0
Wealth Management
An Unbiased Approach to Managing Your Investments
Designed for the Affluent Investor
Basics of Investing
Fundamental Principle of Investing
RISK
EXPECTEDRETURN
LOW HIGH
CASH
BONDS
STOCKS
Basics of Investing
Types of Investors
RISK
RETURN
LOW HIGH
HIGH
MANAGES
ONLY
RISK
MANAGES
BOTH RISK
& RETURN
MANAGES
ONLY...
Something to Consider:
“Stocks have outperformed fixed income securities over time.
Why not always invest in stocks for fu...
The impact
of risk on
retirement
income
© American Funds Distributors, Inc.
The impact
of risk on retirement income
The primary concern for most investors is the possibility of permanently losing th...
Some Assumptions Do Not Apply
Before Retirement
Cash flow not an issue
Known time horizon
Risk = standard deviation
Cash f...
Why Do We Invest?
To satisfy a current goal
To satisfy a future goal
Goals Drive Investments,
Investments DO NOT Drive Goa...
Asset Allocation Overview
What type of investor are you?
Influencing Factors:
Age, Retirement Goals and Horizon, Investmen...
The Common Approach:
Aggressive
I don’t want to lose any
money, but if I can still
make a little money, that’s
great!
I wa...
Determining Your Risk Tolerance
The Expanded Approach:
Risk Questionnaires
Your Age and Time Horizon
Your Assets and Savin...
Objective – Buy a New Home
Doug
Accumulation period:
One year
Distribution period:
One-time distribution
Sample Portfolio ...
Objective: Save for Child’s College
Education
Janet
Accumulation period:
15 years
Distribution period:
4 years
Equity-inco...
Objective: Invest for Retirement
Ricardo
Accumulation period:
20 years
Distribution period:
20+ years
Growth-
and-income
G...
Objective: Live Off Investment
Tom
Annual account
withdrawals: 6%
Equity-income/
balanced Bonds
Growth-
and-income
Growth
...
Objective: Supplement Existing Income
Lori
Annual account
withdrawal: 3%
Bonds
Growth-
and-income
Equity-income/
balanced
...
Basics of Investing
Effect of Variability
PORTFOLIO A PORTFOLIO B
First Year Return Gain 30% Gain 10%
Value After First Ye...
Not in Hard Copies: Variance Drain
• Here’s an example:
– Using coin-flipping
– 50% chance of coming up heads or tails
– I...
Variance drain: Average Return
• Let’s put some money to the numbers and see
– For the experiment, we will start with $200...
Variance drain: Compounded Return
– Volatility is reduced by lowering the risk you take
– In this experiment, you will onl...
The Impact of Volatility
Impact on a Hypothetical $100,000 Portfolio
Year 1
Return
Year 2
Return
Average
Return
Compound
R...
First, a Little Perspective
Source: Capital Research and Management Company as of December 2012. Declines assume a 50% rec...
Market Declines are Inevitable
From October 2007 to March 2009, the S&P 500 fell over 56%. As of February
2010, it has sin...
MSCI Index
Affiliation
 Developed Markets  Frontier Markets
 Emerging Markets
SCALE Ten Billion
One Trillion
Stocks
Historical Return from 1926 to 2011:
0%
2%
6%
8%
%RETURN
12%
4%
10%
ASSET CLASSES
CASH (T-Bill)
FIXED INCOME/BONDS
...
Risk
Different Asset Classes can be Measured
Cash
Fixed Income/Bonds
Stocks
HOW DO WE MEASURE THE
RISK FOR EACH ASSET CLAS...
Measuring Risk
Consider the weather in San Francisco and Kansas City
Measuring Risk
Defines risk in terms of variability or volatility of return
Measures total volatility -- both downside and...
Measuring Risk
US T-Bills have a historical mean return of 2.96% and a standard deviation of 0.57%
We would expect 95% of ...
Measuring Risk
S&P 500 Large Cap Stocks
The S&P 500 has a historical mean return of 9.62% and a standard deviation of 18.1...
Measuring Risk
Small Cap Stocks have a historical mean return of 11.47% with a standard deviation of
22.23%. We would expe...
Measuring Risk
International Stocks have a historical mean return of 8.97% with a standard deviation
of 22.58%. We would e...
Measuring Risk
Real Estate has a historical mean return of 10.35% with a standard deviation of
14.79%. We would expect 95%...
Summary
As of 12/31/2012
3 Yr
Historical
IWB
Large
Cap
IWN
Small
Cap
DODFX
Intl.
Fund
VWO
Emrg.
Markets
FGOVX
Intermd
Govt...
Measuring Risk
Standard Deviation of Asset Classes
-30% -10% 30% 50%
3%
CASH
9%
BONDS
10%
LARGE STOCKS
11.5%
SMALL STOCKS
...
Measuring Risk
2006
Histogram of Stocks’ Performance Based on the S&P 500
(given in percent)
2004 2009
2000 2007 1998 2003...
Mixing Assets Together
Equity Assets
Fixed Assets
Real estate
Hedge funds
Annuities
Insurance
Private Equity
Venture Capit...
Modern Portfolio Theory (MPT)
Diversification
Every investment decision should have as its objective
the enhancement of th...
Modern Portfolio Theory (MPT)
Perfect Positive Correlation of Returns
TIME
$
Modern Portfolio Theory (MPT)
Perfect Negative Correlation of Returns
TIME
$
Modern Portfolio Theory (MPT)
No Correlation of Returns
TIME
$
Modern Portfolio Theory (MPT)
Real World Example
TIME
Past performance is not indicative of future results.
$
In US dollars. Indices are not available for direct investment. Their performance does not reflect the expenses associated...
The Risk Dimensions Delivered
Periods based on rolling annualized returns. 121 total 25-year periods. 181 total 20-year pe...
The Risk Dimensions Delivered
Periods based on rolling annualized returns. 703 total 25-year periods. 763 total 20-year pe...
Asset Allocation
What is Asset Allocation?
CASH STOCKS
BONDS
Asset Allocation
Is Asset Allocation Important?
ASSET ALLOCATION
POLICY: 91.5%
MARKET TIMING: 1.8%
SECURITY SELECTION: 4.6...
Asset Allocation
The Efficient FrontierRETURN
RISK
100% BONDS
MAXIMUM RISK PORTFOLIO
100% STOCKS
This graph is for illustr...
Asset Allocation
Portfolio EfficiencyRETURN
A
B
C
D
E
F
G
H
I
J
RISK
This graph is for illustrative purposes only and does...
Asset Allocation
The Efficient FrontierRETURN
RISK
100% BONDS
MAXIMUM RISK PORTFOLIO
100% STOCKS
This graph is for illustr...
The Basic Institutional Portfolio
Barclays Capital data, formerly Lehman Brothers, provided by Barclays Bank PLC. The S&P ...
Substituting Short-Term for Long-Term Fixed Income
Annualized
Compound
Return
Annualized
Standard
Deviation
Model Portfoli...
Diversifying a Portfolio Into US Small Cap Stocks
Annualized
Compound
Return
Annualized
Standard
Deviation
Model Portfolio...
Diversifying a Portfolio Into US Value Stocks
Barclays Capital data, formerly Lehman Brothers, provided by Barclays Bank P...
A Fully Diversified Portfolio
Rebalanced annually. Barclays Capital data, formerly Lehman Brothers, provided by Barclays B...
The Importance of Long-Term Discipline
The S&P data are provided by Standard & Poor’s Index Services Group. One-Month US T...
Asset Allocation
Importance of a Rebalancing Strategy
TIME
100%
75%
50%
25%
TARGETALLOCATION
REBALANCING REQUIRED
REBALANC...
Scenario Average Annual Return Standard Deviation End Value
Scenario One: Buy & Hold 11.53% 13.57% $8,874,742
Scenario Two...
Monte Carlo Simulation
A large number of random trials are run.
Patterns in the trial’s outcomes show the most likely rang...
Monte Carlo Simulation
1998
Monte Carlo Simulation
1998 1965 1953 1957 1991 1971
1955 1979 1978 1993 1969 1992
1974 1961 1990 1996 1962 1956
1983 1951...
Monte Carlo Simulation
Example:
If you could choose from any of the following three
investments, which would you select?
#...
Monte Carlo Simulation
You would think that they would all be the same…but…
0 1 2 3 4 5 6 7 8 9 10
$400
$350
$300
$250
$20...
Monte Carlo Simulation
Instead of a single $100 investment, test the same choices
for different investors…
What if I were ...
Monte Carlo Simulation
One choice may produce over TWICE the amount of money
0 1 2 3 4 5 6 7 8 9 10
$300,000
$250,000
$200...
Monte Carlo Simulation
What about a different investor?
If I had $100,000 and I needed $15,000 per year, would it last
10 ...
Monte Carlo Simulation
You would run out of money with #2!
0 1 2 3 4 5 6 7 8 9 10
$250,000
$200,000
$150,000
$100,000
$50,...
Monte Carlo Simulation
The ending results of our three choices
depend on YOUR plan…
They all produced an average of 11.6 %...
Declines Can Erode Retirement Income
© American Funds Distributors, Inc. AI-33386
2000 2001 2002
100,000
80,000
60,000
40,...
Monte Carlo Simulation
WHEN you receive a return can be far more important
than your average return
Monte Carlo Simulation
Most plans assume you will achieve the average return each
year and ignore bull and bear markets.
U...
Future Markets
— Warren Buffett
Berkshire Hathaway shareholder letter, 1988
© American Funds Distributors, Inc. AI-90
“We ...
Investing in an Uncertain Market
Set realistic expectations
Stick to sound investment strategies
Customize your portfolio ...
Wealth Management - Week 2
Wealth Management - Week 2
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Wealth Management - Week 2

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

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  • This chart shows the very basic rules that typically regard the risk/return characteristics of the three major asset classes. A blend of these three gives us the most basic forms of asset allocation.
  • Similar to the previous chart, this basically profiles the type of investor. Locating where an investor is on this chart will help to find out which investment, or combination of investments, is best to achieve the desired levels of risk and return.
  • The primary concern for most investors is the possibility of permanently losing their money. Such a loss can prevent them from reaching their financial goals.Whether investing to meet a long-term objective or taking retirement income from their investments, it’s critical that investors recognize the risks they face and try to manage them with the help of their financial adviser.Today I’d like to focus on understanding the impact of risk on retirement income. During retirement, when market volatility can be magnified and time to recover losses can be compressed, the margin for error narrows. That’s why it’s important for investors at this stage to seek retirement-income strategies that can be resilient when markets decline and can generate consistent streams of income.
  • The primary concern for most investors is the possibility of permanently losing their money. Such a loss can prevent them from reaching their financial goals.Whether investing to meet a long-term objective or taking retirement income from their investments, it’s critical that investors recognize the risks they face and try to manage them with the help of their financial adviser.Today I’d like to focus on understanding the impact of risk on retirement income. During retirement, when market volatility can be magnified and time to recover losses can be compressed, the margin for error narrows. That’s why it’s important for investors at this stage to seek retirement-income strategies that can be resilient when markets decline and can generate consistent streams of income.
  • Some common assumptions about investing during one’s saving years simply don’t apply to retirement planning. For example:Cash flow from investments typically is not an issue before retirement. On the other hand, cash flow during retirement is critical because it can have a profound impact on portfolios.Investors saving for retirement can generally determine the time horizon during which they intend to invest. The good news is that we are expected to live longer. However, because investors can’t precisely predict their life expectancy, they don’t know how long they will need income in their retirement years.I’ll talk a little more about that in a moment.One of the statistical measures often used in the industry to assess the risk of an investment is standard deviation. Standard deviation measures the spread of returns from the mean — essentially, the returns’ range of low to high relative to mean.Risk for retirees — regardless of how it’s measured— can mean losing capital and, ultimately, outliving their retirement savings.
  • Maintaining a grasp of the underlying goal is key to developing an investment strategy.
  • Risk questionnaires most commonly contain anywhere from 5-25 questions that help assess one’s risk. Examples include: How important to me is Capital Preservation? (Rate from 1-5, with 1 being not important and 5 being extremely important) How important is low volatility in my portfolio? How important is growth in my portfolio? How important is cash flow? Age and Time Horizon: How many more years will I work before I retire? Will I fully retire or continue to work part time? Given increased life expectancy tables, how long do I want to plan on living off of retirement assets?Assets and Savings Potential: How much can I contribute to
  • Here’s a sample portfolio for Doug, an investor in the accumulation phase. He and his wife, who have a newborn baby, plan to have another child in the near future. So, they anticipate moving out of their apartment and into a house in a few years.In order to meet this objective, Doug plans to invest for five years and then take a one-time distribution to use as a down payment for a new home.Doug’s portfolio comprises:10% growth-and-income funds10% equity-income/balanced funds80% bond funds
  • Here’s a sample portfolio for Janet, an investor in the accumulation phase.Janet has a 3-year-old son. And because she’s a single mother, one of her biggest concerns is how she’s going to pay for her toddler’s college education.So, Janet wants to start a college fund for her son as soon as possible. She has the next 15 years to invest, followed by four years during which she’ll need income to pay for tuition and other college expenses. Janet’s portfolio comprises:25% growth funds35% growth-and-income funds20% equity-income/balanced funds20% bond funds
  • Here’s a sample portfolio for Ricardo, an investor in the accumulation phase.Ricardo works as a computer support representative and has just started to invest in a 401(k) retirement plan sponsored by his employer. He plans to invest in his 401(k) for the next 20 years and anticipates taking income from his investment for more than 20 years.Ricardo’s portfolio comprises:45% growth funds40% growth-and-income funds15% equity-income/balanced funds
  • Here’s a sample portfolio for Tom, an investor in the distribution phase.Tom is a recent retiree. After more than 30 years of traveling from city to city selling medical supplies to hospitals, he’s looking forward to a more stable lifestyle — spending quality time with his wife, children and grandchildren.Now that he’s in retirement, Tom plans to live off his investment — withdrawing 6% from his account each year.Tom’s portfolio comprises:5% growth funds20% growth-and-income funds15% equity-income/balanced funds60% bond funds
  • Here’s a sample portfolio for Lori, an investor in the distribution phase.Lori is a teacher. And while her and her husband’s combined salary sufficiently supports their family, she wants to supplement her existing income in order to provide additional support to her widowed mother. So, Lori plans to withdraw 3% from her account each year in order to help her mom pay for some of her living and medical expenses.Lori’s portfolio comprises:15% growth funds25% growth-and-income funds20% equity-income/balanced funds40% bond funds
  • Even though you have a 100% return on the upside and only a -50% return on the downside, you still ended up with 0 return.
  • Here’s the example: if you commit, say, half of your capital and can take advantage
  • Talking Points:Although Portfolio 1 experiences a strong gain in the first year, this gain is more than eliminated in year two. Portfolio 2 experiences a much smaller gain and loss during the two-year period. The lower volatility of returns produces a higher compound return and preserves more portfolio value. Managing volatility is particularly crucial during a market downturn. After experiencing a loss, a portfolio must earn an even higher return in future periods to fully recover to its previous level.Investors should design portfolios to experience less fluctuation in returns. Lower volatility can result in a higher compound return and greater terminal wealth. The photo here shows an investor that on the red track who seems to be happy, while the person on the yellow track looks to be frightened. Which of these two investors do you think is most likely to experience the various points on the Behavioral Finance chart we talked about last week?
  • There’s no escaping the fact that the market will fluctuate — sometimes for the better, other times for the worse. That’s just the nature of investing. Of course, it’s the bad times we have the most difficulty with. I don’t know if this will help, but if you look back at the stock market’s history since 1900, you’ll see that declines happened and, yes, on a regular basis. They also varied widely in intensity, frequency and length. Routine declines of 5% or more have occurred about three times a year and have lasted an average of 47 days. In contrast, bear markets — when stocks fall 20% or more — have occurred about once every 3½ years and have lasted about 11 months, on average. This table provides a good overview of how often the Dow Jones Industrial Average has dropped since 1900. As you can see, declines are really just par for the course when it comes to investing.
  • Because market declines can erode principal, they can have a severe effect on portfolios designed to provide income. Let’s look at what history has taught us about some of those inevitable market declines. This is an illustration of the S&P 500 Index monthly returns from January 1, 1931, through December 31, 2011 —. There have been 14 US Recessions — lasting from days to months to years. These bars indicate the duration and severity of these declines, which have ranged from short and mild to long and severe.
  • Talking Points:This cartogram depicts the world not according to land mass, but by the size of each country’s stock market relative to the world’s total market value (free-float adjusted).  Population, gross domestic product, exports, and other economic measures may influence where people invest. But the map offers a different way to view the universe of equity investment opportunities. If markets are efficient, global capital will migrate to destinations offering the most attractive risk-adjusted expected returns. Therefore, the relative size and growth of markets may help in assessing the political, economic, and financial forces at work in countries. The cartogram brings into sharp relief the investible opportunity of each country relative to the world. It avoids distortions that may be created or implied by attention to economic or fundamental statistics, such as population, consumption, trade balances, or GDP. By focusing on an investment metric rather than on economic reports, the chart further reinforces the need for a disciplined, strategic approach to global asset allocation. Of course, the investment world is in motion, and these proportions will change over time as capital flows to markets offering the most attractive returns.
  • When you think of the weather in San Francisco and Kansas City, do you think it’s the same? While the two cities have a similar average annual temperature of 57° and 54° respectively, they experience dramatically different ranges in temperature. This spread in temperature is the standard deviation. Generally, the weather in San Francisco varies 5° from the average (52° to 62°). However, there is a greater fluctuation in temperature for Kansas City, where the temperature can vary as much as 18° from the average (36° to 72°). Now, consider what this means if applied to your investment portfolio. Although two portfolios can have similar annualized returns, the ride along the way can be significantly different. One portfolio may have a higher standard deviation, reflecting more ups and downs while the other portfolio could have a lower standard deviation, indicating a smoother ride
  • The standard deviation of a fund measures this risk by measuring the degree to which the fund fluctuates in relation to its mean return, the average return of a fund over a period of time. Variance:A measure of the dispersion of a set of data points around their mean value. Variance is a mathematical expectation of the average squared deviations from the mean.
  • VUSTX LT Govt8.34%13.65%
  • Talking Points:The size and BtM effects appear in both US and international markets—strong evidence that the risk factors are systematic across the globe.This graph demonstrates the higher expected returns offered by small cap stocks and value (high-BtM) stocks in the US, non-US developed, and emerging markets. Note that the international and emerging markets data is for a shorter time frame.Small cap stocks are considered riskier than large cap stocks, and value stocks (as defined by a higher book-to-market ratio) are deemed riskier than growth stocks. These higher returns reflect compensation for bearing higher risk. A multifactor approach incorporates both size and value measures—and exposure to non-US markets—in an effort to increase expected returns and reduce portfolio volatility. An effective way to capture these effects is through portfolio structure.
  • This slide documents the frequency with which the value and size premiums have been positive over various time periods in the international (non-US) developed stock markets from 1975-2011.  In the international markets, value stocks have outperformed growth stocks—and small cap stocks have outperformed large cap stocks—in a majority of all rolling return periods measured. The value premium has been strongly positive more often than the size premium. The time periods, which range from five to twenty-five years, are based on annualized returns for rolling 12-month periods (e.g., January-December, February-January, March-February, etc.). The total number of 12-month periods for each time frame is indicated in the footnotes. The set of available data for non-US developed markets is considerably shorter than US markets. As a result, the smaller set of observations can amplify the effect of sustained periods of negative or positive premiums. This may explain part of the frequency difference between the 20-year and 15-year periods for the international small cap premium.
  • This slide documents the frequency with which the value and size premiums have been positive over various time periods in the US stock market from 1926 to 2011.  As the results illustrate, US value stocks have outperformed US growth stocks—and US small cap stocks have outperformed US large cap stocks—in a majority of all the rolling return periods measured. The US value premium has been positive more often than the size premium. The time periods, which range from five to twenty-five years, are based on annualized returns for rolling 12-month periods (e.g., January-December, February-January, March-February, etc.). The total number of 12-month periods for each time frame is indicated in the footnotes.
  • Thiscurve forms from a graph plotting return and risk indicated by volatility, which is represented by standard deviation. According to the modern portfolio theory, funds lying on the curve are yielding the maximum return possible given the amount of volatility.,
  • Talking Points:The slide shows the basic allocation of a two-component portfolio, which is named the “Basic Institutional Portfolio” (Model Portfolio 1) in this example. Between 1973 and 2009, Model Portfolio 1 produced an annualized compound return of 9.41% with annualized standard deviation of 11.18%.The next few slides will demonstrate a multifactor approach to portfolio design. The analysis will show how adding major risk measures in the US and non-US markets can increase expected returns and reduce volatility in the portfolio.
  • Talking Points:Model Portfolio 2 reflects a move from long-term to short-term fixed income. A simple reallocation to the one-year Treasury note index reduced annualized compound return and annualized standard deviation during this time period.This change does not offer a higher return benefit, but it can help advance the overall strategy for an investor who wants to pursue the higher expected returns of equities. This type of investor may be better served holding shorter-term government instruments, then “spending” the risk on greater exposure to equity risk factors (small cap or value), where the expected return premiums are potentially increased.
  • Talking Points:Model Portfolio 3 incorporates the size effect into the asset allocation by reducing the S&P 500 component from 60% to 30% of the portfolio and committing the difference to US small cap stocks, as represented by the US Small Cap index.This movement from large to small cap US stocks results in a boost to the portfolio’s annualized compound return—but also adds a potent amount of volatility to Model Portfolio 3 (standard deviation).An investor might conclude that this increase in annualized return may not justify a large jump in standard deviation. But this allocation is not yet complete. Acceptance of more risk from the BtM effect offers a compelling example of diversification’s potential.
  • Talking Points:Model Portfolio 4 shows the historical benefit of adding value stocks in both small and large cap measures to the portfolio allocation. This is achieved by reducing the US small cap component from 30% to 15%—and moving the allocation to 15% US Large Value and 15% Targeted Value Indexes.The portfolio now has more exposure to value, which boosts annualized return while reducing volatility. The reintroduction of larger company size (from small cap to large value) counteracts the higher volatility of small value stock exposure in the Targeted Value Index.Now compare Model Portfolio 4 to the original 60/40 balanced strategy in Model Portfolio 1. Adding higher weights of small cap and value risk dimensions raised the portfolio’s annualized compound return; however, this required acceptance of higher annualized standard deviation. There is one more step in this structured tradeoff example—and it is found outside the US.
  • Talking Points:Model Portfolio 5 completes this multifactor construction by diversifying outside the US. All four US asset classes are reduced by half, from 15% to 7.5% allocations, and the balance is apportioned equally to five non-US asset classes—international large, small, large value, and small value indexes, and emerging markets blended index.The portfolio’s 60% equity allocation is now evenly split between the US and international markets, with roughly equal exposures to size and BtM. The historical data for the performance period shows Model Portfolio 5 producing the highest annualized compound return of all the portfolios, without an increase in volatility. In fact, adding the global component reduces the variability in the portfolio’s return due to the lower correlation of international and US risk dimensions. Compared to the original 60/40 balanced strategy, Model Portfolio 5 offers higher annualized return with only slightly higher volatility. A globally diversified allocation harnesses the power of markets, manages the risk-return tradeoff, provides broad diversification, and offers calculated exposure to compensating risk factors through structured investing.
  • Talking Points:Equities can reward investors who maintain a long-term outlook. But inconsistent short-term performance may test one’s commitment to a long-term strategy. This slide reveals how such temptations may arise—and the dangers of yielding to them. Since 1926, the S&P 500 Index has offered an annualized compound return far above the return on one-month Treasury bills. This long-term effect confirms the higher returns offered by equities. During the seventeen-year sub-period between 1965 and 1981, T-bills slightly outperformed stocks, illustrating that the equity premium is not reliably positive.
  • These are actual results based off of a hypothetical 20 year portfolio of:30% Barclays Munis25% Russell 1000 Growth10% MSCI EAFE10% Russell 200025% Russell 1000 ValueNote that threshold rebalancing is the choice method of portfolio management. When the allocation to, say, large cap value deviates by 20% of the target allocation or, in this case, 20% of 25% is 5%, so if it is out of balance by 5% or more, then the portfolio is rebalanced. Systematic rebalancing, as in scenario 2, is better than no rebalancing at all, but will likely incur unnecessary trading costs. Perhaps the most significant benefit to rebalancing is the selling of overvalued asset classes as they have appreciated in the portfolio (causing a break through the 20% target on the upside, and the buying of undervalued assets on the 20% downside)
  • Talking Points: This slide shows performance of a balanced investment strategy following a few historical crises. Each crisis is labeled with the month and year that it occurred or peaked. The subsequent one-, three-, and five-year annualized returns start from the first day of the month following each crisis. Although a global investment strategy would have suffered losses immediately following most events, the financial markets recovered over time, as indicated by the positive three- and five-year annualized returns. Negative events such as these may tempt investors to flee the financial markets. But diversification and a long-term perspective can help investors apply discipline to ride out the storm.A quick note: as of today, the S&P 500 is up roughly 54% since september 29th 2008. Composition of the Normal Balanced Strategy:IndexPercentS&P 500 Index 12%Fama/French US Large Cap Value Index 12%Fama/French US Small Cap Index 6%Fama/French US Small Cap Value Index 6%Dow Jones Wilshire REIT Index 6%Fama/French International Value Index 6%International Small Cap Index 3%International Small Cap Value Index 3%MSCI Emerging Markets Index 1.8%Fama/French Emerging Markets Value Index 1.8%Fama/French Emerging Markets Small Cap Index 2.4%Merrill Lynch One-Year US Treasury Note Index 10%Citigroup World Government 10%Bond Index 1-3 Years (hedged) Lehman Brothers Treasury Bond Index 1-5 Years 10%Citigroup World Government 10%Bond Index 1-5 Years (hedged)
  • Severe declines such as the 2000-2002 bear market can deplete principal and seriously distort the amount of income withdrawn from a portfolio.A hypothetical initial investment of $100,000 in the S&P 500 Index on March 24, 2000, with monthly withdrawals totaling 5% annually and increasing 4% each year to account for inflation, would have fallen to $43,961 — less than half the original amount. Let’s look at what happened to the withdrawal rate during that time frame.[Note to presenter: Advance slide to show the rising withdrawal rate fever line.]By October 9, 2002, it would have increased to 12.3% — more than twice the initial withdrawal rate of 5%.[Note to presenter: The 12.3% withdrawal rate is calculated by dividing the total amount withdrawn in the third year, which was $5,408 ($5,000 increasing by 4% each year), by $43,961 (the ending value).]By the way, the total amount withdrawn over the entire period — from March 24, 2000, through October 9, 2002 — was $12,904. Clearly, this would not be a sustainable arrangement for most investors. As you can see from this illustration, the preservation of principal in declining markets — as well as growth of capital — is integral to retirement planning. Moreover, investors seeking a sustainable source of income might want to consider the potential benefits of professionally managed investments rather than investments in an index. I’ll discuss these benefits in a moment.Finally, investors at this stage should seek effective strategies that can provide downside resilience.
  • “We do not have, never have had, and never will have an opinion about where the stock market, interest rates, or business activity will be a year from now.”That’s not just my opinion; it’s the view of Warren Buffett, the nation’s most famous investor. Mr. Buffet included this statement in his 1988 letter to the shareholders of Berkshire Hathaway.We don’t know what will happen to the market either. But there are a few things on which we can all agree.
  • When investing in an uncertain market, here are some simple rules to remember:Set realistic expectationsYou may not be able to predict the market, but you can learn from history. As we’ve seen, financial markets can go up, go down or even stay flat. In addition, we’ve recognized that market declines are natural and have eventually ended. By looking at different types of investments and their historical averages, you can gain a better perspective in order to set realistic expectations and assess your tolerance for volatility.Stick to sound investment strategiesWe discussed three specific techniques — buy and hold, regular investing and diversification — and the various benefits they provide if practiced consistently. These strategies can help you effectively cope with market uncertainty and keep you focused on your long-term financial goals.Customize your portfolioDifferent investors have different needs, depending on their investment phase, financial goals and income requirements. If one portfolio doesn’t fit all investors, the same is true for your portfolio at different stages of your life. Whether you’re in the accumulation phase or the distribution phase, you can customize your portfolio to suit your investment objective.Invest for the long termDuring periods of market uncertainty, it’s critical that you stay committed to your long-term fundamentals. Be patient and ride out the waves. Bull and bear markets come and go. Successful investors stay the course.
  • Transcript of "Wealth Management - Week 2"

    1. 1. Wealth Management An Unbiased Approach to Managing Your Investments Designed for the Affluent Investor
    2. 2. Basics of Investing Fundamental Principle of Investing RISK EXPECTEDRETURN LOW HIGH CASH BONDS STOCKS
    3. 3. Basics of Investing Types of Investors RISK RETURN LOW HIGH HIGH MANAGES ONLY RISK MANAGES BOTH RISK & RETURN MANAGES ONLY RETURN
    4. 4. Something to Consider: “Stocks have outperformed fixed income securities over time. Why not always invest in stocks for future funding?” Answer: Time Horizon and Risk Tolerance evolve with age
    5. 5. The impact of risk on retirement income © American Funds Distributors, Inc.
    6. 6. The impact of risk on retirement income The primary concern for most investors is the possibility of permanently losing their money. Such a loss can prevent them from reaching their financial goals.. Whether investing to meet a long-term objective or taking retirement income from their investments, it’s critical that investors recognize the risks they face and try to manage them with the help of their financial adviser. During retirement, if market volatility becomes magnified and time to recover losses becomes compressed, the margin for error narrows. That’s why it’s important for investors at this stage to seek retirement-income strategies that can be resilient when markets decline and can generate consistent streams of income. © American Funds Distributors, Inc.
    7. 7. Some Assumptions Do Not Apply Before Retirement Cash flow not an issue Known time horizon Risk = standard deviation Cash flow is critical Unknown time horizon Risk = loss of capital During Retirement
    8. 8. Why Do We Invest? To satisfy a current goal To satisfy a future goal Goals Drive Investments, Investments DO NOT Drive Goals Basics of Investing
    9. 9. Asset Allocation Overview What type of investor are you? Influencing Factors: Age, Retirement Goals and Horizon, Investment Experience, Personality Source: Investopedia.com Fixed Income Equities Cash Equivalents Fixed Income Equities Cash Equivalents Fixed Income Equities Cash Equivalents Fixed Income Equities Cash Equivalents Less Risk More Risk Conservative Moderate Aggressive Very Aggressive
    10. 10. The Common Approach: Aggressive I don’t want to lose any money, but if I can still make a little money, that’s great! I want to make money and I don’t mind taking a few risks to make it happen. I want to make the most money possible! I am willing to take whatever risks needed to make it happen! Conservative Moderate Determining Your Risk Tolerance
    11. 11. Determining Your Risk Tolerance The Expanded Approach: Risk Questionnaires Your Age and Time Horizon Your Assets and Savings Potential Your Level of Comfort Your Spending Level Risk is approached from two different directions 1. How much risk do I need to take? 2. How much risk do I want to take? I need to consider several factors to determine my true risk tolerance…
    12. 12. Objective – Buy a New Home Doug Accumulation period: One year Distribution period: One-time distribution Sample Portfolio – Accumulation Phase This sample portfolio is for illustrative purposes only. Please consider individual objectives, risk tolerance and time horizon. © American Funds Distributors, Inc. AI-30038 Bonds Growth-and- Income Equity-Income/ Balanced
    13. 13. Objective: Save for Child’s College Education Janet Accumulation period: 15 years Distribution period: 4 years Equity-income/ balanced Bonds Growth- and-income Growth This sample portfolio is for illustrative purposes only. Please consider individual objectives, risk tolerance and time horizon. © American Funds Distributors, Inc. AI-30038 Sample Portfolio – Accumulation Phase
    14. 14. Objective: Invest for Retirement Ricardo Accumulation period: 20 years Distribution period: 20+ years Growth- and-income Growth Equity-income/ balanced This sample portfolio is for illustrative purposes only. Please consider individual objectives, risk tolerance and time horizon. © American Funds Distributors, Inc. AI-30038 Sample Portfolio – Accumulation Phase
    15. 15. Objective: Live Off Investment Tom Annual account withdrawals: 6% Equity-income/ balanced Bonds Growth- and-income Growth Sample Portfolio – Distribution Phase This sample portfolio is for illustrative purposes only. Please consider individual objectives, risk tolerance and time horizon. © American Funds Distributors, Inc. AI-30038
    16. 16. Objective: Supplement Existing Income Lori Annual account withdrawal: 3% Bonds Growth- and-income Equity-income/ balanced Growth This sample portfolio is for illustrative purposes only. Please consider individual objectives, risk tolerance and time horizon. © American Funds Distributors, Inc. AI-30038 Sample Portfolio – Distribution Phase
    17. 17. Basics of Investing Effect of Variability PORTFOLIO A PORTFOLIO B First Year Return Gain 30% Gain 10% Value After First Year $1,300,000 $1,100,000 Second Year Return Loss 10% Gain 10% Value After Second Year $1,170,000 $1,210,000 Average return for each portfolio was 10% per year. Portfolio B with a stable return had a real dollar return which was $40,000 greater than Portfolio A RULE: Given 2 portfolios with the same arithmetic return the portfolio with the lowest volatility will always have the highest real dollar return. For illustrative purposes only. This chart does not reflect the performance of any specific investment. Original Value $1,000,000 $1,000,000
    18. 18. Not in Hard Copies: Variance Drain • Here’s an example: – Using coin-flipping – 50% chance of coming up heads or tails – In the experiment, heads doubles your money and tails loses half your money Head 100% Tails -50% Heads 100% Heads 100% Tails -50% Heads 100% Tails -50% Tails -50% Heads 100% Tails -50% Average 25% Seems highly profitable right?
    19. 19. Variance drain: Average Return • Let’s put some money to the numbers and see – For the experiment, we will start with $2000 Head 100% $4000 Tails -50% $2000 Heads 100% $4000 Heads 100% $8000 Tails -50% $4000 Heads 100% $8000 Tails -50% $4000 Tails -50% $2000 Heads 100% $4000 Tails -50% $2000 Return 0% You started with $1000 and ended with $1000 • How is that possible? • Your average return was 25%, but your compounded return is 0
    20. 20. Variance drain: Compounded Return – Volatility is reduced by lowering the risk you take – In this experiment, you will only commit half of your capital, thereby halving your risk Investment: $1000 Half Balance Return Head 50% $1500 Tails -25% $1125 Heads 50% $1688 Heads 50% $2531 Tails -25% $1898 Heads 50% $2848 Tails -25% $2136 Tails -25% $1602 Heads 50% $2403 Tails -25% $1802 Total Return 80% After 10 flips, you had a total return of 80%, or 6.1% compounded per flip • You netted a profit of $800 on this investment so far
    21. 21. The Impact of Volatility Impact on a Hypothetical $100,000 Portfolio Year 1 Return Year 2 Return Average Return Compound Return Value at End of Year 2 Portfolio #1 50% -50% 0% -13.4% $75,000 Portfolio #2 10% -10% 0% -0.5% $99,000 For illustrative purposes only. Image Source: http://www.saturdayeveningpost.com/2010/07/26/in-the-magazine/finance/investing-america.html
    22. 22. First, a Little Perspective Source: Capital Research and Management Company as of December 2012. Declines assume a 50% recovery rate. *As measured by the unmanaged Dow Jones Industrial Average. † Average length of time from market high to market low. © American Funds Distributors, Inc. AI-40235 Type of Decline Average Frequency Average Length Last Occurrence Previous Occurrence Difference (in Days) -5% or more (Routine) About 3Times per Year 47Days Nov-12 Jun-12 153 -10% or more (Moderate) About Once a Year 115Days Oct-11 Jul-10 457 -15% or more (Severe) About Once Every Two Years 216Days Oct-11 Mar-09 944 -20% or more (Bear Market) About Once Every 3.5Years 338Days Mar-09 Oct-02 2343 Source: The Unmanaged Dow Jones Industrial Average Assumes 50% Recovery ofLost Value Measures Market High to Market Low A History of Declines Declines are inevitable and are a natural part of investing. While in the midst of a decline, it is difficult to estimate the intensity and length. It is important to understand that, while frequency, intensity and length vary, these events have been somewhat regular for over a century.
    23. 23. Market Declines are Inevitable From October 2007 to March 2009, the S&P 500 fell over 56%. As of February 2010, it has since rallied back 40%.
    24. 24. MSCI Index Affiliation  Developed Markets  Frontier Markets  Emerging Markets SCALE Ten Billion One Trillion
    25. 25. Stocks Historical Return from 1926 to 2011: 0% 2% 6% 8% %RETURN 12% 4% 10% ASSET CLASSES CASH (T-Bill) FIXED INCOME/BONDS (LT Gov Bonds) STOCKS (LC Stocks) 14% Ibbotson Associates U.S. Return & Risk Data: 1926-2009 Source: Stocks, Bonds, Bills and Inflation 2009 Yearbook. 2009 Ibbotson Associates, Inc. Based on copyrighted works by Ibbotson and Sinquefield. All right reserved. Used with permission. Past performance does not guarantee future results. 5.72% 3.59% 9.77%
    26. 26. Risk Different Asset Classes can be Measured Cash Fixed Income/Bonds Stocks HOW DO WE MEASURE THE RISK FOR EACH ASSET CLASS?
    27. 27. Measuring Risk Consider the weather in San Francisco and Kansas City
    28. 28. Measuring Risk Defines risk in terms of variability or volatility of return Measures total volatility -- both downside and upside dispersion of a portfolio’s return - - to the average return It shows how much variation there is from the average. 95% of ALL observations fall with +/- 2 standard deviations MEAN RETURN-1 SD-2 SD +1 SD +2 SD Standard Deviation = 95%
    29. 29. Measuring Risk US T-Bills have a historical mean return of 2.96% and a standard deviation of 0.57% We would expect 95% of all returns to fall within a range of 1.85% to 4.1%. MEAN RETURN-1 SD-2 SD +1 SD +2 SD Range of 2.25% 1.85% 2.42% 3.53% 4.10% 2.96% 1989-2012 Std Dev = 0.57% Data Source: Morningstar, Barclays US Treasury Bill TR US T-Bills
    30. 30. Measuring Risk S&P 500 Large Cap Stocks The S&P 500 has a historical mean return of 9.62% and a standard deviation of 18.11% We would expect 95% of all returns to fall within a range of -26.6% to 45.8%. MEAN RETURN-1 SD-2 SD +1 SD +2 SD Range of 72.44% -26.60% -8.49% 27.73% 45.84% 9.62% Std Dev = 18.11%Data Source: www.russell.com 1973-2011
    31. 31. Measuring Risk Small Cap Stocks have a historical mean return of 11.47% with a standard deviation of 22.23%. We would expect 95% of all returns to fall within a range of -32.9% to 55.9% MEAN RETURN-1 SD-2 SD +1 SD +2 SD Range of 88.92% -32.99% -10.76% 33.7% 55.93% 11.47% Std Dev of 22.23% Small Cap Stocks Data Source: www.russell.com, Ibbotson & Associates, 1973-1978, Russell 2000, 1979-2011
    32. 32. Measuring Risk International Stocks have a historical mean return of 8.97% with a standard deviation of 22.58%. We would expect 95% of all returns to fall within a range of -36.1% to 54.1% MEAN RETURN-1 SD-2 SD +1 SD +2 SD Range of 90.32% -36.19% -13.61% 31.55% 54.13% 8.97% Std Dev of 22.58% International Stocks Data Source: www.russell.com, MSCI EAFE
    33. 33. Measuring Risk Real Estate has a historical mean return of 10.35% with a standard deviation of 14.79%. We would expect 95% of all returns to fall within a range of -19.23% to 39.93% MEAN RETURN-1 SD-2 SD +1 SD +2 SD Range of 56.16% -19.23% -4.44% 25.14% 39.93% 10.35% Std Dev of 14.79% Real Estate Data Source: www.russell.com, NAREIT Equity REIT Index
    34. 34. Summary As of 12/31/2012 3 Yr Historical IWB Large Cap IWN Small Cap DODFX Intl. Fund VWO Emrg. Markets FGOVX Intermd Govt DODIX Corp/ Mrtg VUSTX LT Gov GSHIX High Yield Ave. Return 5.06% 6.49% 0.65% 0.23% 4.83% 6.85% 8.34% 9.62% Std. Dev. 19.20% 24.62% 26.72% 29.60% 3.67% 4.76% 13.65% 13.06% Equity Funds Bond/ Fixed Income Funds Increasing Standard Deviation & Returns Fund Names are not investment recommendations. Data Source: Asset Allocation, Roger Gibson, 2008
    35. 35. Measuring Risk Standard Deviation of Asset Classes -30% -10% 30% 50% 3% CASH 9% BONDS 10% LARGE STOCKS 11.5% SMALL STOCKS 1972-2008 Data Source: Asset Allocation, Roger Gibson, 2008
    36. 36. Measuring Risk 2006 Histogram of Stocks’ Performance Based on the S&P 500 (given in percent) 2004 2009 2000 2007 1998 2003 1997 1990 2005 1986 1999 1995 1981 1994 1979 1998 1991 1977 1993 1972 1996 1989 1969 1992 1971 1983 1985 1962 1987 1968 1982 1980 1953 1984 1965 1976 1975 1946 1978 1964 1967 1955 2001 1940 1970 1959 1963 1950 1973 1939 1960 1952 1961 1945 2002 1966 1934 1956 1949 1951 1938 1958 1974 1957 1932 1948 1944 1943 1936 1935 1954 1931 1937 1930 1941 1929 1947 1926 1942 1927 1928 1933 LARGE COMPANY STOCKS -40 -30 -20 -10 0 10 20 30 40 50 60 Source: Stocks, Bonds, Bills and Inflation 2009 Yearbook. 2009 Ibbotson Associates, Inc. Based on copyrighted works by Ibbotson and Sinquefield. All right reserved. Used with permission. Past performance does not guarantee future results. 2008 2010 2012 2011
    37. 37. Mixing Assets Together Equity Assets Fixed Assets Real estate Hedge funds Annuities Insurance Private Equity Venture Capital Assets choices How do I mix them together?
    38. 38. Modern Portfolio Theory (MPT) Diversification Every investment decision should have as its objective the enhancement of the portfolio’s return, the reduction of risk, or both. The purpose of diversification is not merely to increase returns, but rather to achieve a desired level of return with a minimum level of risk. To protect a portfolio from being vulnerable to just one asset class, it is important to develop policies that will lead to diversified portfolios.
    39. 39. Modern Portfolio Theory (MPT) Perfect Positive Correlation of Returns TIME $
    40. 40. Modern Portfolio Theory (MPT) Perfect Negative Correlation of Returns TIME $
    41. 41. Modern Portfolio Theory (MPT) No Correlation of Returns TIME $
    42. 42. Modern Portfolio Theory (MPT) Real World Example TIME Past performance is not indicative of future results. $
    43. 43. In US dollars. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. US value and growth index data (ex utilities) provided by Fama/French. The S&P data are provided by Standard & Poor’s Index Services Group. CRSP data provided by the Center for Research in Security Prices, University of Chicago. International Value data provided by Fama/French from Bloomberg and MSCI securities data. International Small data compiled by Dimensional from Bloomberg, StyleResearch, London Business School, and Nomura Securities data. MSCI EAFE Index is net of foreign withholding taxes on dividends; copyright MSCI 2010, all rights reserved. Emerging markets index data simulated by Fama/French from countries in the IFC Investable Universe; simulations are free-float weighted both within each country and across all countries.
    44. 44. The Risk Dimensions Delivered Periods based on rolling annualized returns. 121 total 25-year periods. 181 total 20-year periods. 241 total 15-year periods. 301 total 10-year periods. 361 total 5-year periods. International Value and Growth data provided by Fama/French from Bloomberg and MSCI securities data. International Small data compiled by Dimensional from Bloomberg, StyleResearch, London Business School, and Nomura Securities data. International Large is MSCI EAFE Index net of foreign withholding taxes on dividends; copyright MSCI 2010, all rights reserved. Foreign securities prices may decline or fluctuate because of: (a) economic or political actions of foreign governments, and/or (b) less regulated or liquid securities markets. Investors holding these securities are also exposed to foreign currency risk (the possibility that foreign currency will fluctuate in value against the US dollar). Securities of small companies are often less liquid than those of large companies. As a result, small company stocks may fluctuate relatively more in price. Mutual funds distributed by DFA Securities LLC. Value beat growth 100% of the time. Value beat growth 100% of the time. Value beat growth 100% of the time. Value beat growth 100% of the time. Value beat growth 98% of the time. Small beat large 100% of the time. Small beat large 100% of the time. Small beat large 84% of the time. Small beat large 76% of the time. Small beat large 75% of the time. International Value vs. International Growth International Small vs. International Large January 1975 – December 2011 In 5-Year Periods In 10-Year Periods In 15-Year Periods In 20-Year Periods In 25-Year Periods Value beat growth 100% of the time. Value beat growth 100% of the time. Value beat growth 100% of the time. Value beat growth 100% of the time. Value beat growth 98% of the time.
    45. 45. The Risk Dimensions Delivered Periods based on rolling annualized returns. 703 total 25-year periods. 763 total 20-year periods. 823 total 15-year periods. 883 total 10-year periods. 943 total 5-year periods. Performance based on Fama/French Research Factors. Securities of small companies are often less liquid than those of large companies. As a result, small company stocks may fluctuate relatively more in price. Mutual funds distributed by DFA Securities LLC. Value beat growth 100% of the time. Value beat growth 100% of the time. Value beat growth 99% of the time. Value beat growth 96% of the time. Value beat growth 86% of the time. Small beat large 96% of the time. Small beat large 83% of the time. Small beat large 78% of the time. Small beat large 68% of the time. Small beat large 60% of the time. US Value vs. US Growth US Small vs. US Large July 1926 – December 2011
    46. 46. Asset Allocation What is Asset Allocation? CASH STOCKS BONDS
    47. 47. Asset Allocation Is Asset Allocation Important? ASSET ALLOCATION POLICY: 91.5% MARKET TIMING: 1.8% SECURITY SELECTION: 4.6% OTHER FACTORS: 2.1% Source: Asset Allocation by Roger Gibson Asset Allocation cannot eliminate the risk of fluctuating prices or uncertain returns. In other words it cannot eliminate Market Risk
    48. 48. Asset Allocation The Efficient FrontierRETURN RISK 100% BONDS MAXIMUM RISK PORTFOLIO 100% STOCKS This graph is for illustrative purposes only and does not represent any individual scenario.
    49. 49. Asset Allocation Portfolio EfficiencyRETURN A B C D E F G H I J RISK This graph is for illustrative purposes only and does not represent any individual scenario.
    50. 50. Asset Allocation The Efficient FrontierRETURN RISK 100% BONDS MAXIMUM RISK PORTFOLIO 100% STOCKS This graph is for illustrative purposes only and does not represent any individual scenario. EFFICIENT PORTFOLIO IS A BLEND OF STOCKS AND BONDS.
    51. 51. The Basic Institutional Portfolio Barclays Capital data, formerly Lehman Brothers, provided by Barclays Bank PLC. The S&P data are provided by Standard & Poor’s Index Services Group. Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Not to be construed as investment advice. Returns of model portfolios are based on back-tested model allocation mixes designed with the benefit of hindsight and do not represent actual investment performance. See cover page for additional information. S&P 500 Index Barclays US Government/Credit Bond Index Annualized Compound Return Annualized Standard Deviation Model Portfolio 1 9.41% 11.18% Barclays US Govt./Credit Bond Index S&P 500 Index Model Portfolio 1 40% 60%
    52. 52. Substituting Short-Term for Long-Term Fixed Income Annualized Compound Return Annualized Standard Deviation Model Portfolio 1 9.41% 11.18% Model Portfolio 2 8.82% 10.18% Barclays US Govt./Credit Bond Index S&P 500 Index Merrill Lynch One-Year US Treasury Note Index Model Portfolio 1 40% 60% Model Portfolio 2 60% 40% S&P 500 Index One-Year US Treasury Note Index Barclays Capital data, formerly Lehman Brothers, provided by Barclays Bank PLC. The S&P data are provided by Standard & Poor’s Index Services Group. The Merrill Lynch Indices are used with permission; copyright 2010 Merrill Lynch, Pierce, Fenner & Smith Incorporated; all rights reserved. Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Not to be construed as investment advice. Returns of model portfolios are based on back-tested model allocation mixes designed with the benefit of hindsight and so not represent actual investment performance. See cover page for additional information.
    53. 53. Diversifying a Portfolio Into US Small Cap Stocks Annualized Compound Return Annualized Standard Deviation Model Portfolio 1 9.41% 11.18% Model Portfolio 2 8.82% 10.18% Model Portfolio 3 9.63% 11.86% Barclays US Govt./Credit Bond Index S&P 500 Index Merrill Lynch One-Year US Treasury Note Index US Small Cap Index Model Portfolio 1 40% 60% Model Portfolio 2 60% 40% Model Portfolio 3 30% 40% 30% One-Year US Treasury Note Index S&P 500 Index US Small Cap Index Barclays Capital data, formerly Lehman Brothers, provided by Barclays Bank PLC. The S&P data are provided by Standard & Poor’s Index Services Group. The Merrill Lynch Indices are used with permission; copyright 2010 Merrill Lynch, Pierce, Fenner & Smith Incorporated; all rights reserved. Dimensional Index data compiled by Dimensional. Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Not to be construed as investment advice. Returns of model portfolios are based on back-tested model allocation mixes designed with the benefit of hindsight and do not represent actual investment performance. See cover page for additional information.
    54. 54. Diversifying a Portfolio Into US Value Stocks Barclays Capital data, formerly Lehman Brothers, provided by Barclays Bank PLC. The S&P data are provided by Standard & Poor’s Index Services Group. The Merrill Lynch Indices are used with permission; copyright 2010 Merrill Lynch, Pierce, Fenner & Smith Incorporated; all rights reserved. Dimensional Index data compiled by Dimensional. Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Not to be construed as investment advice. Returns of model portfolios are based on back-tested model allocation mixes designed with the benefit of hindsight and do not represent actual investment performance. See cover page for additional information. Annualized Compound Return Annualized Standard Deviation Model Portfolio 1 9.41% 11.18% Model Portfolio 2 8.82% 10.18% Model Portfolio 3 9.63% 11.86% Model Portfolio 4 10.60% 11.78% Barclays US Govt./Credit Bond Index S&P 500 Index Merrill Lynch One-Year US Treasury Note Index US Small Cap Index US Large Value Index Targeted Value Index Model Portfolio 1 40% 60% Model Portfolio 2 60% 40% Model Portfolio 3 30% 40% 30% Model Portfolio 4 15% 40% 15% 15% 15% One-Year US Treasury Note Index S&P 500 Index US Small Cap Index US Large Value Index Targeted Value Index
    55. 55. A Fully Diversified Portfolio Rebalanced annually. Barclays Capital data, formerly Lehman Brothers, provided by Barclays Bank PLC. The S&P data are provided by Standard & Poor’s Index Services Group. The Merrill Lynch Indices are used with permission; copyright 2010 Merrill Lynch, Pierce, Fenner & Smith Incorporated; all rights reserved. Dimensional Index data compiled by Dimensional. Emerging Markets Blended Index consists of 50% Fama/French Emerging Markets Index, 25% Fama/French Emerging Markets Small Cap Index, and 25% Fama/French Emerging Markets Value Index. Fama/French Emerging Markets, Fama/French Emerging Markets Value and Fama/French Emerging Markets Small Cap Index weightings allocated evenly between Dimensional International Small Cap Index and Fama/French International Value Index prior to January 1989 data inception. Dimensional International Small Cap Value Index weighting allocated to International Small Cap Index prior to July 1981 data inception. International Value weighting allocated evenly between International Small Cap and MSCI World ex USA Index prior to January 1975 data inception. Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Not to be construed as investment advice. Returns of model portfolios are based on back-tested model allocation mixes designed with the benefit of hindsight and do not represent actual investment performance. See cover page for additional information. Annualized Compound Return Annualized Standard Deviation Model Portfolio 1 9.41% 11.18% Model Portfolio 2 8.82% 10.18% Model Portfolio 3 9.63% 11.86% Model Portfolio 4 10.60% 11.78% Model Portfolio 5 11.64% 11.24% Barclays US Govt./Credit Bond Index S&P 500 Index Merrill Lynch One-Year US Treasury Note Index US Small Cap Index US Large Value Index Targeted Value Index Intl. Large Index Intl. Small Index Intl. Large Value Index Intl. Small Value Index Emerging Markets Blended Index Model Portfolio 1 40% 60% Model Portfolio 2 60% 40% Model Portfolio 3 30% 40% 30% Model Portfolio 4 15% 40% 15% 15% 15% Model Portfolio 5 7.5% 40% 7.5% 7.5% 7.5% 6% 6% 6% 6% 6% One-Year US Treasury Note Index S&P 500 Index US Small Cap Index US Large Value Index Targeted Value Index International Large Index International Small Index International Large Value Index International Small Value Index Emerging Markets Blended Index Quarterly: 1973-2013
    56. 56. The Importance of Long-Term Discipline The S&P data are provided by Standard & Poor’s Index Services Group. One-Month US Treasury Bills data © Stocks, Bonds, Bills, and Inflation Yearbook™, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield). For illustrative purposes only. Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Values change frequently and past performance may not be repeated. There is always the risk that an investor may lose money. Annualized Compound Returns (%) 1926-2011 1965-1981 1982-2011 S&P 500 Index 9.81 6.33 11.17 One-Month US Treasury Bills 3.66 6.66 4.98
    57. 57. Asset Allocation Importance of a Rebalancing Strategy TIME 100% 75% 50% 25% TARGETALLOCATION REBALANCING REQUIRED REBALANCING REQUIRED REBALANCING REQUIRED TARGET RANGE Source: Sungard® Expert Solutions
    58. 58. Scenario Average Annual Return Standard Deviation End Value Scenario One: Buy & Hold 11.53% 13.57% $8,874,742 Scenario Two: Periodic Rebalancing – Rebalance at the end of each quarter 11.85% 10.87% $9,391,171 Scenario Three: Threshold Rebalancing – Rebalance when the allocation deviates beyond +/- 20% of target 11.98% 12.14% $9,606,430 Source: Financial Planning Magazine, Dec 2005 Assume a hypothetical $1,000,000 Portfolio over 20 years, Allocated as shown Russell 1000 Growth 25% Russell 1000 Value 25% Russell 2000 10% MSCI EAFE 10% Barclays Municipal 30% Why Rebalance?
    59. 59. Monte Carlo Simulation A large number of random trials are run. Patterns in the trial’s outcomes show the most likely range and concentration of results. Please Note: The following examples are for illustrative purposes only. The results shown do not represent the returns of any particular investment.
    60. 60. Monte Carlo Simulation 1998
    61. 61. Monte Carlo Simulation 1998 1965 1953 1957 1991 1971 1955 1979 1978 1993 1969 1992 1974 1961 1990 1996 1962 1956 1983 1951 1958 1967 1973 1997 1950 1956 1976 1994 1995 1948
    62. 62. Monte Carlo Simulation Example: If you could choose from any of the following three investments, which would you select? #1 11.6 $299 #2 11.6 $299 #3 11.6 $299 INVESTMENT CHOICE TEN YEAR RETURN GROWTH OF $100
    63. 63. Monte Carlo Simulation You would think that they would all be the same…but… 0 1 2 3 4 5 6 7 8 9 10 $400 $350 $300 $250 $200 $150 $100 $50 YEAR GROWTH OF $100 #1 #2 #3 You may want to understand the path you took to achieve the ending goal
    64. 64. Monte Carlo Simulation Instead of a single $100 investment, test the same choices for different investors… What if I were saving $10,000 a year? Would they produce the same results?
    65. 65. Monte Carlo Simulation One choice may produce over TWICE the amount of money 0 1 2 3 4 5 6 7 8 9 10 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $0 GROWTH OF $10,000 INVESTED EACH YEAR #1 #2 #3 Same returns…BIG difference in ending results… #2 Wins! YEAR
    66. 66. Monte Carlo Simulation What about a different investor? If I had $100,000 and I needed $15,000 per year, would it last 10 years?
    67. 67. Monte Carlo Simulation You would run out of money with #2! 0 1 2 3 4 5 6 7 8 9 10 $250,000 $200,000 $150,000 $100,000 $50,000 $0 -$50,000 -$100,000 VALUE OF $100,000 WITHDRAWING $15,000 ANNUALLY #1 #2 #3 Same returns… big difference in ending results… #1 Wins! YEAR
    68. 68. Monte Carlo Simulation The ending results of our three choices depend on YOUR plan… They all produced an average of 11.6 % over the 10 year period! INVESTMENT 1INVESTOR INVESTMENT 2 INVESTMENT 3 Invest $100 Save $10K/year Invest $100K Withdraw $15K/year $299 $299 $299 $119,117 $256,038 $171,909 $120,285 -$55,722 $41,097
    69. 69. Declines Can Erode Retirement Income © American Funds Distributors, Inc. AI-33386 2000 2001 2002 100,000 80,000 60,000 40,000 20,000 0 S&P 500 Index, $100,000 initial investment, monthly withdrawals totaling 5% annually, increasing 4% each year, 3/24/00 – 10/9/02 Results reflect reinvestment of all distributions. 9 6 3 0 15% 12 12.3% withdrawal rate 5% withdrawal rate $43,961
    70. 70. Monte Carlo Simulation WHEN you receive a return can be far more important than your average return
    71. 71. Monte Carlo Simulation Most plans assume you will achieve the average return each year and ignore bull and bear markets. Understand your Odds With probability analysis, you project many results; including both bull and bear markets
    72. 72. Future Markets — Warren Buffett Berkshire Hathaway shareholder letter, 1988 © American Funds Distributors, Inc. AI-90 “We do not have, never have had, and never will have an opinion about where the stock market, interest rates, or business activity will be a year from now.”
    73. 73. Investing in an Uncertain Market Set realistic expectations Stick to sound investment strategies Customize your portfolio to suit your investment objective Invest for the long term and stay the course © American Funds Distributors, Inc. AI-30043
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