Generational Wealth Management - Week 1
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Generational Wealth Management - Week 1

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Week One material for Generational Wealth Management course. ...

Week One material for Generational Wealth Management course.

The information contained in this presentation is for illustrative and informational purposes only and should not be considered investment advice.

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  • If you have any scheduling issues, you’re interested in a particular focus, you think of something between classes, or you’d like a second opinion on anything, please feel free to use our contact information at any time.
  • Learning Process: My name is Art Doglione…….(a bit about yourself). The Center for Private Wealth Management was started in 2000 as a platform for individual investors to become better stewards of their own wealth. We do not endorse any investment services, managers, or strategies as the content is designed to be academic. If the name of any investment company or stock appears within the material it is simply because that company had great information we wanted to resource or that a given stock could help us illustrate a point.For the past 12 years and counting, we’ve taught several programs to hundreds of investors like you, to several groups, and have even written a financial literacy course for a college preparatory highschool. So we are familiar with all levels of experience and aptitude, please feel free to ask any question as the course progresses. As it stands now, the class time is scheduled from 6:30 to 9:30 for the next several Tuesdays. I understand that this may be a bit late for many of you and we can certainly push the class up to 6:00 and finish a earlier if that suits everyone. …..As for course material, as you can see, I’ve handed out a hard copy of the materials for tonight’s course. If you prefer the hard copies I can certainly continue to bring them, or we can provide you with the materials that are formatted for a tablet or laptop.As far as breaks, we can usually plan on taking one or two brief 5-10 minute breaks about within the class.
  • Learning Process: This is the general format of the class, I anticipate that we may move through the material quickly because there are fewer of you to ask questions. That being said, if you have any questions, please do not hesitate to ask. We established this six step process as a way to allow individuals and families to comprehensively evaluate their situation and make more informed decisions regarding their wealth. For some of you, the information contained in certain sections may be more of a review, as I will try to teach the material in a way that individuals of all levels of sophistication can easily follow. We will generally follow the steps listed above, with each step being covered in one class session. If, at any time, you have a question about something, please feel free to ask. In addition, we can answer more detailed questions through email outside of class if you like. Please feel free to use me as a resource for any and all questions you may have.
  • Participants are strongly urged not to alter their investment structure based on the early classes.Wealth Management does not provide specific investment or tax advice.This course covers many subjects relating to investments and certain portions may not coincide with the participant’s perception or experience. Participants are urged to ask questions at any time.Participants may have questions about subjects not covered in the course material. Instructors are available during breaks and after class to answer questions.
  • Many people are confused when it comes to investing. Everyone has an opinion but not everyone is right. In order to better understand investing, its important to learn the vocabulary and underlying theories that investments are based on. Why are you here? What are you hoping to accomplish?
  • Many people base their investment decisions on emotions, rather than discipline or logic. When markets are going up, individual investors feel ‘good’ about them and when markets are going down, people tend to panic and feel poorly about them.
  • Through some mental bias, people think in hindsight that they "sort of" considered the possibility of such events; this gives them confidence in continuing to formulate predictions. But our tools for forecasting and risk measurement cannot begin to capture black swans. Indeed, our faith in these tools make it more likely that we will continue to take dangerous, uninformed risks.If we could not measure the risks of potential blowups, what were we to do? The answer is simple: We should try to create situations that won't fall apart when we encounter black swans—or that might even gain from these unexpected events.
  • Average investors do better when the market is generally in an uptrend. They confidently add money when the market is rising but give up most of their gains when the market declines. Fear of further declines cause them to sell out or reduce their stock holdings during market declines.It is not investment fees or being better informed that has the greatest impact on the actual investor’s return; it’s their behavior.Those investors that panicked out of the market at the end of 2008 and early 2009 may never recover their losses. Most of them don’t even realize the losses were caused by their own actions. It’s easier to blame Wall Street or the Government.
  • The average equity-fund investor saw annual returns of only 3.49% in the 20 years through 2011, according to the latest analysis from Dalbar. Compare that with the average 7.81% annual return of the S&P 500.Even ‘average’ institutional managers fared significantly better than individual investors, while the best institutional managers perform even better.
  • Because individual investors tend to invest without using a disciplined approach, their returns typically are lower than the market rate of return. Many times, this can be explained by investors taking a short term approach to investing, allowing emotions to drive their investment behavior rather than a systematic approach.
  • The average equity-fund investor saw annual returns of only 3.49% in the 20 years through 2011, according to the latest analysis from Dalbar. Compare that with the average 7.81% annual return of the S&P 500.Even ‘average’ institutional managers fared significantly better than individual investors, while the best institutional managers perform even better.
  • Behavioral Finance has gained more prominent recognition in recent years as markets have exhibited more volatility and bubbles. Although people tend to act ‘rationally’ there are instances where emotion and psychology influence our decisions, causing us to behave in unpredictable or irrational ways. Behavioral finance is important to understand so that we can remove our own biases and understand that markets don’t always behave rationally.
  • Traditional finance assumes that humans act rationally and logically, and that these actions are predictable. Traditional finance utilizes models like the Capital Asset Pricing Model (CAPM) to explain and predict rational behavior. For the most part, the CAPM does a respectable job of explaining market behavior. However, over time, the CAPM and other logical theories could not explain certain anomalies and other unpredicted behavior. Behavioral finance seeks to explain our actions, rational or irrational, rather than predict them.
  • To start, I’d like to go over the first recorded financial bubble. Tulips were not natural to the Netherlands, but were first imported from Turkey. The tulips attracted a lot of attention and popularity, which drew significant speculation. In today’s dollars, most of these tulip bulbs would have cost hundreds of thousands of dollars, and in some exceptional cases, millions of dollars. Don’t forget that we’re talking about tulip bulbs. In the wake of this disaster, many people lost their jobs and homes, or were deeply indebted for the remainder of their lives (sound familiar?).
  • Currently, the world economy is in the corrective stages of a residential real estate bubble. The signs of houses being overvalued, and excess speculation dominating the market were there for people to discover. The bubble was compounded by the use of leverage (debt) to purchase overvalued assets. This is exactly what occurred before the Great Depression, when investors purchased stock on margin (debt).
  • We’re biased and we tend to make irrational or emotion investment decisions that typically harm our portfolio performance. In order to become better investors, we need to understand what types of biases exist, and which biases we fall victim to so that we can make corrections. Here are several biases, I’ll focus on a couple that are particularly present in making poor investment choices. (Dot Not need to provide these definitions for the class, they are here for reference if asked)Overconfidence - someone's subjective confidence in their judgments is reliably greater than their objective accuracy, especially when confidence is relatively high.Escalation Bias - Investors invest more in money-losing investments for which they feel responsible than they invest in an ongoing successful investment.Mental Accounting - Rather than rationally viewing every dollar as identical, mental accounting helps explain why many investors designate some of their dollars as "safety" capital which they invest in low-risk investments, while at the same time treating their "risk capital" quite differently.Anchoring – Investors tend to hang on to losing investments, waiting for the investment to break even at the price at which it was purchased. Thus, they anchor the value of their investment to the value it once had, and instead of selling it to realize the loss, they take on greater risk by holding it in the hopes it will go back up to its purchase price.Confirmation & Hindsight Bias - The confirmation bias suggests that an investor would be more likely to look for information that supports his or her original idea about an investment rather than seek out information that contradicts it. Hindsight bias is when a person believes (after the fact) that the onset of some past event was predictable and completely obvious, whereas in fact, the event could not have been reasonably predicted.Regression Towards the Mean – When extreme events take place, the subsequent event tends to be closer to the average; only individuals tend to attribute this occurrence to other factors. Herd Behavior - the tendency for individuals to mimic the actions (rational or irrational) of a larger group. Individually, however, most people would not necessarily make the same choice.Gambler’s Fallacy - When an individual erroneously believes that the onset of a certain random event is less likely to happen following an event or a series of events. This line of thinking is incorrect because past events do not change the probability that certain events will occur in the future. Example: flipping a coin 20 times and getting ‘heads’ each time does not effect the probability of getting heads on the 21st flip, but people tend to use this as a factor in making their decisions. Prospect Theory – People value gains and losses differently. People tend to base decisions on perceived gains rather than losses. Thus, if a person were given two equal choices, one expressed in terms of possible gains and the other in possible losses, people would choose the former.
  • Escalation bias causes investors to invest more in money-losing investments for which they feel responsible than they invest in an ongoing successful investment. The popular concept of “averaging down” to reduce the average price paid for the investment may be representative of this bias.Some hedge-funds took leveraged bets against dot-com companies in the late 90s. As stock prices went up, they continued to short (sell) the stocks. Most funds that did this went belly up before the bubble burst in 2000-2001. Although correct in their analysis, they went bankrupt by escalating the size of their position. The rational, traditional finance model would expect investors to re-evaluate holdings for potential bad news that they had failed to incorporate into their initial valuation. If the re-evaluation supports the investment, then more could be added. Otherwise, it would be wiser to exit the position and take the loss.
  • From an investment perspective, suppose that XYZ stock had very strong revenue in the last year, causing its share price to shoot up from $25 to $80. Unfortunately, one of the company's major customers, who contributed to 50% of XYZ's revenue, had decided not to renew its purchasing agreement with XYZ. This change of events causes a drop in XYZ's share price from $80 to $40. By anchoring to the previous high of $80 and the current price of $40, the investor erroneously believes that XYZ is undervalued. Keep in mind that XYZ is not being sold at a discount, instead the drop in share value is attributed to a change to XYZ's fundamentals (loss of revenue from a big customer). In this example, the investor has fallen prey to the dangers of anchoring. When it comes to avoiding anchoring, there's no substitute for rigorous critical thinking. Be especially careful about which figures you use to evaluate a stock's potential. Successful investors don't just base their decisions on one or two benchmarks, they evaluate each company from a variety of perspectives.
  • In case any of you are unfamiliar with the term “Fiduciary”, it is basically defined as: A person legally appointed and authorized manage assets for another person. The fiduciary manages the assets solely for the benefit of the other person rather than for his or her own profit.Understanding the process by which a fiduciary works for another person can help understand the same processes that can add discipline to your own investment style. The Fiduciary Process is to:1 – Organize: Which is to lay out all of the different variables for your situation (goals, investments, risk tolerance, income needs, etc)2 – Formalize: Putting down a formal strategy with investments, spending, and contributions.3 – Implementation: Putting part 2 into action.4 – Monitor: Making sure that you can track the effectiveness of your total portfolio, monitor your expenses and withdrawals, and track performance of assets/managers.
  • Putting together a plan and setting attainable goals is important to achieve success. Writing out a plan and setting goals forces individuals to think aboutpotential hurdles and how to get past those hurdles.
  • Goals must be specific, measurable, action oriented, realistic, and time specific. For example, simply setting a goal that you want to 20lbs, by the end of the year, has little value unless you plan actions that will help you reach that goal.
  • In the next short 25 year period of your financial life cycle you are tasked to accumulate enough wealth to retire on. This task becomes a hit or miss proposition when one considers the way markets trade relative to your financial life cycle.
  • Because people are living longer, having the right wealth management plan is key. Many people have fears that they ‘outlive’ their money.
  • For some people, having more free time during retirement leads them to spend more than when they were working. If you plan on spending more during retirement, that must be considered when planning for retirement.
  • Survival Money – Money that I have to have to make ends meet“What If” Money - Money that I must have to meet life’s unexpected twistsFreedom Money - Money to do all the things that bring enjoyment and fulfillment to my lifeGift Money – Money for the people and causes that I care aboutDream Money – Money for the things that I’ve always dreamed of having and doing
  • Survival Money – Money that I have to have to make ends meet“What If” Money - Money that I must have to meet life’s unexpected twistsFreedom Money - Money to do all the things that bring enjoyment and fulfillment to my lifeGift Money – Money for the people and causes that I care aboutDream Money – Money for the things that I’ve always dreamed of having and doing
  • Survival Money – Money that I have to have to make ends meet“What If” Money - Money that I must have to meet life’s unexpected twistsFreedom Money - Money to do all the things that bring enjoyment and fulfillment to my lifeGift Money – Money for the people and causes that I care aboutDream Money – Money for the things that I’ve always dreamed of having and doing
  • Proper wealth management can help people become financially independent.
  • A bond, quite simply, is an instrument of debt. I’m sure you are all quite familiar with the general features of bonds, but I‘ll do my best to be thorough so that you feel more comfortable with them as we go forward. *A supranational is a group that supports the development of the economically integrated group of countries is that single government agencies will make decisions for all the countries. Thus the agency is larger and the decisions have more impact that a single country agency. Example European union , European parliament, European court of justice, monetary authority etc.
  • A bond, quite simply, is an instrument of debt. I’m sure you are all quite familiar with the general features of bonds, but I‘ll do my best to be thorough so that you feel more comfortable with them as we go forward. *A supranational is a group that supports the development of the economically integrated group of countries is that single government agencies will make decisions for all the countries. Thus the agency is larger and the decisions have more impact that a single country agency. Example European union , European parliament, European court of justice, monetary authority etc.
  • A bond, quite simply, is an instrument of debt. I’m sure you are all quite familiar with the general features of bonds, but I‘ll do my best to be thorough so that you feel more comfortable with them as we go forward. *A supranational is a group that supports the development of the economically integrated group of countries is that single government agencies will make decisions for all the countries. Thus the agency is larger and the decisions have more impact that a single country agency. Example European union , European parliament, European court of justice, monetary authority etc.
  • A bond, quite simply, is an instrument of debt. I’m sure you are all quite familiar with the general features of bonds, but I‘ll do my best to be thorough so that you feel more comfortable with them as we go forward. *A supranational is a group that supports the development of the economically integrated group of countries is that single government agencies will make decisions for all the countries. Thus the agency is larger and the decisions have more impact that a single country agency. Example European union , European parliament, European court of justice, monetary authority etc.
  • Reinvestment Risk – The risk related to what the interest rate will be when income and/or principal from investments is reinvested. If interest rates fall, the investors will be worse off when reinvestment occurs. If they rise, they will be better off. Two Factors have an effect on the degree of reinvestment rate risk: Maturity of the Bond – The longer the maturity, the higher likelihood that interest rates will be lower than they were at the time of the bond purchase. Interest Rate of the Bond – The higher the interest rate, the bigger the coupon payments that have to be reinvested, and consequently, the bigger the reinvestment rate risk.
  • Inflation Risk – The risk that inflation will undermine performance of an investment.
  • When the yield curve shifts, the price of the bond, which was initially priced based on the initial yield curve, will change in price. If the yield curve flattens, then the yield spread between long- and short-term interest rates narrows, and the price of the bond will change accordingly. If the bond is a short-term bond maturing in three years and the three-year yield decreases, the price of this bond will increase. If the yield curve steepens, this means that the spread between long- and short-term interest rates increases. Therefore, long-term bond prices will decrease relative to short-term bonds. Changes in the yield curve are based on bond risk premiums and expectations of future interest rates.
  • Credit Risk – The risk that stems from a borrower’s failure to repay their debt and/or interest.The higher the perceived credit risk, the higher the rate of interest that investors will demand for lending their capital. Credit risks are calculated based on the borrowers' overall ability to repay. This calculation includes the borrowers' collateral assets, revenue-generating ability and taxing authority (such as for government and municipal bonds).
  • Some bonds, like U.S. Treasury securities, are quite easy to sell because there are many people interested in buying and selling such securities at any given time.Liquidity risk is the risk that you will not be easily able to find a buyer for a bond you need to sell. A sign of liquidity, or lack of it, is the general level of trading activity: A bond that is traded frequently in a given trading day is considerably more liquid than one which only shows trading activity a few times a week.
  • Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.For example, if you are a U.S. investor and you have a bond in Canada, the return that you will realize is affected by both the change in the price of the bond and the change in the value of the Canadian dollar against the U.S. dollar. So, if you realize a 10% return in your Canadian bond but the Canadian dollar depreciates 10% against the U.S. dollar, this will amount to no gain at all.
  • This is a table that compares the average returns of various fixed income asset classes over the last 10 years.
  • Primary goal is to preserve capital and prevent loss in a portfolio.Preservation of capital is a priority for retirees and those approaching retirement, since they may be relying on their investments to generate income to cover their living expenses, and have limited time to recoup losses if markets experience a downdraft.
  • Aimed to supplement equities in a portfolio and reduce the overall volatility of that portfolio. We will get more into volatility, risk, etc in next week’s course.
  • The goal of most bond funds is to generate a return for investors by investing in a variety of bonds that generate a healthy and consistent income stream. For most funds, there isn't a focus on capital appreciation like there is for equity funds. However, depending on the level of income needed or desired, additional risk may need to be accepted by the bond buyer.
  • Total return accounts for two categories of return: income and capital appreciation. Income includes interest paid by fixed-income investments, distributions or dividends. Capital appreciation represents the change in the market price of an asset.
  • Liability is limited to the Stock Owner’s investment in the company.Liquidation rights permit stock owners to receive proceeds from the liquidation of a firm. Generally speaking, assets will be received from a liquidation in the following hierarchy: secured creditors, general creditors, preferred stock holders, common stock holders. Voting rights allow stockholders to vote on matters of corporate policy and who will make up the board of directors. Voting often involves decisions on issuing securities, initiating corporate actions and making substantial changes in the corporation's operations.Dividends (total return, income generation, etc)Capital Appreciation – stock price increase.
  • Stocks are classified based off their place of origin, their market capitalization (size) and their propensity to reinvest or payout their retained earnings.
  • Big/large cap - These companies have a market cap between $10 billion to $200 billion. Many well-known companies fall into this category, including companies like Microsoft, Walmart and General Electric, and Apple. Typically, large-cap stocks are considered to be relatively stable and secure. Both mega and largecap stocks are often referred to as blue chips. Mid cap - Ranging from $2 billion to $10 billion, this group of companies is considered to be more volatile than the large- and mega-cap companies. Growth Stocks represent a significant portion of the mid caps. Some of the companies might not be industry leaders, but may be well on their way to becoming one.Small cap - Typically new or relatively young companies, small caps have a market cap between $300 million to $2 billion. Although their track records won't be as lengthy as those of the mid to mega caps, small caps do present the possibility of greater capital appreciation - but at the cost of greater risk. Micro cap - Mainly consisting of penny stocks, this category denotes market capitalizations between $50 million to $300 million fall into this category. The upward potential of these companies is similar to the downside potential, so they do not offer the safest investment, and a great deal of research should be done before entering into such a position. Nano cap - Companies having market caps below $50 million are nano caps. These companies are the most risky, and the potential for gain is often relatively small. These stocks typically trade on pink sheets or OTCBB (Over the Counter Bulletin Board).
  • Dividend Reinvestment is the heart of compounding. You can see on this chart how the effects of investing none, half, or 100% of dividends can have a significant steepening-effect to your income curve. However, reinvesting dividends can end up leading to significant concentration-risk; meaning that your portfolio may be over-exposed to one particular security.
  • This is a real world illustration of the previous slide. As the real price of the S&P 500 has increased significantly over time, the Real total Return figure is much higher because of the compounding effects of dividend payments.
  • Note that 2008 was the second-worst year on record. The worst year on record -- 1931 -- was preceded by two down years and was also followed by a down year. So far, 2008 is surrounded by up years.
  • Over the Long term periods, 1802-2006, 1802-1870, 1871-1925, 1926-2012, and 1946-2012, stocks delivered very similar real returns of approx. 6.4-6.7% with long term 1802-2012 of 6.6%. But Stocks can deviate from the long term average for long periods of time. For example:1946-1965 = 10%1966-1981= -.4%1981-1999= double the long-term average, 13.6%2000-2012 = Virtually flat at -0.1%
  • By looking at this, you may notice how inflation at approximately 3% can eat into your real returns. So, according to this chart, Small Cap stocks seem to be the best method for investing in the long term… However, in the next class we’ll discuss how to properly identify the risk profile of an investment portfolio, the effects of volatility, and how to create a portfolio around a given person’s needs and wants.

Generational Wealth Management - Week 1 Generational Wealth Management - Week 1 Presentation Transcript

  • Wealth Management An Unbiased Approach to Managing Your Investments Designed for the Affluent Investor
  • Adam Harding, CFP® Instructor Phone: 480.306.8705 Email: adam@thecfpwm.com Fax: 480.505.4034 Contact Information
  • Course Introduction Six Weeks Course Material: Online Slides, Discussion Boards, Email Correspondence
  • Wealth Management Process – Six Steps Step 1 • Understanding Investor Behavior and Setting Goals Step 2 • Defining Asset Classes and Measuring Different Types of Risk Step 3 • Understanding Asset Allocation, Diversification, and Volatility Step 4 • Tax and Estate Planning Considerations Step 5 • Selecting Investment Managers, Evaluating Advisors, and Preparing Heirs for the Responsibility of Wealth Step 6 • Collaborating Knowledge and Implementation
  • Notes of Caution Participants are strongly urged not to alter their investment structure based on the early classes. Wealth Management does not provide specific investment or tax advice. This course covers many subjects relating to investments and certain portions may not coincide with the participant’s perception or experience. Participants are urged to ask questions at any time. Participants may have questions about subjects not covered in the course material. Instructors are available during breaks and after class to answer questions.
  • Beta Academics Investment Seminars Mutual Fund Companies NASDAQ Brokerage Firms College Costs Alpha Performance Reports Standard Deviation Correlation CPAs Investment Advisors Books Real Estate Diversification Print Media Attorneys Insurance Pension Defined Benefit Television Risk Relatives Retirement S & P 500 CNBC Discount Brokers Mortgage Brokers Money Managers Liquidity Internet Bankers Friends Neighbors Line of Credit Confusion ?
  • Example: Calling the bottom is impossible Boston Globe, Aug 12, 2000 – “…at these undervalued prices…we’re not selling any stock at these prices”. (on Monday, Aug 14, the S&P 500 closed at 1491. Four years later on Aug 12, 2004, the S&P fell a further 29% to close at 1063.) Wired Magazine, Dec 4 2000 – “Fred Siegel, president of investment management firm Siegel Group, believes that it is unlikely that the Nasdaq will drop more than another 200 points.” (The Nasdaq fell over 1,000 points shortly after Siegel made his prediction.) Market guru and former hedge fund manager Jim Cramer TheStreet.com said it best in Jan 2001: “I get paid to call bottoms. I don’t see one yet, but in my 18 years of trading I’ve never called one exactly right yet. I don’t see why this time will be any different.” Wealth Management is More than Investing… Source: DCA: It Gets You In At the Bottom, Cory Janssen DCA does not assure a profit and does not protect against loss in declining markets.
  • Cycle of Human Emotions Point of maximum financial opportunity Optimism Excitement Thrill Euphoria Anxiety Denial Fear Desperation Panic Capitulation Despondency Depression Hope Relief Optimism Point of maximum financial risk “Wow, I feel great about this investment.” “Maybe the markets just aren’t for me.” “Temporary setback. I’m a long-term investor.” Source: Westcore Funds/Denver Investment Advisers LLC, 1998
  • Black Swan Event We rarely see Black Swans coming, but when they do arrive, they shape our world profoundly. - World Wars I & II - September 11, 2001 - The Rise of the Internet - The Great Recession Sourec: http://online.wsj.com/article/SB10001424127887324735104578120953311383448.html An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult to predict.
  • The “Guess Right Ratio” This Chart shows fund inflows and outflows to determine how often investors correctly time the market. Investors make money when the ratio exceeds 50%.
  • How have institutional portfolios compared to retail portfolios? *Barclays Aggregate Bond Index “2011 Quantitative Analysis of Investor Behavior” from Dalbar, Inc. 2012 The Institutional Process 7.81% 3.49% 0.95% 6.5% -4.6% 7.9% 8.0% 41.0% S&P Average Equity Investor Average Fixed Income Investor Fixed Income Benchmark* Minimum Mean Median Maximum “Institutional”“Retail”
  • Many retail investors do not use a disciplined approach. Result
  • Investor Behavior tends to be the cause of underperformance Source: Bemanaged.com The Institutional Process
  • Behavioral Finance What is it? – It is the “study of the influence of psychology on the behavior of financial practitioners and the subsequent effect on markets.” Why is it important? – It helps explain “why and how markets might be inefficient.” Psychological forces motivating the people and institutions that move the stock market daily, weekly and so on.
  • Traditional vs. Behavioral Finance Traditional Finance Humans react rationally in the marketplace Decisions based in fact and exclusive of sentiment Does not explain the anomalies Behavioral Finance Borrows from Cognitive Psychology Explains those events that are unexplainable by rational means Behavioral Finance is not an arm of Traditional Finance, it’s a replacement. Behavioral Finance implies that when greed prevails, markets tend to overshoot their true values, and when fear prevails, markets tend to undershoot their true values.
  • Tulip Mania •Tulip mania – a period in the Dutch Golden Age during which contract prices for bulbs of tulips reached extraordinarily high levels •At the peak, in February 1637, tulip contracts sold for more than 10 times the annual income of a skilled craftsman. •Some bulbs were traded for as much as 2400 lbs of wheat, or 2 tons of butter. Tulip Mania is generally considered the first recorded speculative bubble.
  • Signs of Modern Day Tulip Mania
  • Biases and Investments •We are biased. •Types: •Overconfidence •Escalation Bias •Mental Accounting •Anchoring •Confirmation & Hindsight Bias •Regression to the Mean •Herd Behavior •Gambler’s Fallacy •Prospect Theory Biases lead to misevaluations
  • Escalation Bias • Overconfidence can lead to escalation bias • Hedge-funds that took leveraged bets against dot- com companies in the late 90s • Long-Term Capital Management Hedge Fund “The market can stay irrational longer than you can stay solvent. “ – John Maynard Keynes
  • Anchoring • During normal decision making, individuals anchor, or overly rely, on specific information or a specific value and then adjust to that value to account for other elements of the circumstance. • Usually once the anchor is set, there is a bias toward that value. • EG- the status quo for the price of an engagement ring is supposedly 2 months salary. This figure is irrelevant and placed into society by profit maximizing jewelry companies; yet many men compare what they earn in 2 months to the amount they should spend.
  • The Fiduciary Process
  • Needs and Goals Example In 1953, a study of Yale students was conducted. 3% had written goals and 97% did not. In the 1973 follow-up, the 3% who had goals had accomplished more than the 97% who had not. Putting together a plan and setting attainable goals is important to achieve success. Writing out a plan and setting goals forces individuals to think about potential hurdles and how to get past those hurdles.
  • Performance Goals • Specific • Measurable • Action Oriented • Realistic • Time Specific Goals must be specific, measurable, action oriented, realistic, and time specific. For example, simply setting a goal that you want to 20lbs by the end of the year has little value unless you plan actions that will help you reach that goal.
  • Financial Life Cycle
  • Trends In Retirement People are living longer and spending more time in retirement 2012 2025 2050 Men 25 20 15 10 5 0 TIMEINYEARS LIFE EXPECTANCY AFTER AGE 65 10 16 13 19 16 22 Women
  • Lifestyle Inflation Lifestyle inflation is the phenomena of expenses actually increasing during retirement. It is not due to inflation or taxation, but to the increase in leisurely pastimes; golf, travel, dining out, attending performances, etc. How will your retirement spending change? TRAVEL 66% DINING OUT 37% GIFTS 33%
  • Monetary Needs: Maslow Meets Retirement IMCA Dream Gift Freedom Security Survival
  • Dream Gift Freedom Security Survival Things to own, places to go, goals to accomplish Charities, church, ch ildren, special interests Hobbies, travel, p ersonal growth, and education Housing, Food, Clothing, Trans portation Health issues, aging parents, emergency repairs $ $ $ $ $ Monetary Needs: Maslow Meets Retirement Total $ IMCA
  • Dream Gift Freedom Security Survival Things to own, places to go, goals to accomplish Charities, church, ch ildren, special interests Hobbies, travel, p ersonal growth, and education Housing, Food, Clothing, Trans portation Health issues, aging parents, emergency repairs $ $ $ $ $ Monetary Needs: Maslow Meets Retirement Total $ 1,000/mo 1,500 2,000 2,500 3,000 10,000/month IMCA
  • Reaching Your Goals Financial independence is when you can maintain your desired lifestyle for the remainder of your life without the worry of money. LIFESPAN INCOMEPRODUCTIONCAPACITY DESIRED LIFESTYLE FINANCIAL INDEPENDENCE FINANCIAL DEPENDENCE
  • Learn To Ask The Question: “How can I build multiple, sustainable income streams?”
  • Bonds (Fixed Income)
  • Bond Basics What is a bond? • A bond, quite simply, is an instrument of debt. I’m sure you are all quite familiar with the general features of bonds, but I‘ll do my best to be thorough so that you feel more comfortable with them as we go forward.
  • Bond Basics What is the difference between a stock and a bond? • Owners of bonds have often have some kind of underlying collateral that secures their interest. Example: if a company goes bankrupt, after selling it’s assets it will pay bondholders and creditors before paying stockholders.
  • Bond Basics Who issues bonds? National Governments Government Agencies Supranational Agencies States and Municipalities Corporations Asset Securitization
  • Bond Basics Source: Dimensional Fund Advisors
  • Key Risks of Bond Investing •Interest Rate Risk – Reinvestment Risk – Inflation Risk – Yield Curve Risk •Credit Risk •Liquidity Risk •Currency Risk
  • Key Risks of Bond Investing Interest Rates Bond Prices % $ Interest Rate Risk – Reinvestment Risk Reinvestment Risk – The risk related to what the interest rate will be when income and/or principal from investments is reinvested. If interest rates fall, the investors will be worse off when reinvestment occurs. If they rise, they will be better off. Two Factors have an effect on the degree of reinvestment rate risk: Maturity of the Bond – The longer the maturity, the higher likelihood that interest rates will be lower than they were at the time of the bond purchase. Interest Rate of the Bond – The higher the interest rate, the bigger the coupon payments that have to be reinvested, and consequently, the bigger the reinvestment rate risk.
  • Interest Rates – Last 30 Years Source: https://www.google.com/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&cad=rja&docid=3Q5TY1WELBT2_M&tbnid=6gsn2z4I1P4mJM:&ved=0CAMQjhw&url=http%3A%2F%2Ffinance.fortune.cnn.com%2F2012%2F11%2F28%2Fhigh- yield-debt%2F&ei=-e1BUqW3L6aRiAKt9oBw&bvm=bv.53077864,d.cGE&psig=AFQjCNEcybrE27qZ5C_vgVKmTXzn1z5Vgw&ust=1380138855843339
  • Key Risks of Bond Investing Interest Rate Risk – Inflation Risk Cash flows from future investments won’t be worth as much in the future in real terms. Nominal & Real Income from Bond in Year 1 = $1,000 Yearly Inflation = 3% Nominal Income in Year 2 = $1,000 Real Income in Year 2 = $970 Real Income in Year 10 = $744.09
  • Key Risks of Bond Investing Interest Rate Risk – Yield Curve Risk Shifting yield curves cause the price of a bond to change. Interest rates cause the yield curve to shift. When the yield curve shifts, the price of the bond, which was initially priced based on the initial yield curve, will change in price. If the yield curve flattens, then the yield spread between long- and short-term interest rates narrows, and the price of the bond will change accordingly. If the bond is a short-term bond maturing in three years and the three-year yield decreases, the price of this bond will increase. If the yield curve steepens, this means that the spread between long- and short-term interest rates increases. Therefore, long-term bond prices will decrease relative to short-term bonds. Changes in the yield curve are based on bond risk premiums and expectations of future interest rates.
  • Key Risks of Bond Investing S&P/Fitch Description AAA Extremely High Quality AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ CCC CCC- CC C D Default Very High Quality Speculative Very Speculative/Near Default High Quality Credit Risk Higher perceived risk means that the lender will demand a higher rate of interest for their capital. Investment Grade Speculative Grade (“Junk”)
  • Key Risks of Bond Investing Liquidity Risk The ability to easily sell your bonds. The market for bonds is typically “thinner” than the market for stocks; meaning that there are fewer buyers and sellers. US Treasuries, historically, have had no liquidity risk. Small market bonds, “callable” bonds, and small face value bonds tend to have higher liquidity risk.
  • Key Risks of Bond Investing Currency Risk Money must be converted to another currency to make a certain investment, then any changes in the currency exchange rate will cause that investment's value to either decrease or increase when the investment is sold and converted back into the original currency.
  • FixedIncome Type Average Annualized Return Lowest Annual 12 MonthRolling Return Highest Annual 12 MonthRolling Return Standard Deviation EndingValue of $10,000 Investment Treasury Bills 1.90% 0.10% 5.50% 0.39% 12,075.00$ Intermediate Treasury Bonds 4.09% -1.40% 12.00% 3.50% 14,932.00$ LongTreasury Notes 7.64% -12.90% 32.70% 13.50% 20,897.00$ Government Agency Bonds 4.24% -1.60% 10.20% 2.90% 15,147.00$ Treasury InflationProtectedSecurities (TIPS) 6.65% -7.50% 19.50% 7.30% 19,042.00$ Mortgage BackedSecurities 4.13% -0.10% 10.60% 2.30% 14,997.00$ Asset BackedSecurities 5.45% -16.80% 26.30% 8.10% 17,003.00$ Municipal Bonds 5.10% -3.60% 14.80% 5.40% 16,448.00$ Investment Grade Corporate Bonds 8.10% -22.50% 46.60% 12.80% 21,796.00$ HighYieldCorporate Bonds 10.61% -31.20% 64.90% 10.61% 27,434.00$ ForeignBonds 8.03% -9.80% 23.70% 9.40% 21,661.00$ PreferredStock 4.70% -59.73% 124.00% 23.70% 15,834.00$ Convertible Bonds 7.24% -33.20% 46.20% 14.30% 20,124.00$ Investment Comparison Characteristics and Returns – 1/31/2003 to 12/31/2012 Source: Morningstar Advisor Workstation, Hypothetical Illustration. Past performance not indicative of future results.
  • Suitability Four general uses for bonds •Capital preservation •Equity hedge •Income generation •Total return  Short maturity Treasuries  High quality short maturity municipals
  • Suitability  Long maturity Treasuries  High quality long maturity municipals Four General Uses for Bonds •Capital Preservation •Equity Hedge •Income Generation •Total Return
  • Suitability  May require taking on credit risk  Achieve yield target while minimizing risk of loss Four General Uses for Bonds •Capital Preservation •Equity Hedge •Income Generation •Total Return
  • Suitability  Combine sectors with low correlation  Overweight cheap sectors, avoid rich sectors Four General Uses for Bonds •Capital Preservation •Equity Hedge •Income Generation •Total Return
  • Equities
  • Principal Features of Stocks •Limited Liability •Liquidation Rights •Voting Rights •Potential for Dividends •Potential Appreciation
  • Major Equity Indices • S&P 500 – Market-weighted index of 500 actively traded large cap US companies • Dow Jones Composite – Price-weighted average of 30 significant US stocks • NASDAQ Composite – An index of the stocks traded on the NASDAQ stock exchange • Russell 3000 – An index that measures the performance of the largest 3000 US stocks • Russell 1000 – An index that measures the performance of the largest 1000 US stocks. • Russell 2000 – An index that measures the smallest 2000 stocks of the largest 3000 US stocks. • MSCI EAFE – An index that measures equity performance outside of the US and Canada. • Dow Jones US Real Estate– This index measures the performance of US REITs.
  • Stock Classification Domestic / International LargeCap / MidCap / SmallCap / MicroCap / NanoCap Core (Blend) / Value / Growth
  • Stock Classification • Domestic Stocks—issued by a corporation or company headquartered in the United States • International Stocks—issued by a corporation or company headquartered outside of the United States
  • Stock Classification • Large Cap Stocks ($10 billion and above) • Mid Cap Stocks ($2 billion - $10 billion) • Small Cap Stocks ($300 million - $2 billion) • Micro Cap Stocks ($50 million – $300 million) • Nano Cap Stocks (Less than $50 million) Market Capitalization is the number of shares outstanding times the stock price. In other words, the current market value of the company
  • Stock Classification • Growth—companies with higher price-to-book ratios and higher forecasted growth values. In general, earnings chase price • Value—Companies with lower price-to-book ratios and lower forecasted growth values. In general, price chases earnings. • Core – When neither Value nor Core is dominant. When referring to equity mutual funds, this is often referred to as “Blend”.
  • The Power of Compounding Source: seekingalpha Dividend Reinvestment is the heart of compounding. You can see on this chart how the effects of investing none, half, or 100% of dividends can have a significant steepening-effect to your income curve. However, reinvesting dividends can end up leading to significant concentration-risk; meaning that your portfolio may be over-exposed to one particular security.
  • The Power of Compounding S&P 500 Historical Return Source: Hays Advisory
  • Market Cycles and Crisis Events The following slide shows major events over the last several decades. You can see the effect of these events and how the market has rebounded.
  • A Chronicle of Crises S&P 500 Historical Return Source: Dalbar, Inc. Quantitative Analysis of Investor Behavior Great Depression Tech Wreck Suez Canal Crisis Black Monday Nixon Resignation Great Recession
  • S&P 500 Cycles Since 1928
  • Stock Valuation S&P 500 Historical P/E10 Ratio P/E10Ratio Source: www.multipl.com Mean: 16.49 Median: 15.89 Min: 4.78 (Dec 1920) Max: 44.20 (Dec 1999)
  • Stock Valuation S&P 500 Historical Dividend Yield Yield% Mean: 4.43% Median: 4.37% Min: 1.11% (Aug 2000) Max: 13.84 (June 1932) Source: www.multipl.com
  • Stock Valuation S&P 500 Real Price Price Source: www.multipl.com
  • Annual Stock Market Returns 1926 through 2011 Source: Source: cbsnew.com
  • Annual Stock Market Returns Source: Source: Siegel, Jeremy, Stocks for the Long Run (2007). Update 2012 January 1802 – June 2012 Real Returns Long-Term 1802-2012 6.6% Major Sub-Periods I 1802-1870 6.7% II 1871-1925 6.6% III 1926-2012 6.4% Post-War Periods 1946-2012 6.4% 1946-1965 10.0% 1966-1981 -0.4% 1982-1999 13.6% 2000-2012 -0.1%
  • Annualized Returns From 1/1926 to 12/2011Return% Source: Ibbotson and Asociates Historical Asset Class Returns 2.99% 3.59% 5.72% 9.77% 11.88% US Inflation US 30-Day Treasury Bills US Long Term Government Bonds S&P 500 US Small Cap Stocks