Derek Bonney, CFA, is writing an investment policy statement for one of his high net worth clients, Joey Rook. Rook is a retiree who receives Social Security benefits but because he was self-employed, has no pension income. Rook's social security benefits cover all but $1,000 of his monthly living expenses. He has a portfolio of SI.2 million, an effective tax rate of 30%, and recently purchased a vacation cabin with mortgage and maintenance expenses of $6,000 per month.
After meeting with his client, Bonney writes the following policy statement: "The total return objective is to earn 7% after-tax. At no time should the principal amount decline in value by more than 15%." The most valid criticism of this return objective statement is that:
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A. B. C.C
The most valid criticism of the return objective statement in Derek Bonney's investment policy statement for Joey Rook is that it fails to consider Rook's current income needs.
The statement mentions that the total return objective is to earn 7% after-tax, and it also states that the principal amount should not decline in value by more than 15%. While these objectives address the investment returns and protection of principal, they do not adequately address Rook's specific income needs.
Based on the information provided, Rook receives Social Security benefits that cover all but $1,000 of his monthly living expenses. Additionally, he has a mortgage and maintenance expenses of $6,000 per month for his vacation cabin. These expenses are not fully covered by his Social Security benefits, indicating that Rook requires additional income to meet his current needs.
The return objective statement should take into account Rook's current income needs, including the shortfall between his Social Security benefits and his expenses. By not considering Rook's income needs, the investment policy statement fails to address an important aspect of his financial situation.
To create a more comprehensive return objective statement, Derek Bonney should consider incorporating Rook's income needs and ensuring that the investment strategy generates sufficient income to cover the shortfall. This could involve a combination of generating investment income, managing portfolio withdrawals, or exploring alternative income sources to bridge the gap between Rook's expenses and his current income.