FPA NCA 2012 winter educational symposium asset dedication slides

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Slide presentation from the 2012 FPA National Capital Area Winter Symposium

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FPA NCA 2012 winter educational symposium asset dedication slides

  1. 1. …economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014. Federal Reserve Monetary Policy Release January 25th, 2012 WHERE ARE INTEREST RATES GOING?
  2. 2. $16.4 trillion THE US DEBT CEILING
  3. 3. 10 YEAR US TREASURY BOND YIELDS 1800-2010
  4. 4. CONTRASTING RETURN ENVIRONMENTS RISING = 1950-1981 FALLING = 1981-2011
  5. 5. SUSTAINED LOW INTEREST RATES
  6. 6. VOLATILITY DRIVES DOWN TOTAL RETURN Source: Citigroup World Govt. Bond Index – Japan 1-5 Year Total Return = 2.9%
  7. 7. "It's not return on my money I'm interested in… …it's return of my money“ Mark Twain
  8. 8. THE CRITICAL PATH • On their way to the moon, the Apollo ships were off course more than 95% of the time • Because they knew the trajectory the ship should follow, the astronauts could make corrections along the way so that the ships could make it to the moon and back • In the same way, the financial plan provides the trajectory that clients’ portfolios need to follow to reach their goals • The Critical Path serves as a customized benchmark to guide each client’s portfolio to make corrections and decisions approaching and through retirement
  9. 9. LIFETIME CRITICAL PATH® Transition
  10. 10. LIFETIME CRITICAL PATH®
  11. 11. RETIREMENT CRITICAL PATH®
  12. 12. BRINGING INVESTMENTS AND PLANS TOGETHER • The financial plan articulates how investors plan to spend their money • Investments ought to reflect the goals they are funding instead of risk tolerance that is not tied to the goals • There are numerous behavioral benefits for having the investments flow from the plan
  13. 13. Portfolio Financial Plan
  14. 14. SPLITTING THE PORTFOLIO TO REFLECT GOALS • Sub-portfolios are dedicated to specific purposes – Income and Growth • Each sub-portfolio is made up of asset classes best suited to their purpose • The Income Portfolio is dedicated to protecting principal and providing predictable cash flows using individual bonds • The Growth Portfolio is tasked with delivering long-term growth using equities and other growth oriented assets
  15. 15. Portfolio
  16. 16. Growth Portfolio Income Portfolio
  17. 17. Equities + Others Individual Bonds
  18. 18. Protected Principal and Predictable Income
  19. 19. Protected Principal and Predictable Income
  20. 20. Higher Expected Return but Short-term Volatility Protected Principal and Predictable Income
  21. 21. Protected Principal and Predictable Income Higher Expected Return but Short-term Volatility
  22. 22. Predictability Uncertainty
  23. 23. Systematically transfer uncertainty of equities to predictability of bonds to reduce the volatility of funding retirement spending.
  24. 24. DE-RISKING THE PORTFOLIO 1. Protect Principal 2. Reduce uncertainty of funding spending needs 3. Reduce sensitivity to market risks • Interest rate risk • Equity market risk
  25. 25. BEHAVIORAL BENEFITS 1. Mental accounting 2. Dedicate assets to the purpose they best serve 3. Tie portfolio performance to the goals outlined in the financial plan
  26. 26. CASE STUDIES
  27. 27. Helen and George: Age: 67 Assets: $2,000,000 Income need: $100,000 Expected Inflation: 3% Plan Horizon: 30 Years
  28. 28. LIFETIME SPENDING NEEDS $2MM PORTFOLIO, $100K/YR, 3% INFLATION
  29. 29. INITIAL 8 YEARS OF SPENDING NEEDS YEAR 1 8 Years of Income
  30. 30. Year Issue Principal Interest Portfolio Cash Flows Target Cash Flows 2012 CD $77,000 $22,905 $99,905 $100,000 2013 CD $82,000 $21,416 $103,416 $103,000 2014 CD $86,000 $20,035 $106,035 $106,090 2015 CD $91,000 $17,818 $108,818 $109,273 2016 CD $98,000 $14,855 $112,855 $112,551 2017 CD $104,000 $11,713 $115,713 $115,927 2018 CD $112,000 $7,455 $119,455 $119,405 2019 Agency Bond $121,000 $2,496 $123,496 $122,987 $889,692 $889,234 BUILDING AN INCOME MATCHING PORTFOLIO Quotes: 9/6/2011
  31. 31. Year Issue Principal Interest Portfolio Cash Flows Target Cash Flows 2012 CD $77,000 $22,905 $99,905 $100,000 2013 CD $82,000 $21,416 $103,416 $103,000 2014 CD $86,000 $20,035 $106,035 $106,090 2015 CD $91,000 $17,818 $108,818 $109,273 2016 CD $98,000 $14,855 $112,855 $112,551 2017 CD $104,000 $11,713 $115,713 $115,927 2018 CD $112,000 $7,455 $119,455 $119,405 2019 Agency Bond $121,000 $2,496 $123,496 $122,987 $889,692 $889,234 TARGET INCOME STREAM Quotes: 9/6/2011
  32. 32. Year Issue Principal Interest Portfolio Cash Flows Target Cash Flows 2012 CD $77,000 $22,905 $99,905 $100,000 2013 CD $82,000 $21,416 $103,416 $103,000 2014 CD $86,000 $20,035 $106,035 $106,090 2015 CD $91,000 $17,818 $108,818 $109,273 2016 CD $98,000 $14,855 $112,855 $112,551 2017 CD $104,000 $11,713 $115,713 $115,927 2018 CD $112,000 $7,455 $119,455 $119,405 2019 Agency Bond $121,000 $2,496 $123,496 $122,987 $889,692 $889,234 MATCHING CASH FLOWS TO SPENDING NEEDS Quotes: 9/6/2011
  33. 33. Year Issue Principal Interest Portfolio Cash Flows Target Cash Flows 2012 CD $77,000 $22,905 $99,905 $100,000 2013 CD $82,000 $21,416 $103,416 $103,000 2014 CD $86,000 $20,035 $106,035 $106,090 2015 CD $91,000 $17,818 $108,818 $109,273 2016 CD $98,000 $14,855 $112,855 $112,551 2017 CD $104,000 $11,713 $115,713 $115,927 2018 CD $112,000 $7,455 $119,455 $119,405 2019 Agency Bond $121,000 $2,496 $123,496 $122,987 $889,692 $889,234 TIMING THE CASH FLOWS Quotes: 9/6/2011
  34. 34. PORTFOLIO COSTS 8 Years = $829,656 Total Income = $889,692
  35. 35. PORTFOLIO COSTS 8 Years = $829,656 (60/40) 10 Years = $1,035,495 (50/50) 30 Years = $2,753,814 (0/100) Quotes: 9/6/2011
  36. 36. PORTFOLIO COSTS 8 Years = $829,656 (60/40) 10 Years = $1,035,495 (50/50) 30 Years = $2,753,814 (0/100) Quotes: 9/6/2011 30-year portfolio exceeds resources
  37. 37. Top Investment Risks Defined by Individual Investors 64% 54% 36% 0% 10% 20% 30% 40% 50% 60% 70% Outliving Savings Not Saving Enough Market Volatility Source: Financial Advisor Retirement Income Planning Experiences, Strategies, and Recommendations; FPA Research Center White Paper; December 2011.
  38. 38. LIFETIME SPENDING NEEDS $2MM PORTFOLIO, $100K/YR, 3% INFLATION
  39. 39. YEAR 1 8 Years of Income 22 Years of Uncertainty
  40. 40. YEAR 2 8 Years of Income 21 Years of Uncertainty ? ? ? ? Roll or Don’t Roll? 8 Years of Income
  41. 41. YEAR 2 8 Years of Income 21 Years of Uncertainty Above CP → Roll 1 Year
  42. 42. YEAR 3 8 Years of Income 20 Years of Uncertainty Above CP → Roll 1 Year
  43. 43. YEAR 4 8 Years of Income 19 Years of Uncertainty Above CP → Roll 1 Year
  44. 44. YEAR 5 8 Years of Income 18 Years of Uncertainty Above CP → Roll 1 Year
  45. 45. YEAR 6 10 Years of Income 15 Years of Uncertainty Well Above CP → Roll 2 Years
  46. 46. WELL ABOVE CRITICAL PATH
  47. 47. YEAR 6 10 Years of Income 15 Years of Uncertainty Well Above CP → Roll 2 Years
  48. 48. YEAR 7 9 Years of Income 15 Years of Uncertainty Not Above CP → Don’t Roll
  49. 49. BELOW CRITICAL PATH
  50. 50. YEAR 7 9 Years of Income 15 Years of Uncertainty Not Above CP → Don’t Roll
  51. 51. YEAR 8 8 Years of Income 15 Years of Uncertainty Not Above CP → Don’t Roll
  52. 52. STILL BELOW
  53. 53. YEAR 8 8 Years of Income 15 Years of Uncertainty Not Above CP → Don’t Roll
  54. 54. YEAR 9 8 Years of Income 14 Years of Uncertainty Above CP → Roll 1 Year
  55. 55. BACK ABOVE CRITICAL PATH
  56. 56. LONG-TERM PROBABILITY OF SUCCESS Expected Return Over Rolling 30 Year Periods Since: 1927 1947 Average Return* 7.7% 9.4% Minimum Return* 0.0% 7.1% Maximum Return 13.3% 13.3% Average Longevity (Years) 28 30 Minimum Longevity 13 30 Maximum Longevity 30 30 Probability Portfolio Lasts 30 Years or more 83.6% 100.0% Prob. Portfolio Above Critical Path Target After 30 Years 83.6% 100.0% 8-year Income Portfolio of US Treasury Bond, Growth Portfolio allocation to CRSP 1-10 Total US Market
  57. 57. HISTORICAL AUDIT ROLLING 30-YEAR PERIODS, 1927-2010 8-year Income Portfolio of US Treasury Bond, Growth Portfolio allocation to CRSP 1-10 Total US Market
  58. 58. TOTAL RETURN IS NOT FOR DECUMULATION Expected Return Over Rolling 30 Year Periods Since: 1927 1947 Average Return* 6.7% 7.3% Minimum Return* 0.0% 0.0% Maximum Return 12.6% 12.6% Average Longevity (Years) 29 30 Minimum Longevity 14 25 Maximum Longevity 30 30 Probability Portfolio Lasts 30 Years or more 80.0% 85.7% Prob. Portfolio Above Critical Path Target After 30 Years 80.0% 85.7% 60% CRSP 1-10 Total US Market/40% 10-Year US Treasury Index
  59. 59. HISTORICAL AUDIT – 60/40 TOTAL RETURN ROLLING 30-YEAR PERIODS, 1927-2010 60% CRSP 1-10 Total US Market/40% 10-Year US Treasury Index
  60. 60. HISTORICAL AUDIT – 8 YEAR ROLLING ROLLING 30-YEAR PERIODS, 1927-2010 8-year Income Portfolio of US Treasury Bond, Growth Portfolio allocation to CRSP 1-10 Total US Market
  61. 61. Celia and Henry: Age: 57 Assets: $843,402 Annual Savings: $35,000 Planned Retirement: 30 Years Plan Horizon: 40 Years
  62. 62. DEFERRED INCOME PORTFOLIO EXTEND OUT THE YIELD CURVE Purchase 10 to 15 years out on the yield curve
  63. 63. BUILDING TO RETIREMENT 25 Years of Uncertainty 5 Years of Future Income
  64. 64. BUILDING TO RETIREMENT 24 Years of Uncertainty 6 Years of Future Income
  65. 65. BUILDING TO RETIREMENT 23 Years of Uncertainty 7 Years of Future Income
  66. 66. BUILDING TO RETIREMENT 23 Years of Uncertainty 7 Years of Future Income
  67. 67. BUILDING TO RETIREMENT 22 Years of Uncertainty 8 Years of Future Income
  68. 68. WHY NOT A BOND FUND? 1. Volatility around funding 2. Sensitivity to rising interest rates 3. Lack of control
  69. 69. 10 YEAR US TREASURY BOND YIELDS 1800-2010
  70. 70. BOND FUND VOLATILITY REVEALED RISING INTEREST RATES 1950-1981 10-year Treasury Index is the proxy for high quality bond funds
  71. 71. BOND FUND VOLATILITY REVEALED RISING INTEREST RATES 1950-1981 10-year Treasury Index is the proxy for high quality bond funds
  72. 72. BOND FUND INCOME VARIABILITY/SHORTFALL COMPARISON OVER 8-YEAR HORIZONS 1950-1981 Starting value = cost of 8-year Income Portfolio for each year. Target cash flows = $100,000/year plus 3% inflation. 10-year Treasury Index is the proxy for high quality bond funds
  73. 73. WHY NOT A BOND LADDER? 1. Cash flows are not tied to actual needs 2. Income is more expensive
  74. 74. WHY NOT A SIMPLE BOND LADDER? Year Bond Ladder Income Portfolio Target Cash Flows 2012 $133,636 $103,297 $100,000 2013 $131,428 $108,750 $103,000 2014 $130,452 $111,082 $106,090 2015 $122,982 $113,612 $109,273 2016 $121,468 $116,438 $112,551 2017 $113,690 $119,099 $115,927 2018 $106,378 $121,714 $119,405 2019 $101,330 $124,691 $122,987 2020 $104,576 $127,180 $126,677 2021 $96,636 $130,502 $130,477 Total Cash Flow $1,162,576 $1,176,366 Cost $1,052,363 $1,051,250 Quotes: 9/6/2011
  75. 75. WHY NOT A BOND LADDER? Year Bond Ladder Income Portfolio Target Cash Flows 2012 $133,636 $103,297 $100,000 2013 $131,428 $108,750 $103,000 2014 $130,452 $111,082 $106,090 2015 $122,982 $113,612 $109,273 2016 $121,468 $116,438 $112,551 2017 $113,690 $119,099 $115,927 2018 $106,378 $121,714 $119,405 2019 $101,330 $124,691 $122,987 2020 $104,576 $127,180 $126,677 2021 $96,636 $130,502 $130,477 Total Cash Flow $1,162,576 $1,176,366 Cost $1,052,363 $1,051,250 $13,790 Greater Total Cash Flow From Income Portfolio
  76. 76. WHY NOT A PERIOD CERTAIN ANNUITY? 1. Expensive 2. Inflexible
  77. 77. WHY NOT A PERIOD CERTAIN ANNUITY? Year Period Certain Income Portfolio 2012 $95,400 $98,235 2013 $98,262 $104,183 2014 $101,210 $105,590 2015 $104,246 $108,236 2016 $107,374 $110,222 2017 $110,595 $113,056 2018 $113,913 $115,887 2019 $117,330 $118,115 2020 $120,850 $120,837 2021 $124,475 $124,385 Total Cash Flow $1,093,654 $1,118,746 Cost $1,000,000 $999,808 Quotes: 9/6/2011 www.immediateannuity.com
  78. 78. WHY NOT A PERIOD CERTAIN ANNUITY? Year Period Certain Income Portfolio 2012 $95,400 $98,235 2013 $98,262 $104,183 2014 $101,210 $105,590 2015 $104,246 $108,236 2016 $107,374 $110,222 2017 $110,595 $113,056 2018 $113,913 $115,887 2019 $117,330 $118,115 2020 $120,850 $120,837 2021 $124,475 $124,385 Total Cash Flow $1,093,654 $1,118,746 Cost $1,000,000 $999,808 $25,092 Greater Total Cash Flow From Income Portfolio
  79. 79. In 2008, AIG was the largest issuer of fixed annuities. US Government capital infusion = $182 billion
  80. 80. Which is safer? 1. FDIC Insured CDs and Government Agency bonds OR 2. Insurance companies
  81. 81. DIVIDEND INCOME UNPREDICTABILITY According to Standard and Poor’s, dividend payments from companies in the S&P 500 dropped by 23.5% from January 2008 to January 2009
  82. 82. REIT INCOME UNPREDICTABILITY According to Cohen and Steer’s, publicly traded REITs cut their dividends by 26% in 2009
  83. 83. White Papers: The Cost of Waiting for Rates to Rise De-risking Retirement Income The Safety of Investment Grade Bonds Slides: Presentation Financial Inspiration (Joke)

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