Endowment - 3 Spending Rule Methods

[AFusername1234]

Hi All - is anyone able to clarify what I’m missing here. Personally, I found the smoothing rule to be a little odd.
3 Methods:
1). Simple (X% times MV t-1)
-straight fwd calculation. Nothing wonky here
2). 3 year avg (X% rate) times (MV T-1+MV T-2+MV T-3)/3
-used to smooth spending/reduce volatility
3). Smoothing rule formula, which I presume we do not need to know (there is no explicit LOS asking to calculate). Nevertheless, in which instance is using the smoothing rule most appropriate? I can’t remember if it over/underweight’s more recent/older values
Thanks in advance, happy studying!

 

[The Song of the]

A good smoothing rule will overweight recent values and is designed to reduce fluctuatioins in an institution’s operating budget. The issue with smoothing rule #2 is that it gives values from three years ago the same weight as the value last year and so the CFA prefers one with a declining average of trailing values. See CFA Exam 2009 AM Q3 for an example.

 

[Viceroy]

^^ Damn dude ! Quoting a 2009 AM for Endowment Smoothing Rules.
You gotta be in the first percentile at this point. Or I just suck A$$. Or both.

 

[AFusername1234]

Nailed it! Thanks

 

[daharmattan1]

Keep in mind that if a smoothing rule is used that should help dampen volatility of spending as well, which should then decrease liquidity requirements all else equal (that’s come up in previous mocks a lot)

 

[June06]

Geometric smoothing rule: The geometric spending rule gives some smoothing but less weight to older periods. It weights the prior year’s spending level adjusted for inflation by a smoothing rate which is usually between 0.6 and 0.8, as well as the previous year’s beginning-of-period portfolio value:
Remember the most common case, 75/25 smoothing rule, 75% of last year’s spending and 25% of 5% of last year’s endowment market value.
Only 25% using the latest market value.

 

[FrankCFA]

I like 75/25 smoothing rule, it helps me remember this formula.