Question
Dave, a well-known retired Finance professor has reached his 70th birthday and will retire. Dave owns his home (the mortgage is paid off) and not
Dave, a well-known retired Finance professor has reached his 70th birthday and will retire. Dave owns his home (the mortgage is paid off) and not does not want to move. Dave has no living family and wants to leave his house to the university.
Dave has an investment account with a $180,000 balance. Conservatively invested, the account is yielding 9 percent. Dave also has a savings account with a $12,000 balance earning 5 percent. This savings account is for unexpected expenses and emergencies and Dave wants to maintain the balance at $12,000.
Dave's basic living expenses now average about $1,500 per month and he plans to spend $500 per month on travel and hobbies. To maintain this planned standard of living, he will have to rely on his investment account. The interest from the account is $16,200 per year (9 percent of $180,000), or $1,350 per month.
Dave will also receive $750 per month in Social Security payments for the rest of his life. These payments are indexed for inflation. That is, they will automatically increase in proportion to changes in the consumer price index. Dave is concerned about inflation. His social security payments will increase with inflation, but the interest on his investment account will not.
Dave needs advice. Suppose Dave wants to plan for a 20-year retirement. He is willing to use all of his investment account to fund his retirement. He wants his spending to increase along with inflation over that period. In other words, he wants his spending to stay the same in real terms throughout his retirement.
Assumptions: the investment account will continue to earn 9 percent during retirement. The inflation rate will be constant at 4 percent during retirement.
a) What are Dave's yearly expenses?
b) What is Dave's yearly income?
c) Dave wants to spend the same amount in real terms each year, can he retire given his current situation?
d) Dave may be willing to sell his house when he retires and use $200,000 from the sale to help fund his retirement. How much money can Dave to spend each year if he sells his house? How does your advice change if Dave will sell his house in year 10 of his retirement and contribute $200,000 to his retirement.
e) Dave may be willing to liquidate his emergency savings account to help fund his retirement. How would you advice Dave to invest this money. How does Dave's retirement situation change if he liquidates his emergency savings?
f) Dave cannot retire in his current situation. How would you advice Dave to fund the shortfall? Be exact and show your calculations.
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