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Old 11-30-2012, 09:46 AM   #1
Confused about dryer sheets
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Hi everyone,

This is probably a very simple exercise for those of you who are experienced investors and not so math challenged like me.

I need to figure a nominal rate of return for my taxable cash and investment accounts together as one basket for use with a financial planning software package I recently purchased. The software uses this nominal rate of return (minus inflation of course) to calculate my adjusted gross income (AGI), which is of particular interest to me because of the Patient Protection and Affordable Care Act (PPACA). I'm retiring early, will be buying health insurance on the new health insurance exchanges, and will be essentially living off savings until I'm old enough to tap into my IRA's and receive social security benefits.

It might be easiest for me if we lay out a hypothetical scenario and work through it. Please assume the following...

$100,000 in cash/CD's earning 1% interest.
$300,000 in a single target-date mutual fund paying 2% in dividends once annually. Assume capital growth of 5%.

Let's say I need to sell $20,000 worth of the mutual fund shares each year to raise cash for living expenses.

Now I know my AGI will include the 1% interest from the cash/CD's and 2% dividend from the mutual fund. THAT nominal rate of return seems simple enough to calculate. It should be the volume weighted average of the two interest rates, or 1.75% in this particular example. Is this correct?

How do I include in the nominal rate of return (for the software mind you) of the $20,000 worth of the mutual fund shares I sold? Assuming an annual capital appreciation of 5% for the mutual fund, it occurs to me that 5% of the $20,000 ($1,000) would be taxable capital gains in the first year. How about the next year and so on?

Assuming I'm not way off base so far, I'm stumped on how to I include those capital gains into the overall nominal rate of return.

Thanks in advance,

John L.
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Old 11-30-2012, 11:01 AM   #2
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In your situation, I think you need to consider how the software will use the nominal return assumption that you provide since it seems to be using the data to project AGI.

Normally, I would view your nominal rate of return as being a weighted average, in your example your 100 of cash earns 1% and your 300 of mutual funds earns 7% so the weighted average is 5.5%. Or put another way, in a year the cash will grow by 1 and the mutual funds will grow by 21 so 422 in relation to 400 is a 5.5% return

However, I'm hesitant to suggest to you that is the right outcome without knowing how the software uses that assumption. Perhaps you could also ask the makers of the software.
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Old 11-30-2012, 11:29 AM   #3
Confused about dryer sheets
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Quote:
Originally Posted by pb4uski View Post
In your situation, I think you need to consider how the software will use the nominal return assumption that you provide since it seems to be using the data to project AGI.
My experimentation with the software indicates it uses the nominal rate of return minus inflation and considers the entire result as taxable income and part of the AGI. As an aside, the software also allows one to specify what portion of this income is capital gains for proper tax treatment.
Quote:
Normally, I would view your nominal rate of return as being a weighted average, in your example your 100 of cash earns 1% and your 300 of mutual funds earns 7% so the weighted average is 5.5%. Or put another way, in a year the cash will grow by 1 and the mutual funds will grow by 21 so 422 in relation to 400 is a 5.5% return
I would normally agree, but in my case that capital growth part of the mutual fund isn't a taxable event until I sell some or all of the shares. This is why I think there's a more complex estimation I need to do to get my nominal rate of return for accurate modeling.

I hope that makes sense.

BTW, the software I'm using is ESPlanner Pro.

Thanks,

John L.
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Old 11-30-2012, 11:47 AM   #4
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This may provide some insights.

How do I account for unrealized capital gains? | ESPlanner Inc.

Also troll the forum or ask via support.
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Old 11-30-2012, 12:46 PM   #5
Confused about dryer sheets
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Quote:
Originally Posted by pb4uski View Post
This may provide some insights.

How do I account for unrealized capital gains? | ESPlanner Inc.

Also troll the forum or ask via support.
Thanks for the link... it's helpful.

I'll do some additional experimenting to see how these settings interact.

John L.
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