions with Grant Webb, the Maclins’ express concern about achieving their educational goals for their children and their own retirement goals. The Maclins tell Webb:
• They want to have sufficient funds to retire in 18 years when their children begin their
4 years of university education.
• They have been unhappy with the portfolio volatility they have experienced in recent years and they do not want to experience a loss greater than 12% in any one year.
• They do not want to invest in alcohol and tobacco stocks.
• They will not have any additional children.
After their discussions, Webb calculates that in 18 years the Maclins will need £2 million to meet their educational and retirement goals. Webb suggests that their portfolio be structured to limit shortfall risk (defined as expected total return minus two standard deviations) to no lower than a - 12% return in any one year. Maclin’s salary and all capital gains and investment income are taxed at 40% and no tax-sheltering strategies are available. Webb’s next step is to formulate an investment policy statement for the Maclins.
a. Formulate the risk objective of an investment policy statement for the Maclins.
b. Formulate the return objective of an investment policy statement for the Maclins. Calculate the pretax rate of return that is required to achieve this objective. Show your calculations.
c. Formulate the constraints portion of an investment policy statement for the Maclins, addressing each of the following:
i. Time horizon
ii. Liquidity requirements
iii. Tax concerns
iv. Unique circumstances