Long Term Investment Performance

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  • Measuring Historical Long-Term Market Performance Basic statistical analysis of historical asset returns can reveal the growth rate of wealth invested in an asset class or portfolio and the riskiness or volatility of asset classes. Compound annual return The compound annual return is measured by the geometric mean. It measures the average performance of an asset or portfolio over a given time period. In other words, it is a backward-looking statistic that determines the change in wealth over more than one period. Arithmetic mean The arithmetic mean is just the simple average of returns. This measure of average better represents typical performance over single periods. Risk Risk is measured by standard deviation. It measures the fluctuation of returns around the arithmetic average return of the investment. The higher the standard deviation, the greater the variability (and thus risk) of the investment returns.
  • Types of Asset Classes The first step in developing an asset-allocation policy is learning about asset classes and their performance characteristics. Stocks Large stocks are stocks of companies with relatively large market values. Small stocks are more volatile than large stocks and, in terms of capitalization, are usually defined as the bottom 20% of the companies listed on the New York Stock Exchange. International stocks represent stocks of foreign companies. Bonds The U.S. government is the largest bond issuer in the world. The payment of interest and principal is backed by the U.S. Treasury and, for this reason, government bonds are considered to be one of the safest investments in the world. Corporate bonds usually offer a higher rate of return than government bonds due to the risk of default. High-yield bonds exhibit significantly more risk of default than investment-grade corporate bonds. Municipal bonds are issued by state and local governments, and the income is exempt from federal income tax. However, the alternative minimum tax (AMT) and state and local taxes could apply, and federal taxes would apply to any capital gains. International bonds are issued by foreign governments or corporations. Cash equivalents Cash equivalents represent investments in short-term, high-quality securities such as money market funds, Treasury bills, and certificates of deposit (CDs). These investments are less volatile than stocks or bonds and are highly liquid (easily convertible to cash). CDs are insured by the Federal Deposit Insurance Corporation (FDIC) up to $100,000 and offer a fixed rate of return. The FDIC insurance on CDs applies in cases of insolvency of the bank, but does not protect market value. Other types of cash investments are not insured, and their market value and yield may fluctuate with market conditions. An investment in a money market fund is not insured or guaranteed by the FDIC or any other government agency. Although the funds seek to preserve the value of your investment at $1 per share, it is possible to lose money by investing in a money market fund. Real assets Real assets are those assets falling outside of the traditional classifications of stocks, bonds, and cash equivalents. They have a value independent of the monetary units in which they are denominated and, because of this, can sometimes serve as an effective hedge against inflation.
  • Ibbotson ® SBBI ® 1926–2009 An 84-year examination of past capital market returns provides historical insight into the performance characteristics of various asset classes. This graph illustrates the hypothetical growth of inflation and a $1 investment in four traditional asset classes over the time period January 1, 1926, through December 31, 2009. Large and small stocks have provided the highest returns and largest increase in wealth over the past 84 years. As illustrated in the image, fixed-income investments provided only a fraction of the growth provided by stocks. However, the higher returns achieved by stocks are associated with much greater risk, which can be identified by the volatility or fluctuation of the graph lines. Government bonds and Treasury bills are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than the other asset classes. Furthermore, small stocks are more volatile than large stocks, are subject to significant price fluctuations and business risks, and are thinly traded. About the data Small stocks in this example are represented by the fifth capitalization quintile of stocks on the NYSE for 1926–1981 and the performance of the Dimensional Fund Advisors, Inc. (DFA) U.S. Micro Cap Portfolio thereafter. Large stocks are represented by the Standard & Poor’s 500 ® , which is an unmanaged group of securities and considered to be representative of the stock market in general. Government bonds are represented by the 20-year U.S. government bond, Treasury bills by the 30-day U.S. Treasury bill, and inflation by the Consumer Price Index. Underlying data is from the Stocks, Bonds, Bills, and Inflation ® (SBBI ® ) Yearbook , by Roger G. Ibbotson and Rex Sinquefield, updated annually. An investment cannot be made directly in an index.
  • Ibbotson ® SBBI ® 1990–2009 Examining the past 20 years of capital market returns can provide historical insight into the performance characteristics of various asset classes. This image illustrates the hypothetical growth of a $1 investment in four traditional asset classes, as well as inflation, over the time period January 1, 1990 through December 31, 2009. Over a 20-year time period, one would expect stocks to produce greater returns and higher ending wealth values than fixed-income investments. Small stocks did perform better than all the other asset classes. However, large stocks had a more difficult time recovering after the recent banking and credit crisis, and finished slightly below bonds over the most recent 20-year period. In general, stocks are associated with much greater risk, which can be identified by the volatility or fluctuation of the graph lines. Government bonds and Treasury bills are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than the other asset classes. Furthermore, small stocks are more volatile than large stocks and are subject to significant price fluctuations, business risks, and are thinly traded. About the data Small stocks in this example are represented by the fifth capitalization quintile of stocks on the NYSE for 1970-1981 and the performance of the Dimensional Fund Advisors, Inc. (DFA) U.S. Micro Cap Portfolio thereafter. Large stocks are represented by the Standard & Poor’s 500 ® , which is an unmanaged group of securities and considered to be representative of the stock market in general. Government bonds are represented by the 20-year U.S. government bond, Treasury bills by the 30-day U.S. Treasury bill, and inflation by the Consumer Price Index. Underlying data is from the Stocks, Bonds, Bills, and Inflation ® (SBBI ® ) Yearbook , by Roger G. Ibbotson and Rex Sinquefield, updated annually. An investment cannot be made directly in an index.
  • The Past 10 Years A shorter term perspective of capital market returns can provide historical insight into the performance characteristics of various asset classes. This graph illustrates the hypothetical growth of a $1 investment in four traditional asset classes, as well as inflation, over the time period January 1, 2000, through December 31, 2009. While stocks rode a bull market through the late 1990s, the early 2000s saw a steep decline in the market. Bonds prospered during this time, as Americans sought a flight to safety. The stock market then began a dramatic recovery in 2003. Over a 10-year time period, one would expect stocks to produce greater returns and higher ending wealth values than fixed-income investments. However, due to the two major crises and associated stock market declines experienced during the last decade, stocks were no longer the top performers, being replaced by long-term government bonds. In fact, large stocks lagged behind all the other asset classes examined over the past decade. Also, stocks are generally associated with much greater risk, which can be identified by the volatility or fluctuation of the graph lines. Government bonds and Treasury bills are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than the other asset classes. Furthermore, small stocks are more volatile than large stocks and are subject to significant price fluctuations, business risks, and are thinly traded. About the data Small stocks in this example are represented by the Dimensional Fund Advisors, Inc. (DFA) U.S. Micro Cap Portfolio. Large stocks are represented by the Standard & Poor’s 500 ® , which is an unmanaged group of securities and considered to be representative of the stock market in general. Government bonds are represented by the 20-year U.S. government bond, Treasury bills by the 30-day U.S. Treasury bill, and inflation by the Consumer Price Index. Underlying data is from the Stocks, Bonds, Bills, and Inflation ® (SBBI ® ) Yearbook , by Roger G. Ibbotson and Rex Sinquefield, updated annually. An investment cannot be made directly in an index.
  • Long-Term Asset Class Performance Understanding the risk and return characteristics of individual asset classes can help determine which investment vehicles are most appropriate for your portfolio. This table shows both annual and 12-month rolling period performance measures for four traditional asset classes from 1926–2009. While small and large stocks have the greatest historical returns, these returns are associated with much greater volatility (risk), as evidenced by a higher standard deviation, the range between the highest and lowest 12-month returns, and the percentage of periods that were negative. About the data The annual statistics are calendar-year computations, whereas the rolling period statistics are a series of overlapping, contiguous periods of data. In this case, the first rolling period is January 1926–December 1926; the second rolling period is February 1926–January 1927, etc. The average positive return is the arithmetic average of all periods that experienced a positive return, while the average negative return is the arithmetic average of all periods that experienced a negative return. An investment cannot be made directly in an index. Small stocks in this example are represented by the fifth capitalization quintile of stocks on the NYSE for 1926–1981 and the performance of the Dimensional Fund Advisors, Inc. (DFA) U.S. Micro Cap Portfolio thereafter. Large stocks are represented by the Standard & Poor’s 500 ® , which is an unmanaged group of securities and considered to be representative of the stock market in general. Government bonds are represented by the 20-year U.S. government bond and Treasury bills by the 30-day U.S. Treasury bill.
  • Bond Market Performance Bonds are generally not known as the leading asset class for wealth accumulation; however, they have provided relatively stable returns since 1926. This image illustrates the hypothetical growth of a $1 investment in high-yield corporate bonds, corporate bonds, government bonds, municipal bonds, and cash over the period January 1, 1926, through December 31, 2009. In accordance with their higher risk (due to risk of default), high-yield and corporate bonds outperformed government bonds and Treasury bills. Although municipal bonds underperformed other bonds, the income they generate is usually exempt from federal income taxes. Historically, bonds have generally had a low correlation to stocks. There have even been short periods of time when bonds have outperformed stocks, such as the mid-1970s recession and the early 2000s bear market. For this reason, bonds can provide excellent diversification benefits. Diversification does not eliminate the risk of investment losses. Government bonds and Treasury bills are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while stocks and corporate bonds are not guaranteed. Stocks have been more volatile than the other asset classes. With corporate bonds, an investor is a creditor of the corporation and the bond is subject to default risk. High-yield corporate bonds exhibit significantly more risk of default than investment grade corporate bonds. Municipal bonds may be subject to the alternative minimum tax (AMT) and state and local taxes, and federal taxes would apply to any capital gains distributions. About the data High-yield corporate bonds are represented by Barclays domestic corporate high-yield bond index, corporate bonds by the Ibbotson Associates long-term high-grade corporate bond index, government bonds by the 20-year U.S. government bond, municipal bonds by 20-year prime issues from Salomon Brothers’ Analytical Record of Yields and Yield Spreads from 1926–1984 and Mergent’s Bond Record thereafter, and Treasury bills by the 30-day U.S. Treasury bill. An investment cannot be made directly in an index. The data assumes reinvestment of all income and does not account for taxes or transaction costs.
  • Growth and Value Investing Equity investors are faced with several choices of style when selecting stocks or mutual funds. Typically, stock investments are broken down into small and large, in addition to growth and value. Growth stocks are generally those that have high earnings and/or sales growth. Value stocks, on the other hand, are seen as companies with lower growth potential that could possibly be turned around. Typically, value stocks are those that have been on the receiving end of disappointing news, causing the price to be bid down. This chart shows the growth of $1 invested in large-growth, large-value, small-growth, and small-value stocks at the beginning of 1970. Over this time period, value stocks outperformed growth stocks by a large margin, with small value exhibiting the best performance. It is important to note, however, that in some periods growth stocks have outperformed their value counterparts. Returns and principal invested in stocks are not guaranteed. Furthermore, small stocks are more volatile than large stocks, are subject to significant price fluctuations and business risks, and are thinly traded. About the data Growth and value stocks in this example are represented by the Ibbotson Associates Growth and Value Indexes for 1970–1997 and the Morningstar Style Indexes thereafter. Ibbotson Associates Growth and Value Indexes calculated based on data from CRSP US Stock Database and CRSP US Indices Database, Center for Research in Security Prices (CRSP ® ), The University of Chicago Booth School of Business. Used with permission. An investment cannot be made directly in an index. The data assumes reinvestment of income and does not account for transaction costs or taxes.
  • Stocks, Commodities, REITs, and Gold International stocks, real estate investment trusts (REITs), commodities, and gold have traditionally served to lower the overall risk of a domestic portfolio. This image illustrates the hypothetical growth of a $1 investment in domestic stocks, international stocks, commodities, REITs, and gold over the time period January 1, 1980 to December 31, 2009. REITs were the best-performing asset class over this time period, with $1 growing to approximately $28.15. U.S. stocks came in second, with $1 growing to $24.40. International stocks, commodities, real estate, and gold are often overlooked in an investor’s asset allocation decision. These assets can be excellent vehicles for diversification purposes, because their returns have demonstrated low or even negative correlation with more traditional assets. In other words, when traditional assets have done poorly, these alternative assets may have done well, thereby reducing the overall volatility (risk) of your portfolio. Commodities, real estate, and gold can also be an effective hedge against rising inflation rates. Diversification does not eliminate the risk of experiencing investment losses. Returns and principal invested in stocks, REITs and commodities are not guaranteed. International investments involve special risks such as fluctuations in currency, foreign taxation, economic and political risks, liquidity risks, and differences in accounting and financial standards. Transactions in commodities carry a high degree of risk, and a substantial potential for loss. In light of the risks, you should undertake commodities transactions only if you understand the nature of the contracts (and contractual relationships) into which you are entering and the extent of your exposure to risk. Trading in commodities is not suitable for many members of the public. You should carefully consider whether this type of trading is appropriate for you in light of your experience, objectives, financial resources and other relevant circumstances. Gold, like any other coin or bullion, is subject to investment risks like perceived scarcity of coin, its quality, current demand, market sentiment, and economic factors. About the data U.S. stocks in this example are represented by the Standard & Poor’s 500 ® , which is an unmanaged group of securities and considered to be representative of the stock market in general. International stocks are represented by the Morgan Stanley Capital International Europe, Australasia, and Far East (EAFE ® ) Index, commodities by the Morningstar Long-Only Commodity Index, REITs by the FTSE NAREIT Equity REIT Index ® , and gold by the Federal Reserve (2nd London fix) from 1980–1987 and Wall Street Journal London P.M. closing price thereafter. An investment cannot be made directly in an index.
  • Long Term Investment Performance

    1. 1. Long-Term Investment Performance
    2. 2. Measuring Historical Long-Term Market Performance <ul><li>© 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul><ul><li>Compound annual return (geometric mean) </li></ul><ul><li>The constant single rate of return that, if compounded over multiple holding periods of variable returns, equates a beginning wealth value with an ending wealth value. </li></ul><ul><li>Arithmetic mean </li></ul><ul><li>Simple average of returns. </li></ul><ul><li>Risk (standard deviation) </li></ul><ul><li>The fluctuation of returns around the arithmetic average return of the investment. The higher the standard deviation, the greater the variability (and thus risk) of the investment returns. </li></ul>
    3. 3. Types of Asset Classes <ul><li>© 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul><ul><li>Stocks </li></ul><ul><li>Large stocks </li></ul><ul><li>Small stocks </li></ul><ul><li>International stocks </li></ul><ul><li>Bonds </li></ul><ul><li>Government bonds </li></ul><ul><li>Corporate bonds </li></ul><ul><li>Municipal bonds </li></ul><ul><li>High-yield bonds </li></ul><ul><li>International bonds </li></ul><ul><li>Cash equivalents </li></ul><ul><li>Money market funds </li></ul><ul><li>Treasury bills </li></ul><ul><li>Certificates of deposit </li></ul><ul><li>Real assets </li></ul><ul><li>Real estate </li></ul><ul><li>Commodities </li></ul><ul><li>Gold </li></ul>
    4. 4. Ibbotson ® SBBI ® Stocks, Bonds, Bills, and Inflation 1926–2009 <ul><li>Past performance is no guarantee of future results. Hypothetical value of $1 invested at the beginning of 1926. Assumes reinvestment of income and no transaction costs or taxes. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul>0.10 1 10 100 1,000 $10,000 $12,231 $2,592 $84 $21 $12 Compound annual return • Small stocks 11.9 % • Large stocks • Government bonds • Treasury bills • Inflation 9.8 5.4 3.7 3.0 1926 1936 1946 1956 1966 1976 1986 1996 2006
    5. 5. Ibbotson ® SBBI ® Stocks, Bonds, Bills, and Inflation 1990–2009 <ul><li>Past performance is no guarantee of future results. Hypothetical value of $1 invested at the beginning of 1990. Assumes reinvestment of income and no transaction costs or taxes. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul>1 10 $20 0.60 $7.51 $4.84 $4.87 $1.71 $2.12 Compound annual return • Small stocks 10.6% • Government bonds • Large stocks • Inflation • Treasury bills 8.2 8.2 2.7 3.8 1990 1995 2000 2005
    6. 6. The Past 10 Years 2000–2009 <ul><li>Past performance is no guarantee of future results. Hypothetical value of $1 invested at the beginning of 2000. Assumes reinvestment of income and no transaction costs or taxes. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul>0.50 1 $3 $1.28 $1.31 $0.91 $2.10 $1.84 Compound annual return • Government bonds 7.7% 6.3 • Treasury bills • Small stocks • Inflation • Large stocks 2.8 2.5 – 0.9 2000 2002 2004 2006 2008
    7. 7. Long-Term Asset-Class Performance 1926–2009 <ul><li>Past performance is no guarantee of future results. Assumes reinvestment of income and no transaction costs or taxes. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul>Annual 12-month rolling periods Compound annual return Standard deviation Highest return Lowest return Average positive return Average negative return Percent periods positive Percent periods negative 11.9% 32.8% 316.4% – 75.9% 31.3% – 19.0% 71.4% 28.6% 9.8% 20.5% 162.9% – 67.6% 21.7% – 14.3% 73.0% 27.0% 5.4% 9.6% 54.4% – 17.1% 8.6% – 3.9% 78.1% 21.9% 3.7% 3.1% 15.2% 0.0% 3.8% 0.0% 98.4% 1.6% Small stocks Large stocks Government bonds Treasury bills
    8. 8. Bond Market Performance 1926–2009 <ul><li>Past performance is no guarantee of future results. Hypothetical value of $1 invested at the beginning of 1926. Assumes reinvestment of income and no transaction costs or taxes. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul>$20.53 $36.22 $84.38 $118.63 $247.86 $500 100 10 1 0.10 6.8% 5.9 5.4 4.4 3.7 Compound annual return • High-yield corp bonds • Corporate bonds • Government bonds • Municipal bonds • Treasury bills 1926 1936 1946 1956 1966 1976 1986 1996 2006
    9. 9. Growth and Value Investing 1970–2009 <ul><li>Past performance is no guarantee of future results. Hypothetical value of $1 invested at the beginning of 1970. Assumes reinvestment of income and no transaction costs or taxes. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul>$500 10 1 0.50 1970 1975 1990 1995 2000 2005 $17.79 $51.61 $240.93 $24.43 14.7% 10.4 8.3 7.5 Compound annual return • Small value • Large value • Small growth • Large growth 100 1980 1985
    10. 10. Stocks, Commodities, REITs, and Gold 1980–2009 <ul><li>Past performance is no guarantee of future results. Hypothetical value of $1 invested at the beginning of 1980. Assumes reinvestment of income and no transaction costs or taxes. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2010 Morningstar. All Rights Reserved. 3/1/2010 </li></ul>$100 0.50 1 10 $2.08 $24.40 $18.47 $7.57 $28.15 11.8% 11.2 10.2 7.0 2.5 Compound annual return • REITs • U.S. stocks • International stocks • Commodities • Gold 1980 1985 1995 2000 2005 1990

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