FIN 340 Module 3 Project One Example

Client Analysis: Objectives, Constraints and Investment Policy Statements

[Student Name]

Southern New Hampshire University

FIN 340: Fundamentals of Investments

Project One

[Instructor Name]

[Date]

The organization, setting and figures below are a composite written as a model document. No real employer, client, colleague or patient is described.

Client Analysis: Objectives, Constraints and Investment Policy Statements

Introduction

Before an adviser can recommend investments, the adviser must understand what each client needs the money to do and what limits apply. This project studies two composite households served by a small Keene, New Hampshire, planning firm that charges only fees, using the standard framework of objectives (return and risk) and constraints (time horizon, liquidity, taxes, legal and regulatory factors and unique circumstances). Each analysis ends with a classification and an investment policy statement that will guide the portfolios built in Project Two.

Client One: Tessa Lindqvist

Tessa is 29, single, a dental hygienist earning $72,000 a year with good job security. Her monthly expenses are about $4,200. Her $18,000 of cash sits in a bank savings account paying 1 percent, a $9,000 car loan at 5.9 percent and no other debt. She has just joined her employer's 401(k), contributing 6 percent with a 3.5 percent employer match. Her goals are a $45,000 down payment on a condo within five years and a comfortable retirement at about 65.

Tessa's Return Objective

Tessa has two goals with different horizons. For the condo, she needs $45,000 in five years. Her current savings are her emergency fund, so the condo fund starts from zero; setting aside about $680 a month at a 4 percent return reaches roughly $45,000 in five years. Because the horizon is short, the return objective for this money is capital preservation with a modest yield, not growth. For retirement, her 401(k) contributions of about $500 a month, including the match, need to grow for 36 years. A return of 6 to 7 percent a year would give her a balance that supports retirement spending near her current income, so her retirement return objective is growth.

Tessa's Risk Tolerance

Tessa's willingness to take risk is low. On a short risk questionnaire of the type developed by Grable and Lytton (1999), she scored in the bottom third, and she told the adviser she could not stand to lose money. Kahneman and Tversky (1979) showed that people feel losses roughly twice as strongly as equal gains, and Tessa's reaction is typical of a first-time investor. Her ability to take risk, however, is high: she has secure income, a long horizon, few obligations and an emergency fund after the condo money is set aside. Because ability is high and the risk lies in money she will not touch for decades, the adviser will educate her and recommend above-average risk for retirement savings only, keeping her short-term money safe so that market swings never threaten her condo plan.

Tessa's Constraints

Time horizon: two stages, five years for the condo and 36 years for retirement. Liquidity: an emergency fund of four months of expenses, about $17,000, and the condo fund must be fully available when needed; retirement money is not needed before 59 and a half. Taxes: her taxable income puts her in the 22 percent federal bracket, and New Hampshire has no tax on wages; since the state's interest and dividends tax ended in 2025, investment income is taxed only federally. A Roth 401(k) or Roth IRA is attractive because she expects higher income later. Legal and regulatory: none beyond retirement account rules. Unique: she should pay off the car loan at 5.9 percent before investing new taxable money, since that is a guaranteed return.

Client Two: Gordon and Renee Abernathy

Gordon, 57, is a civil engineer earning $128,000; Renee, 55, is a school business administrator earning $57,000 who will receive a small state pension. They own their home with $90,000 left on the mortgage, which will be paid off in seven years. Their savings total about $860,000: $610,000 in 401(k) and 403(b) accounts, $140,000 in IRAs and $110,000 in a taxable brokerage account, held mostly in stock funds and a few individual stocks Gordon picked. They save $40,000 a year and hope to retire in eight years, when Gordon is 65.

The Abernathys' Return Objective

The couple expects to spend about $96,000 a year in today's dollars in retirement. Social Security and Renee's pension should cover about $58,000 of that once both start, leaving about $38,000 a year, plus extra in the years before Social Security begins. Using a withdrawal rate of about 3 percent, a cautious figure for a retirement that may last 30 years, they need about $1.3 million in today's dollars when Gordon retires. Solving for the return that grows $860,000 plus $40,000 a year to $1.3 million in eight years gives about 1.5 percent a year above inflation, or roughly 4.5 percent in nominal terms with inflation near 3 percent. After retirement, their portfolio must keep pace with inflation while paying out about 3 percent a year. Their return objective is therefore moderate: steady income with enough growth to protect purchasing power.

The Abernathys' Risk Tolerance

Gordon is comfortable with stocks and enjoys picking them, so the couple's willingness to take risk is above average. Their ability is only average and falling. A 30 percent decline in stocks in the year before retirement would cut a stock-heavy portfolio by about $250,000, which could force Gordon to work several more years. With eight years to go and withdrawals to follow, their ability to bear risk is moderate. Here ability wins: their policy should accept less risk than Gordon would choose.

The Abernathys' Constraints

Time horizon: eight years to retirement, then perhaps 30 more, a long horizon with a critical point at retirement. Liquidity: an emergency reserve of about $30,000 and, closer to retirement, two years of withdrawals held in cash or short bonds. Taxes: their combined income places them in the 22 percent bracket; most savings are tax-deferred, so withdrawals will be taxed as income, and the brokerage account should hold tax-efficient investments. Legal and regulatory: required minimum distributions will begin at 75 for both of them under current law. Unique: Gordon's individual stocks are concentrated in three engineering and construction companies, linked to the same industry as his job.

Classification and Policy Statements

Brinson et al. (1986) found that asset allocation explained more than 90 percent of the variation in pension funds' quarterly returns, so these statements focus on allocation ranges rather than securities.

Investment policy statement summary

Tessa's statement directs the adviser to keep the condo fund and emergency reserve in cash and short-term Treasury securities and to invest retirement savings mainly in diversified stocks, reviewed each year and whenever her goals change. The Abernathys' statement calls for a balanced portfolio that gradually reduces stock exposure as retirement approaches, reduces Gordon's concentrated holdings over three years to limit taxes and is reviewed twice a year.

Conclusion

The two clients need very different portfolios, not because of their personalities alone but because of their goals, horizons and capacity to recover from losses. Project Two will translate these statements into specific holdings.

References

Brinson, G. P., Hood, L. R., & Beebower, G. L. (1986). Determinants of portfolio performance. Financial Analysts Journal, 42(4), 39-44. https://doi.org/10.2469/faj.v42.n4.39

Grable, J., & Lytton, R. H. (1999). Financial risk tolerance revisited: The development of a risk assessment instrument. Financial Services Review, 8(3), 163-181. https://doi.org/10.1016/S1057-0810(99)00041-4

Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47(2), 263-291. https://doi.org/10.2307/1914185