Module 7

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Module 7
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2011-09-19 14:12:09
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Module 7
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  1. The annual withdrawal from a portfolio should rarely be based on a portfolio’s taxable income.

    a) True
    b) False
    a) True
  2. The term withdrawal rate refers to the total withdrawals during the first year of retirement as a percentage of the portfolio at the time of retirement.

    a) True
    b) False
    a) True
  3. Portfolio failure means having the portfolio earn less than the expected rate of return.

    a) True
    b) False
    b) False

    Portfolio failure means having the portfolio be worth less than or equal to an intended withdrawal, such that the next withdrawal would zero out the portfolio.
  4. There are no withdrawal strategies that can guarantee there will never be portfolio failure.

    a) True
    b) False
    b) False

    Several strategies could guarantee no portfolio failure. However, they do not guarantee that the annual withdrawal will always be a satisfactory number.
  5. The capital preservation model or the purchasing power preservation model are more likely to be adopted when the client wants to leave a significant bequest to his or her beneficiaries.

    a) True
    b) False
    a) True
  6. There is a well-established professional standard for how much risk of portfolio failure a client should be able to take.

    a) True
    b) False
    b) False

    Research on the topic of maximum risk of portfolio failure varies dramatically on what might be an appropriate level of risk, ranging from negligible risk to as much as 25 percent risk.
  7. Research clearly supports that the equity requirement in a portfolio for a woman is greater than that for a man of the same age.

    a) True
    b) False
    a) True
  8. Virtually all researchers find that a 3 percent withdrawal rate is perfectly safe regardless of a portfolio's asset allocation.

    a) True
    b) False
    a) True
  9. Bengen (1996) suggests that the equity allocation in a retirement portfolio should equal 100 percent minus a person's age.

    a) True
    b) False
    b) False

    As shown in table 7-2, Bengen has several rules that depend on how aggressive the client is willing to be and whether the portfolio is qualified or nonqualified. None of these rules use the number 100.
  10. It makes no difference in the likelihood of portfolio failure if the client has a portfolio with all of the stock invested in an index fund or if the stock is divided among various equity categories, such as small cap stocks and international stocks.

    a) True
    b) False
    b) False

    The evidence suggests that the more diversification in the equity, the longer the retirement portfolio is likely to last.
  11. In Monte Carlo simulations, the conclusions can be quite sensitive to the expected rates of return and standard deviations used in the analysis.

    a) True
    b) False
    a) True
  12. Withdrawal rates from retirement portfolios can generally be maximized with equity allocations of no less than 50 percent but well less than 100 percent.

    a) True
    b) False
    a) True
  13. Published research on annual portfolio withdrawal rates always allows for reductions in the amount withdrawn when the portfolio has performed poorly.

    a) True
    b) False
    b) False

    Some research assumes a flat annuity, and other research has allowed for the possibility of not increasing the annual withdrawal when the portfolio has performed poorly. But none to date has considered actual reductions in the annual withdrawal.
  14. It is critical that withdrawal strategies assume either no change or an increase each and every year of retirement in the dollar amount withdrawn from a portfolio.

    a) True
    b) False
    b) False

    It is well established that in their later years, retirees need less money for daily expenses. In addition, the death of one of the spouses will normally result in a reduction in the annual amount withdrawn.
  15. It is of no significance whether the bond component of a retirement portfolio is immunized or not.

    a) True
    b) False
    b) False

    Immunization of the bond component of a retirement portfolio would almost certainly increase what is a reasonable withdrawal rate.
  16. The most economically efficient harvesting sequence should override any minimum required withdrawal requirements.

    a) True
    b) False
    b) False

    Minimum required withdrawal requirements are mandated by law with penalties for failure to comply. The economic efficiency of the harvesting sequence applies only to voluntary withdrawals.
  17. When considering a voluntary withdrawal from a Roth IRA or a traditional IRA, it does not really matter which account the client takes the cash from unless he or she expects marginal tax rates to change in the future.

    a) True
    b) False
    a) True
  18. When considering a voluntary withdrawal from a nonqualified account and either a Roth IRA or a traditional IRA, the client should almost always take the cash from the nonqualified account first.

    a) True
    b) False
    a) True
  19. The presence of fixed income, such as Social Security retirement income or pension income, could easily cause the client to increase the equity percentage of the portfolio if this income is treated as de facto investment in bonds.

    a) True
    b) False
    a) True
  20. When computing the inflation rate, divide the CPI from 1 year ago by the current CPI and subtract 1.
    a) True
    b) False
    b) False

    When computing the inflation rate, divide the current CPI by the CPI from 1 year ago and subtract 1. This is the opposite of what is stated in the question.
  21. Much of the recent research stipulates that one of the key components to a sustainable retirement withdrawal rate is avoiding spending rates in excess of 4–6 percent.

    a) True
    b) False
    a) True
  22. The Retirement Ris Quotient looks at portfolio sustainability by linking portfolio parameters, spending rates, and longevity risk.

    a) True
    b) False
    a) True
  23. Life annuities decrease the sustainability of a retirement portfolio.

    a) True
    b) False
    b) False

    Life annuities typically increase the sustainability of a retirement portfolio.
  24. Longevity risk can be ignored when preparing a withdrawal plan.

    a) True
    b) False
    b) False

    It is imperative to incorporate longevity risk when preparing a retirement plan. Many research studies that focus on 20, 25, or 30 years of retirement are ignoring this important risk.
  25. The Ris Quotient method advocates that spending rates as high as the 8 to 10 percent can be used if the forward-looking volatility is low enough and the forward-looking expected return is high enough.

    a) True
    b) False
    a) True
  26. Annuitizing a percentage of one’s nest egg generates a mortality subsidy, which increases the portfolio’s investment return.

    a) True
    b) False
    a) True
  27. Put options increase the retirement ruin probability.

    a) True
    b) False
    b) False

    Put options (and a close retail substitute, variable annuities) decrease the retirement ruin probability.
  28. Which of the following factors would be influential in the decision to purchase an annuity?

    A) the nearly irreversible process for purchasing an annuity
    B) whether one’s stock portfolio is dominated by value or growth stocks
    C) the life expectancy of one’s beneficiaries
    D) the maturity mix of any bonds in one’s bond portfolio
    A) the nearly irreversible process for purchasing an annuity

    The fees associated with liquidating an annuity make this a cost prohibitive action. The others are incorrect because they are totally irrelevant when deciding whether or not to buy an annuity.
    (this multiple choice question has been scrambled)
  29. Which of the following statements is characteristic of a 5-year safety stock plan?

    a) Withdrawals for the first 5 years are invested in bonds with maturities of one to 5 years.
    b) Equities are liquidated each year to replenish the cash equivalent holdings. c) During the years when the equity portfolio declines in value, some of the cash equivalents are liquidated in order to replenish the equity portfolio.
    d) During the years when the equity portfolio declines in value, the withdrawals are taken from dividends, interest, and liquidation of cash equivalent holdings.
    d) During the years when the equity portfolio declines in value, the withdrawals are taken from dividends, interest, and liquidation of cash equivalent holdings.

    Withdrawals for the first 5 years are invested in bonds with maturities of one to 5 years describes a laddered portfolio strategy, not a safety stock plan.

    Equities are liquidated each year to replenish the cash equivalent holdings - is a plan with no safety stock.

    During the years when the equity portfolio declines in value, some of the cash equivalents are liquidated in order to replenish the equity portfolio - is the antithesis of a safety stock plan because one objective of a safety stock plan is to avoid selling stocks when they have declined in value
  30. When dealing with retirement portfolios, which of the following statements is (are) correct?

    I. Portfolio income and portfolio withdrawals would rarely be the same numbers.

    II. The only relevant measure of risk is the standard deviation of return on one’s portfolio of assets.

    A) I only
    B) II only
    C) Both I and II
    D) Neither I nor II
    A) I only

    II is incorrect because when managing a retirement portfolio, the relevant measure of risk is the risk of portfolio failure, which is somewhat different than the standard deviation of the annual rates of return.
    (this multiple choice question has been scrambled)
  31. Which of the following statements with respect to the day-to-day mechanics of managing a retirement portfolio is (are) correct?

    I. It would probably be economically inefficient to liquidate some of the securities each month to provide the needed cash.

    II. If the consumer price index for December of the current year is 151.9, and it was 143.2 for December of the prior year, then the appropriate inflation adjustment to a monthly withdrawal from a retirement portfolio for the next year would be to increase it by 6.08 percent.

    A) Neither I nor II
    B) Both I and II
    C) I only
    D) II only
    B) Both I and II

    The inflation factor for this period is computed as 151.9/143.2 – 1, which equals 6.08 percent.
    (this multiple choice question has been scrambled)
  32. Which of the following statements concerning the Retirement Ris Quotient method for determining withdrawal rates from a retirement portfolio is (are) correct?

    I. Life annuities increase the sustainability of a retirement portfolio.
    II. Put options increase the sustainability of a retirement portfolio.

    A) I only
    B) II only
    C) Both I and II
    D) Neither I nor II
    C) Both I and II
    (this multiple choice question has been scrambled)
  33. All the following statements with regard to portfolio withdrawal rates are correct EXCEPT

    A) The gender of the client is immaterial.
    B) Most researchers find minimal value and some even find harm if cash equivalents are given a significant percentage of the portfolio.
    C) Cooley, Hubbard, and Walz found that all-equity portfolios have been able to sustain withdrawal rates of 8 to 9 percent for periods of up to 15 years.
    D) Cooley, Hubbard, and Walz found that Monte Carlo simulations provided about the same results in evaluating withdrawal rate strategies as using overlapping historical periods.
    A) The gender of the client is immaterial.

    The client’s gender is extremely relevant for two reasons. First, women tend to be more conservative; second, women live longer than men. Hence, women need to set lower withdrawal rates.
    (this multiple choice question has been scrambled)
  34. All the following statements concerning voluntary withdrawals from retirement accounts are correct EXCEPT

    a) In some situations, the harvesting sequence matters; in others it does not.
    b) One should always withdraw from a traditional IRA account before withdrawing from a Roth IRA account. c) One should always withdraw from a nonqualified account before withdrawing from a Roth IRA account. d) One should always withdraw from a nonqualified account before withdrawing from a traditional IRA account.
    b) One should always withdraw from a traditional IRA account before withdrawing from a Roth IRA account.

    If the client’s marginal tax rate is expected to decline, then he or she should withdraw from a Roth IRA first (where the withdrawals are tax free) and then a traditional IRA (where the withdrawals are partially or completely taxable).
  35. Which of the following statements is correct regarding the new risk-return paradigm?

    A) The withdrawal rate of a portfolio should typically be based upon the portfolio’s income.
    B) When managing a retirement portfolio, the relevant measure of risk is the risk of portfoliofailure.
    C) Under modern portfolio theory, a planner should choose a portfolio for a client that lies on the client’s lowest possible indifference curve.
    D) Withdrawal strategy refers to the total withdrawals during the first year of retirement as apercentage of the portfolio at the time of retirement.
    B) When managing a retirement portfolio, the relevant measure of risk is the risk of portfolio failure.

    Under modern portfolio theory, a planner should choose a portfolio for a client that lies on the client’s highest possible indifference curve.

    The withdrawal rate of a portfolio should rarely be based upon a portfolio’s income. Instead, it should be based upon the amount of cash that can be withdrawn.

    Withdrawal rate, not withdrawal strategy, refers to the total withdrawals during the first year of retirement as a percentage of the portfolio at the time of retirement.
    (this multiple choice question has been scrambled)
  36. Which of the following statements is correct regarding the new risk-return paradigm?

    A) If the withdrawal rate is equal to the risk-free rate of return, there is no chance of portfolio failure.
    B) The objective of a performance-based annuity is to have the cash withdrawals grow each year at the rate of inflation.
    C) Portfolio failure occurs when the actual income earned by a portfolio is less than the expectedrate of return of the portfolio.
    D) The higher the withdrawal rate, the lower the probability of portfolio failure.
    A) If the withdrawal rate is equal to the risk-free rate of return, there is no chance of portfolio failure.

    The objective of a performance-based annuity is to have the withdrawal each year be based upon the performance of the portfolio during the prior year.

    Portfolio failure occurs when a portfolio is worth less than or equal to an intended cash withdrawal, meaning the next withdrawal would completely exhaust the portfolio.

    The higher the withdrawal rate, the higher the probability of portfolio failure.
    (this multiple choice question has been scrambled)
  37. All of the following statements are correct regarding models used in setting withdrawal rates EXCEPT:

    A) The capital preservation model builds conservatism into setting the withdrawal rate.
    B) Either the capital preservation model or the purchasing power preservation model may beadopted when a client wants to leave an estate to heirs upon death.
    C) The capital preservation model can be accomplished by limiting the cash withdrawals to the risk-free rate of return.
    D) Under the purchasing power preservation model, a client’s portfolio principal balance at death will be equal to their portfolio principal balance at retirement.
    D) Under the purchasing power preservation model, a client’s portfolio principal balance at death will be equal to their portfolio principal balance at retirement.

    Under the purchasing power preservation model, a client’s portfolio principal balance at death will be
    greater than their portfolio principal balance at retirement, because the principal of the portfolio is
    adjusted upward for inflation.
    (this multiple choice question has been scrambled)
  38. Which of the following statements is/are correct regarding the management of retirementportfolios?

    I. Several withdrawal strategies exist that can guarantee a satisfactory withdrawal rate withoutportfolio failure.

    II. The relevant risk measure for a retirement portfolio is the beta of the portfolio.

    A) Only II.
    B) Only I.
    C) Neither I nor II.
    D) Both I and II
    C) Neither I nor II.

    I is incorrect. While there are strategies that can guarantee a satisfactory withdrawal rate, there is still risk
    that the portfolio will fail. Conversely, while there are several that can guarantee the portfolio will not fail,
    these strategies cannot guarantee a satisfactory withdrawal rate.

    II is incorrect. The relevant risk measure for a retirement portfolio is the risk that the portfolio will fail.
    (this multiple choice question has been scrambled)
  39. Which of the following statements is correct regarding the model developed by Ho, Milevsky, andRobinson (1994)?

    A) The model includes two assets – equities and a long-term government bond fund.
    B) The model is based upon nominal rates of return.
    C) According to the model, the equity requirement for women is greater than that required for men.
    D) According to the model, men with low wealth should reduce their equity holdings in theirportfolio beginning at age 55.
    C) According to the model, the equity requirement for women is greater than that required for men.

    The two assets include equities and Treasury bills.

    The model is based upon real rates of return, which are nominal returns adjusted for inflation.

    According to the model, men with low wealth should invest in an all-equity portfolio as late as 75 years of age.
    (this multiple choice question has been scrambled)
  40. Which of the following statements is/are correct regarding studies performed by Bengen regardingretirement portfolios?

    I. In his 1996 article, Bengen suggests that the portion of a retirement portfolio that should beinvested in equities is equal to 100% less the individual’s age.

    II. In his 1994 article, Bengen concluded that a retirement portfolio should have no less than a50% equities allocation and no more than a 75% equities allocation.

    A) Neither I nor II.
    B) Only II.
    C) Only I.
    D) Both I and II.
    B) Only II.

    I is incorrect. Bengen has several rules with respect to the equities allocation in a retirement portfolio. These rules consider a client’s risk tolerance and the type of portfolio (tax-deferred or nonqualified). However, none of these rules use the number 100.
    (this multiple choice question has been scrambled)
  41. All of the following are conclusions of the 1998 study of Cooley, Hubbard, and Walz EXCEPT:

    A) Most retirees would benefit from allocating at least 75% of their portfolio to equities.
    B) For retirees with significant fixed costs and for those who spend less as they age, CPI adjustments will typically cause a sub-optimal exchange of present consumption for future consumption.
    C) At withdrawal rates of 3%-4%, retirees wishing to leave large estates to their heirs will mostlikely be successful.
    D) For payout periods of 15 years or less, withdrawal rates of 8%-9% for stock dominated portfolios appear to be sustainable.
    A) Most retirees would benefit from allocating at least 75% of their portfolio to equities.

    Most retirees would benefit from allocating at least 50% of their portfolio to equities.
    (this multiple choice question has been scrambled)
  42. Which of the following is/are conclusions of the 1999 study of Cooley, Hubbard, and Walz?

    I. Investors who plan to inflation adjust withdrawals should choose higher withdrawal rates andinvest at least 30% of their portfolio in equities.

    II. For portfolios with at least 50% equities allocations, withdrawal rates of 3% or 4% areextremely conservative.

    A) Only I.
    B) Both I and II.
    C) Only II.
    D) Neither I nor II.
    C) Only II.

    I is incorrect. Investors who plan to inflation adjust withdrawals should choose lower withdrawal rates and
    invest at least 50% of their portfolio in equities.
    (this multiple choice question has been scrambled)
  43. All of the following are reasons that most research overstates the probability of portfolio failure EXCEPT:

    A) Ignores the potential early death of a spouse.
    B) Omits normal reduction in living expenses during retirement.
    C) Underestimates flexibility of retirees to adjust the withdrawal rate to income reductions.
    D) Omits transaction fees and taxes.
    D) Omits transaction fees and taxes.

    The omission of transaction fees and taxes from research will understate the probability of portfolio failure.
    (this multiple choice question has been scrambled)
  44. All of the following statements concerning the harvesting sequence are correct EXCEPT:

    A) When considering a voluntary withdrawal from a non-qualified account or an IRA, theindividual should almost always take the withdrawal from the nonqualified account first.
    B) The most economically efficient harvesting sequence should override any required minimum distributions.
    C) If an individual’s tax rate is expected to decline in the future, the individual would be better offstarting withdrawals from a Roth IRA as opposed to a traditional IRA.
    D) Most clients will have their retirement assets in multiple portfolios, rather than one portfolio.
    B) The most economically efficient harvesting sequence should override any required minimum distributions.

    Required minimum distributions are mandated by law, and penalties will apply if the minimum distributions are not taken when required.
    (this multiple choice question has been scrambled)
  45. Which of the following statements is/are correct with respect to the role of other income duringretirement?

    I. The purchase of an annuity is analogous to the purchase of a fully immunized bond investment.

    II. The presence of fixed income, such as a defined benefit pension payment, could easily allowan individual to increase the equity percentage of their portfolio if this income is treated as abond investment.

    A) Neither I nor II.
    B) Only II.
    C) Both I and II.
    D) Only I.
    C) Both I and II.
    (this multiple choice question has been scrambled)
  46. Which of the following statements is correct regarding strategies for retirement portfolios?

    A) The laddered portfolio strategy assumes that a client will invest their retirement portfolioexclusively in fixed income securities.
    B) With a five-year safety stock plan, the cash equivalent holdings in the portfolio would never becompletely exhausted.
    C) The disadvantage of a laddered portfolio strategy is that an individual can wind up selling equities when prices are lower than they were at the start of retirement.
    D) With a five-year safety stock plan, withdrawals for the first five years are invested in bonds withmaturities ranging from one to five years.
    C) The disadvantage of a laddered portfolio strategy is that an individual can wind up selling equities when prices are lower than they were at the start of retirement.

    This describes a laddered portfolio, as opposed to a five-year safety stock plan.
    The laddered portfolio strategy provides for investments in both fixed income and equity securities.

    The entire cash equivalents holding would be eliminated if the stock market declined five
    consecutive years.
    (this multiple choice question has been scrambled)
  47. A client has been taking a monthly distribution of $11,000 for the current year. She takes herpayment on the first of each month, and likes to apply an inflation adjustment every January.Assuming a CPI for the current year of 188.0 and a CPI for last year of 183.8, what is the appropriateamount of monthly distribution the client should take beginning January of next year?

    A) $11,251.
    B) $11,514.
    C) $11,136.
    D) $10,957.
    A) $11,251.

    Inflation adjusted payment = $11,000 x (188.0 / 183.8) = $11,000 x 1.0228 = $11,251
    (this multiple choice question has been scrambled)
  48. A client has been taking a monthly distribution of $11,000 for the current year. She takes herpayment on the first of each month, and likes to apply an inflation adjustment every January.Assuming a CPI for the current year of 181.0 and a CPI for last year of 183.8, what is the appropriate amount of monthly distribution the client should take beginning January of next year?

    A) $10,832.
    B) $11,514.
    C) $10,506.
    D) $11,170.
    A) $10,832.

    Deflation adjusted payment = $11,000 x (181.0 / 183.8) = $11,000 x .98477 = $10,832
    (this multiple choice question has been scrambled)
  49. All of the following statements are correct regarding the Retirement Ris Quotient method fordetermining withdrawal rates from a retirement portfolio EXCEPT:

    A) Spending rates of 8-10% are sustainable if the forward looking volatility is low enough.
    B) The purchase of put options will increase the probability of retirement ruin.
    C) Annuitizing a percentage of the retirement nest egg generates a mortality subsidy.
    D) The greater the median remaining lifespan, the greater the probability of portfolio ruin.
    B) The purchase of put options will increase the probability of retirement ruin.

    The purchase of put options (as well as life annuities) will increase the sustainability of the portfolio.
    (this multiple choice question has been scrambled)

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