Taylor Hopf

Mini Case #2
BSNS 5225-001
September 23, 2015
Chapter 5 Mini Case
Summary
Old Alfred Road is coming of age to retire and has invested his money in various places.
He plans to live off an investment portfolio and monthly Social Security payments. He also has
another savings account but wants to keep that for emergencies. Additionally, he plans on giving
his house and any other assets left over to his daughter.
Portfolio

$180,000
$16,200 in interest per year or $1,350 a month
Nominal interest rate is 9%
Real interest rate is 4.8% 1.09/1.04 = 1.048 1

Social Security
Receive $750 a month, which is adjusted for inflation or $9,000 annually
This amount will stay the same, therefore, having a real interest rate of 0%
Savings Account

$12,000
Nominal interest rate 5%
Real interest rate is .96% 1.05/1.04 = 1.0096 1

Living expenses are $1,500 a month plus $500 traveling expenses

With monthly expenses at $2000 and Alfred receiving $750 in Social Security, he only
has to worry about covering $1250 of expenses on his own through the investment portfolio
($2000 - $750 = $1250).
For the first year of retirement Alfred Road can safely use the interest from his portfolio
to cover all of his expenses per month. This is because inflation has not affected the interest rate
yet, so the nominal and real interests are the same. He will receive the full $1,350 from his
portfolio which will cover the $1250 of expenses after Social Security is used. For the first year,
he will be able to safely spend just the interest earned from the portfolio without having to spend
any of the principle.

After the first year, you must take into account inflation of 4%,. The real interest rate of
his investment portfolio is 4.8%. This will give him a monthly interest payment of $720.
($180,000 * 4.8% = $8,640 per year or $720 a month). Assuming expenses were expressed in
real rates and remain constant, he will still not have enough to cover his portion of expenses not
covered by Social Security. At year end he will not be able to withdraw without touching the
principle since the interest payments will not cover his expenses.
Going beyond the second year, Alfreds interest payments might not be as high because
the interest rate is being applied to less principle since he has been using it to cover a portion of
expenses.
If Mr. Roads decides to deplete his portfolio completely at the end of 20 years, it turns
out to be an annuity due problem. I chose annuity due because he would withdraw the money at
the start of the year. I used the payment function in Excel to calculate the amount he can take out
each year. The values I used in Excel were a 9% interest rate, 20 periods, a present value of
$180,00 and they type was 1. Mr. Roads will receive a yearly annuity of $18,090 at the
beginning of each year, which is a monthly payment of $1,507. With the $750 Social Security
payment added in, he will have $2,257 to spend per month on expenses.
With all of this being said, I would give some Mr. Road some advice on how to plan for
his retirement more effectively. As of right now Mr. Road does not have sufficient funds to cover
all of his expenses with just using interest earned from his portfolio and Social Security
payments. He should either cut down on his expenses or look to move more of his savings
account into the portfolio since it has a higher interest rate.