Susan Lussier's Inherited Portfolio: Does it meet her needs?

Susan Lussier is a 35-year-old divorcee currently employed as a tax

accountant for a major oil and gas exploration company. She has no children
and earns nearly $135,000 a year from her salary and from participation in
the company's drilling activities. Divorced only a year, Susan has found being
single quite exciting. An expert on oil and gas taxation, she is not worried
about job security 0 she is content with her income and finds it adequate to
allow her to buy and do whatever she wishes. Her current philosophy is to
live each day to its fullest, not concerning herself with retirement, which is
too far in the future to require her current attention.
A month ago, Susan's only surviving parent, her father, was killed in a sailing
accident. He had retired in La Jolla, California, 2 years earlier and had spent
most of his time sailing. Prior to retirement, he managed a children's clothing
manufacturing firm in South Carolina. Upon retirement he sold his stock in
the firm and invested the proceeds in a security portfolio that provided him
with supplemental retirement income of over $30,000 per year. In his will, he
left his entire estate to Susan. The estate was structured in such a way that
in addition to a few family heirlooms, Susan received a security portfolio
having a market value of nearly $350,000 and about $10,000 in cash.
Susan's father's portfolio contained 10 securities: 5 bonds, 2 common stocks,
and 3 mutual funds. The accompanying table lists the securities and their
key characteristics. The common stocks were issued by large, mature, wellknown firms that had exhibited continuing patterns of dividend payment over
the past 5 years. The stocks offered only moderate growth potential 0
probably no more than 2% to 3% appreciation per year. The mutual funds in
the portfolio were income funds invested in diversified portfolios of incomeoriented stocks and bonds. They provided stable streams of dividend income
but offered little opportunity for capital appreciation.
Now that Susan owns the portfolio, she wishes to determine whether it is
suitable for her situation. She realizes that the high level of income provided
by the portfolio will be taxed at a rate (federal plus state) of about 40%.
Because she does not currently need it, Susan plans to invest the after-tax
income primarily in common stocks offering high capital gain potential.
During the coming years she clearly needs to avoid generating taxable
income. (Susan is already paying out a sizable portion of her current income
in taxes.) She feels fortunate to have received the portfolio and wants to
make certain it provides her with the maximum benefits, given her financial
situation. The $10,000 cash left to her will be especially useful in paying
broker's commissions associated with making portfolio adjustments.
Questions

a. Briefly assess Susan's financial situation and develop a portfolio objective

for her that is consistent with her needs.
b. Evaluate the portfolio left to Susan by her father. Assess its apparent
objective and evaluate how well it may be doing in fulfilling this objective.
Use the total cost values to describe the asset allocation scheme reflected in
the portfolio. Comment on the risk, return, and tax implications of this
portfolio.
c. If Susan decided to invest in a security portfolio consistent with her needs
- indicated in response to question a - describe the nature and mix, if any, of
securities you would recommend she purchase. Discuss the risk, return, and
tax implications of such a portfolio.
d. Compare the nature of the security portfolio inherited by Susan, from the
response to question b, with what you believe would be an appropriate
security portfolio for her, from the response to question c.
e. What recommendations would you give Susan about the inherited
portfolio?

Answer :
Case 5.2Susan Lussiers Inherited Portfolio: Does It Meet Her Needs?
This case demonstrates that a portfolio designed for one person is not likely
to be appropriate for another. In particular, it emphasizes some of the
considerations in designing a portfolio.
(a)
Susans financial position is quite strong: she has a regular $125,000
per year job and also has inherited a portfolio worth nearly $350,000 and
$10,000 in cash. Susan has a good job and does not have to rely on earnings
from her portfolio to fulfill current income needs, at least for the present.
(However, the oil and gas industry is rather volatile, and she should not be
too complacent about her job security in the future!) Her primary concerns
are capital preservation and capital growth. She probably prefers to receive
capital gains in the future rather than current income. Although she does not
want to talk about retirement. Susan should develop a financial/investment
plan to address this goal. At her age and with her current level of income and
wealth, she could deal with retirement at a later time, but she cannot ignore
it forever.
(b)
Reviewing Susans inherited portfolio indicates that current income was
her fathers chief objectives; the portfolios current yield is nearly 10%. The
asset allocation based on the total cost data is heavily weighted toward

bonds:
46%
bonds
($158,100/$338,800),
29%
common
stock
($96,900/$338,800), and 25% mutual funds ($83,800/$338,800). Susans
father apparently was not a risk-taker, so his portfolio consisted primarily of
bonds, low-risk (low-beta) stocks, and mutual funds. The portfolios return is
not too high, but that is understandable given its low risk.
However, the same portfolio will result in an unduly high tax liability for
Susan because of the portfolios current-income-orientation. This portfolio
will not satisfy her financial objectives; she must therefore restructure the
portfolio to meet her objectives of capital appreciation and tax shelter.
(c)
Since current yield is not an important consideration for Susan, she
should revise the portfolio to include securities with low current yields and
high capital appreciation potential. This will enable her to lower her annual
tax liability. Her asset allocation should be shifted to more stocks and fewer
bonds and mutual funds. Given the relatively large dollar size ($338,800) of
the portfolio, she should be able to achieve adequate diversification on her
own (assuming she is willing to invest the time or hire a professional
investment manager/advisor). She therefore does not have to rely as heavily
on mutual funds. An asset allocation scheme of around 25 percent bonds, 60
percent common stock, and 15 percent mutual funds is one possible
recommendation.
Within each asset category she should hold higher-risk, capitalappreciation-oriented securities rather than the income-oriented securities
currently held. Since Susan is single and has adequate current income, she
appears to be in a position to justify a higher-risk portfolio. For example, the
existing portfolio has stocks with betas of 0.97 and 0.85, respectively. She
could very well substitute for these stocks those with higher betas. She
should sell some of the highly income-oriented mutual fund investments. The
proceeds should be invested in stocks with good potential for capital
appreciation. For the bond segment she might consider convertible bonds
that have the potential for large capital gains.
(d)
As discussed earlier, the inherited portfolio focuses on current income
and capital preservation, rather than Susans objectives of capital gains and
tax shelter. She will want to adjust the portfolio to include more capital
appreciation securities, and she may also want to restructure the portfolio to
meet projected retirement needs and objectives. Her objective should be to
minimize taxation of the portfolios returns while meeting future net worth
and investment objectives. This strategy would probably initially introduce
greater risk but, of course, the expected future returns would be greater.
Furthermore, Susan can afford an increase in risk at this point in time, and
with an appropriate strategy the risks can be minimized. Also, any losses can

be minimized through portfolio adjustments, and any realized losses can be

used to decrease her tax liability.
(e)
The inherited portfolio is very low-risk portfolio. As mentioned in the
response to question c, this is not a good portfolio for Susan. What Susan
really needs is a portfolio offering greater capital appreciation and
consequently, lower taxable income. Susan should reallocate the assets in
the portfolio (as noted in the response to question c) and introduce greater
risk into the revised portfolio. She should sell some bonds and mutual fund
shares and invest the proceeds in other stock issues. Her bond holdings
could include convertibles, and the stocks should have betas in excess of 1.
However, she should also include some fairly liquid investments in case her
job situation changes, monitor her holdings carefully, and review her
objectives and the portfolio if her personal situation changes.
Outside Project
Chapter 5Your Dream Portfolio
Understanding your own attitude toward risk is very important when you are
selecting investment vehicles for inclusion in your portfolio. This project
should help you consider what you would do if you came into some money.
You bought a state lottery ticket last month and yesterday you learned that
you won one million dollars after taxes. What would you do with the money?
While there are certainly bills to be paid and things to buy, assume that you
will have at least $800,000 to invest. What goals do you wish to achieve with
these funds? State them clearly, develop an asset allocation scheme, and
design a portfolio of stocks, bonds, tangibles, and/or limited partnership
investments that you feel would be consistent with achieving your goals.
Using current price quotations from The Wall Street Journal or local
newspapers, create your own dream portfolio.
Briefly explain the rationale for your asset allocation scheme and the reasons
you included each specific investment vehicle in the portfolio. Point out any
concerns or reservations you might have relative to the portfolio you created.

Hint 2
Case 5.2: Susan Lussiers Inherited Portfolio: Does It Meet Her Needs?
Patrick D. Morgan, Sr.
Ashford University
BUS655: Financial Investment Management

Instructor: Nathan Rondeau

February 17, 201

Case 5.2: Susan Lussiers Inherited Portfolio: Does It Meet Her Needs?
Introduction
Susan Lussier is a young professional focused on living life to its fullest. A
recent inheritance has her rethinking her financial choices, especially with
retirement over 20 years away. Susan needs to create a specific investment
strategy to accommodate her lifestyle. Building this strategy includes
evaluating her needs and understanding the structure and purpose of the
portfolio before redesigning it appropriately.
Susans Current Financial Situation
Susan is looking at creating a growth-oriented portfolio, for long term price
appreciation (Gitman, Joehnk, & Smart, 2010, p. 165). She has the income
to maintain and enjoy her current lifestyle so income is not a priority.
Additionally, she is paying 40% overall in taxes, so does not want the extra
$30,000 yearly income the portfolio provides. Her age and retirement plans
give her time to ride out the instabilities of the stock market. Her focus on
asset growth places her in the moderately aggressive to aggressive approach
to investing, allowing her to tolerate high risk to receive a higher return on
her investments with little consideration for current income.
Meeting
Susans needs involves a portfolio heavy concentrated on stock securities
(Model portfolios, n.d.). This is in direct contrast to the inherited portfolio,
which provided her father with a steady stream of income during his
retirement.
Changing Objectives: From Steady Income to Maximum Growth
Susans father had already retired, so his investment goals highly differed
from Susans.
His portfolio fits into the income-oriented portfolio
designation, primarily focusing on providing regular dividend and interest
payments (Gitman, et al, 2010, p. 165). The portfolio successfully fulfilled
its goal by providing Susans father with $30,000 of yearly supplemental
income. Consisting of 10 securities: five bonds, two stocks, and three mutual
funds, the portfolio fits the conservative investor profile, with only 20%
invested in stocks and the rest balanced between income-oriented
investments and stable principle producing instruments (Model portfolios,
n.d.).

Another portfolio aspect is the primarily non-volatile nature. Having betas

ranging from 0.85-1.10, their returns follow the general direction of the
entire stock market. They are subject to market fluctuations, but less risky
than securities with higher betas (Gitman, et al, 2010). Correspondingly,
these securities have less chance of a significant gain for tax reasons. This
worked well for Susans father, who had held the securities for more than a
year, but was probably at a lower tax bracket than his daughter since
retiring. Tax considerations play heavily into reconfiguring the portfolio to
suit Susan's needs.
Choices, Choices
Susan has several choices available when choosing new portfolio assets.
Similar investors looking for higher returns tend to invest in small- or mid-cap
growth securities or venture into foreign stocks. Small- and mid-cap stocks
are small and medium sized companies, companies with capitalization of
$300M to $10B (Mid cap, n.d.; Small cap, n.d.). By pickings companies in
specialized or growth industries, or opening up new markets by creating new
products, Susan is choosing companies with the potential for significant
growth, but also involving a significant amount of risk. Similarly, she could
start with stocks of companies outside of the United States. The risk with the
fluctuating currency exchange rate and politics of these countries increases
her potential returns. She could also concentrate on up to 90 percent
equities or similar higher risk, growth-focused investments to have the
higher returns she wants (Model portfolios, n.d.). Leaving the other 10% in
bonds increases her income growth over time. She can choose to maintain
the bonds she has, or swap those out to move into foreign-issued bonds or
other instruments fitting her aggressive growth seeking needs.
Since her tax bracket is 28% based on her current income, if Susan
reallocates the portfolio before she has held the assets for a year, she will
gain a significant tax benefit. Timing the sale correctly allows her to have
the amount added to her yearly taxable income versus paying her regular
taxes and the additional capital gains. Additionally she would be able to use
the $10,000 inheritance to pay the other taxes. If she kept the portfolio as it
is for over a year while weighting her options and selecting alternate
securities, she would then paying an additional 15% for capital gains. This
tax implication means that she needs to restructure her portfolio carefully to
get the most benefit in both the short- and long-terms
Summary
Susan should reallocate her portfolio to fit her more aggressive needs for
growth versus the income-based strategy evidenced by the current holdings.
She needs to divest herself of the current income-producing items in her

portfolio. She can use the $10,000 inheritance money to take care of the
capital gains taxes from the sale, and use the proceeds to select items more
suited to her needs. At this point, she can to choose her new investments
herself, primarily equities or similar higher risk investments, weighted toward
aggressive growth, small company and international investments. She also
has the option of taking advantage of a fund that automatically reallocates
the holdings for her, called a life cycle fund. This option allows her to
concentrate on enjoying life versus managing her investments. Either option
helps Susan design a portfolio reflecting the aggressive investing style she
seeks. .
References
Gitman, L. J., Joehnk, M. D., & Smart, S. B. (2010). Fundamentals of investing
(11th ed.). Boston, MA: Pearson Addison Wesley.
ING Retirement Plans. (n.d.). Model portfolios: A model that lives up to your
personal
standards.
Retrieved
from
ING
Retirement
Plans:
http://www6.ingretirementplans.com/SponsorExtranet/ModelPortfolios.pdf
Mid
cap.
(n.d.).
Retrieved
from
Investopedia:
http://www.investopedia.com/terms/m/midcapstock.asp#axzz2LCPCcY7x
Small
cap.
(n.d.).
Retrieved
from
Investopedia:
http://www.investopedia.com/terms/s/small-cap.asp#axzz2LCPCcY7x