Question

509 CHAPTER 12 MUTUAL FUNDS AND EXCHANGE-TRADED FUNDS Case Problem 12.2 Calvin Jacobs Seeks the Good Life G3 G4 Calvin Jacobs is a widower who recently retired after a long career with a major Midwestern manufacturer. Beginning as a skilled craftsman, he worked his way up to the level of shop super Visor over a period of more than 30 years with the firm. Calvin receives Social Security benefits and a generous company pension. Together, these amount to over $4,500 per month part of which is tax-free). The Jacobses had no children, so he lives alone. Calvin owns a two-bedroom rental house that is next to his home, and the rental income from it covers the mortgage pay ments for both the rental house and his house. Over the years, Calvin and his late wife, Allie, always tried to put a little money aside each month. The results have been nothing short of phenomenal. The value of Calvin's liquid invest- ments (all held in bank CDs and savings accounts) runs well into the six figures. Up to now, Calvin has just let his money grow and has not used any of his savings to supplement his Social Security, pension, and rental income. But things are about to change. Calvin has decided, "What the heck, it's time I start living the good life!" Calvin wants to travel and, in effect, start reaping the benefits of his labors. He has therefore decided to move $100,000 from a savings account to one or two high-yielding mutual funds. He would like to receive $1,000 to $1,500 a month from the fund(s) for as long as possible because he plans to be around for a long time. Questions a. Given Calvin's financial resources and investment objectives, what kinds of mutual funds do you think he should consider? b. What factors in Calvin's situation should be taken into consideration in the fund selection process? How might these affect Calvin's course of action? c. What types of services do you think he should look for in a mutual fund? d. Assume Calvin invests in a mutual fund that earns about 10% annually from dividend income and capital gains. Given that Calvin wants to receive $1,000 to $1,500 a month from his mutual fund, what would be the size of his investment account five years from now? How large would the account be if the fund earned 15% on average and everything else remained the same? How important is the fund's rate of return to Calvin's investment situation? Explain. Excel@Investing

Answer 1

a. He should consider Debt- based Monthly income plan(MIP). It is a moderate risk scheme. This plan provides regular inflow of dividends, which are based on the profits.

b. The factors that should be considered in fund selection are i. Liquidity ii. Rate of return iii. Market Risk iv Entry Exit loads v tax implications

For high rate of return the corresponding riskiness of the funds' return increases. Thus kevin should choose a balanced fund and err on the side of caution.

c. No entry load or any processing charges. Regular updates/information of NAV and dividends via mail or sms.

d. 10% annual returns on an investment of $100000 = 10/100 * 100000 = $10000.

$1000 receipt per month equals $12000 annually.

year 1: dividend income = $10000, payout $12000, Investment value = $100000 +$10000 -$12000 = $98000

year 2: dividend income = 10% of 98000 = 9800, payout $12000, Investment value = $98000+$9800 -$12000 = $95800

year 3: dividend income = 10% of 95800= 9580, payout $12000, Investment value = $95800+$9580-$12000 = $93380

year 4: dividend income = 10% of 93380= 9338, payout $12000, Investment value = $93380+$9338-$12000 = $90718

year 5: dividend income = 10% of 90718= 9071.8, payout $12000, Investment value = $90718+$9071.8-$12000 = $87789.8

The size of investment five years from now @10% earning is $87789.8.

If the fund earned 15% the account size would be $120227, all other assumptions remaining the same.

The funds rate of returns should be more than the annual payouts kevin is expecting for the fund account value to be greater or equal to the initial investment.

Since Calvin wants returns for as long as possible the initial fund value should not be eroded over time, thus its very important that it is 12% on the minimum.