Part Two
At 35 years, all equities will be purged from the portfolio to maximize safety (10% corporates, 70% Treasuries, 20% cash). This means that the fund will generate an average return of (0.48+2.31+.1) = 2.89%
Using Excel, it is determined that the value of the portfolio when John and Mary retire and Paul enters assisted living needs to be $5,775,134. With that level, the portfolio will have money until Paul turns 85, at which point the portfolio will no longer have value. The assumption here is that the payments for the assisted living around going to be held in cash, so there is a need for 20% of the portfolio to be cash, and much of the rest is Treasuries so that it is liquid. Maturities will need to be staggered so that there is a current portion reaching maturity each year, to avoid having to sell below par, thereby removing on key risk factor at the stage when the portfolio has the highest degree of risk aversion. For this reason as well, bond funds cannot be substituted for bonds, because they fluctuate in value with the prevailing interest rates.
Working backwards from the $5,775,134 figure, we need to determine how much John and Mary need to invest in this account. The return during the first 25 years will be (.75*10.3 + .15*4.8 + .1*3.3) = 7.725 + .72 + .33 = 8.775%. The returns from years 26-35 will be (.3*10.3+.4*.48+.3*3.3) = 3.09+1.92+.99 = 6% .
The annual contributions need to be $36,972. This equates to $3,081 per month. Note that compounding is not assumed to be monthly in this example. There are three reasons for that. The first is that fixed income does not pay monthly. The second is that equities do not follow a linear compounding pattern either. The third...
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