John Mesa, CFP CFA, is a portfolio manager in the Trust Department of BigBanc. Mesa has been asked to review the investment portfolios of Robert and Mary Smith, a retired couple and potential clients. Previously, the Smiths had been working with another financial advisor, WealthMax Financial Consultants (WFC). To assist Mesa, the Smiths have provided the following background information:

Family:We live alone. Our only daughter and granddaughter are financially secure and independent.

Health:We are both 65 years of age and in good health. Our medical costs are covered by insurance.

Housing:Our house needs major renovation. The work will be completed within the next six months, at an estimated cost of $200,000.

Expenses:Our annual after-tax living costs are expected to be $150,000 for this year and are rising with inflation, which is expected to continue at 3 percent annually.

Income:In addition to income from the Gift Fund and the Family Portfolio (both described below), we receive a fixed annual pension payment (retirement account that pays fixed amount until death) of $65,000 (after taxes), which continues for both of our lifetimes.

Financial Goals:Our primary objective is to maintain our financial security and support our current lifestyle. A secondary objective is to leave $1 million to our grandchild and $1 million to our local college. We recently completed the $1 million gift to the college by creating a "Gift Fund." Preserving the remaining assets for our granddaughter is important to us.

Taxes:Our investment income, including bond interest and stock dividends, is taxed at 30 percent. Our investment returns from price appreciation (capital gains) are taxed at 15 percent, at the time of sale. We have no other tax considerations.

General Comments:We needed someone like WFC to develop a comprehensive plan for us to follow. We can follow such a plan once it is prepared for us. We invest only in companies with which we are familiar. We will not sell a security for less than we paid for it. Given our need for income, we invest only in dividend-paying stocks.

Investments:We benefit from two investment accounts:

• The Gift Fund ($1 million) represents our gift to the college. During our lifetimes, we will receive fixed annual payments of $40,000 (tax free) from the Gift Fund. Except for the annual payments to us, the Gift Fund is managed solely for the benefit of the collegewe may not make any other withdrawals of either income or principal. Upon our deaths, all assets remaining in the Gift Fund will be transferred into the college's endowment.
• The Family Portfolio ($1.2 million) represents the remainder of our lifetime savings. The portfolio is invested entirely in very safe securities, consistent with the investment policy statement prepared for us by WFC as shown in Exhibit 6.

Exhibit 6.WFC Investment Policy Statement for Smith Family Portfolio

The Smith Family Portfolio's primary focus is the production of current income, with long-term capital appreciation a secondary consideration. The need for a dependable income stream precludes investment vehicles with even modest likelihood of losses. Liquidity needs reinforce the need to emphasize minimum-risk investments. Extensive use of short-term investment-grade investments is entirely justified by the expectation that a low-inflation environment will exist indefinitely into the future. For these reasons, investments will emphasize US Treasury bills and notes, intermediate-term investment-grade corporate debt, and select "blue chip" stocks with assured dividend distributions and minimal price fluctuations.

To assist in a discussion of investment policy, Mesa presents four model portfolios used by BigBanc; Exhibit 7 applies the bank's long-term forecasts for asset class returns to each portfolio.