5. But there are a lot of challenges facing investors, when you design a plan,
including stock market volatility
5
6. Wall Street and the financial media are another challenge.
They can sometimes turn investing into entertainment
6
7. That is why it is so important to focus on what really mattersāyour financial
and life goals
8. A good plan should be designed around an investorās financial AND life
goalsāand as this chart shows, these goals can cover a wide variety of areas.
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9. Once you understand what is important to you as an investor, then you can
start to build an appropriate portfolio with your financial advisor.
10. Like the story of the three little pigsāyou donāt want a straw portfolio built with
whatever investments are āHotā right now in the financial media.
10
11. Nor do you want a āwoodā portfolio which is just a collection of investments
which may not work well together and donāt necessarily reflect your unique
goals and needs.
11
12. Portfolios should be built with investments that provide proper diversification,
work well together and reflect the right balance or risk and potential reward for
each investorās chosen level of risk and time horizon.
12
13. And we believe that science and academic research are critical to building a
prudent portfolio. Great thinkers and economists such as Adam Smith,
Frederich Hayek, Paul Samuelson, Merton Miller, Bill Sharpe, Daniel
Kahneman and of course Harry Markowitz have provided us with powerful
insights into how portfolios should be constructed.
13
14. When it comes to portfolio construction, we believe investors have three key
decisions they need to make. Read slide.
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15. From the smartphone in your pocket to the department store where you buy
your clothes, many companies that are a big part of our lives are public
companies that are listed for trading on a major stock exchange. Not all of
them are big with well-known brand names and not all will be successful long-
term.
However, one of the best opportunities to grow your money over the long-term
can come from making an investment in capitalism and the stock market.
This chart is a good illustration of the long-term growth of US businesses over
the past eighty years.
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16. To be an effective āshock absorber,ā the portfolio should contain:
ā¢ Bonds with shorter maturities that have lower correlations historically to
stocks. This means the bond typically has a 3 to 5 year ālifespanā and does not
go up and down in value at the same time or to the same extent as stocks.
Generally, longer maturity bonds entail more risk
ā¢ Higher-quality bonds that can help dampen portfolio volatility and lower the
risk of a default.
The chart illustrates the risk and reward to portfolios from fixed income
holdings. Of note is the lower volatility of short-term bonds that you can see
represented by the standard deviation number (how much the portfolio goes
up or down in a year). Note also that investors are typically not properly
compensated for the additional risk of longer-term bonds.
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17. Now that you understand about not putting all of your eggs in one basket, by
investing in both stocks and short-term bonds it just makes sense to apply
diversification to the global markets. Today, more than 56% of the total market
capitalization is outside of the US markets!
17
18. This slide depicts the world not according to land mass, but by the size of each
countryās stock market relative to the worldās total market .
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 that offer 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 slide 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 that offer the
most attractive returns.
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19. While the US outperformed almost all other countries in 2012, the long term
picture still points to a need for international diversification, with the US coming
in 39th out of 45 countries in terms of 10-year stock market returns.
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20. This is why we build asset class portfolios that typically contain over 9,000
companies in 45 countries, representing 36 currencies.
While we love the great U.S companies, the science suggests that investing in
thousands of stocks globally rather than a few can help mitigate the overall risk
of the portfolio and may increase your return.
The reason is simple: if you own a lot of companies around the world you will
eliminate the ācompany specific riskā that comes when your portfolio is
exposed to a reversal that may affect one company or one sector or even one
country.
Capitalism and creation of wealth is a worldwide phenomena and the countries
with the highest ā and lowest returns ā change year by year.
International stocks can be riskier than U.S. stocks and are subject to a variety
of additional risks, including currency and political risks. That is why investors
must carefully decide how they will allocate the equity portion of their portfolio
between U.S. and international stocks.
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21. 21
When you consider all you want to achieve in life ā today, tomorrow and for
many years to come ā how hard does your money have to work to help you
get there?
We intuitively understand that when a risk is unrewarded, it is rarely worth
taking, just as we know that we are seldom compensated for taking no
chances at all. āNothing ventured, nothing gainedā as the old saying goes.
Investing involves risks regardless of what you invest in.
In 1992, academic research by Professors Ken French and Eugene Fama Sr.,
identifying two equity risk factors ā small companies and value companies ā
that investors should expect to be compensated for. As an investor, you need
to decide how much of these risks you are willing to take. As the chart shows,
the greater the risk exposure, the greater the expected long-term return
22. The size and BtM ā or value -- effects appear in both US and international
marketsāstrong evidence that the risk factors are systematic across the
globe.
This chart 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. We believe these higher returns reflect compensation for
bearing higher risk.
22
23. This is some of the key academic research we draw upon to help us build
portfolios
23
24. This is some of the key academic research we draw upon to help us build
portfolios
24
25. This is some of the key academic research we draw upon to help us build
portfolios
25
26. This is some of the key academic research we draw upon to help us build
portfolios
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27. To be a successful investor you need discipline and structure ā and ongoing
education ā to manage THROUGH markets rather than TO markets.
You donāt want to āguessā when it comes to investing to meet your life goals.
And donāt let emotions derail your best laid plans
28. Rebalancing is an important step that many people neglect when they try to
manage their own investments. Without rebalancing, portfolios can drift as the
markets change. This drifts can add extra risk to your plan that you never
intended or expected.
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29. As you can see from this chart, the annually rebalanced portfolio was
historically less volatile over the last twenty years. It may not have soared as
much during bull markets, but it didnāt decline as much during bear markets.
And overall, it offered slightly better performance with less risk than the drifting
portfolio.
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30. 30
Investing can be an emotional roller coaster. In this age of the ā24-hour news
cycleā it is easy to forget the role that maintaining our investment portfolios can
play in achieving our long-term goals.
As the illustration shows, at the moment of greatest potential risk, many want
to invest even more money. And at the moment of greatest potential
opportunity, many are tempted to sell. It can be difficult to stay focused on the
long-term when the short-term consumes our thoughts and emotions.
31. 31
Just to show you how investors can sabotage their returns when they donāt
take a long-term perspective, consider this chart which shows that over the
last twenty years, the average investor did substantially worse than major
indices.
Why the big difference? Some investors might think they know when to buy
and sell. But this means they have to be right twice: picking the right time to
buy and the right time to sell. That is a pretty tall order!
Other investors might give in to panic or even greed and make hasty,
emotional decisions.
Whatever the reason, the results as a whole are shocking. The average equity
investor in the study above underperformed the S&P 500 by almost 4% each
and every year. A gap that large can have a real impact over time on an
investorās long-term goals ā even quality of life.
32. Your future is too important to play games with and take unnecessary chances. We
donāt believe you should gamble by trying to time markets or pick winning managers.
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33. Beating the S&P 500 isnāt easy. Of the 862 U.S. Equity Funds from 1998 ā
2007, only 420, or less than half managed to beat the S&P 500. So you might
think, just invest in one of those winning managers, and youāll do fine.
33
34. But 5 years on, in 2012, 248 funds (almost 30%) have closed their doors,
merging or going out of business.
34
35. Andāfive years later--of the original 420 funds that outperformed, 70% failed
to sustain their performance or closed their doors.
And a few of the underperformers even managed to beat the S&P 500. But
there is no predictable pattern to any of this performance up or down. Nothing
that we believe offers a sound guide to which manager to invest with for the
future.
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