Larkspur Financial Advisors
 Asset Management & Financial Planning



B E H AV I O R A L F I NA NC E & YOU R C L I E NTS

...
Agenda
                                                                       2

     Background
          g
     Introduc...
Background
                                                                     3




For Professional Use Only—Not intend...
Background: About Me
                                                                     4

     Current
           Finan...
Background: About Investors
                                                                             5

     A 2003 Sc...
Background: The Results
                                                                                          6


    ...
Behavioral Finance
                                                                     7




                          qu...
Pop Quiz
                                                                        8

     I would rate my driving abilities...
Standard Theory of Finance (Efficient Markets)
                                                                     9

   ...
Why Behavioral Finance?
                                                                     10

     If we always behaved...
Behavioral Finance
                                                                     11

     Behavioral Finance provid...
Our Brains…
                                                                      12
                        Dough v. Dope...
Pop Quiz: Guess Who?
                                                                     13




           “Greed, for l ...
Answer: Gordon Gecko
                                                                     14




For Professional Use Only...
Behavioral Characteristics
                                                                     15
     Loss aversion     ...
Loss Aversion: Pop Quiz
                                                                     16

     A friend wants to ma...
Loss Aversion: The Disproportion of Gain & Loss
                                                                          ...
Loss Aversion: How Investors see risk
                                                                     18

     Client...
Loss Aversion: The Importance of Time
                                                                     19




For Prof...
Disposition Effect
                                                                     20

     The disposition effect re...
Narrow Framing: Trees vs. Forest
                                                                     21

     Would you a...
Narrow Framing: Aggregation
                                                                     22

     Would you flip a...
Mental Accounting: The “House Money Effect”
                                                                     23

     ...
Mental Accounting: 401k Plans
                                                                     24

     In retirement ...
Regret: Omission vs. Commission
                                                                     25

     Q
     Quest...
Regret & Hindsight Bias
                                                                     26

     The inevitability of...
Media Response
                                                                     27




For Professional Use Only—Not i...
Media Response
                                                                     28

     Investors often feel the need...
Media Response: Market Timing
                                                                     29




For Professional...
Herding
                                                                       30

     Investors have a tendency toward “...
Herding: Reading the ‘stars’
                                                                             31


           ...
Optimism & Overconfidence
                                                                     32

     People believe it ...
Overconfidence: “We’re all above average”
                                                                     33

     Pe...
Overconfidence: Real World
                                                                     34

     Two types of clie...
Pop Quiz: Anchoring
                                                                     35

     Take the last three numb...
Pop Quiz: Anchoring
                                                                       36

     Answer: 451 AD
       ...
Anchoring
                                                                         37

     “Anchors” affect an investor’s...
Recency Effect
                                                                     38

     When do people buy burglar al...
Pop Quiz: Recency & Overconfidence
                                                                                       ...
Behavioral Finance: Key points
                                                                     40

     Anticipation ...
Pop Quiz: Guess who?
                                                                     41




            “I got my min...
Answer: Snoop Dogg
                                                                     42




For Professional Use Only—N...
Managing Clients
                                                                     43




                             ...
Look Inward First
                                                                     44

     Recognize that behavioral ...
Helping your Clients: Questions to Ask
                                                                     45

     When ...
Reviewing their Financial Plan
                                                                     46




For Professiona...
Reviewing the IPS
                                                                     47
     A well-formed Policy Statem...
Monitoring the Plan
                                                                     48
What’s relevant:
           Wh...
Sample Performance Reports
                                                                     49




For Professional Us...
Sample Performance Reports
                                                                     50




For Professional Us...
A word about Benchmarks…
                                                                     51

     Benchmarks are a co...
Getting from point A to point B…
                                                                                        5...
Summary: Managing Clients
                                                                     53

           The Financia...
Pop Quiz: Guess who?
                                                                        54




      “I made a big mi...
Answer: Warren Buffett
                                                                     55




For Professional Use On...
For further reading…
                                                                     56

     Wikipedia: A great star...
57




                                                     Thank you.
                                                   ...
Disclosures
                                                                                            58
Before investin...
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Behavioral Finance & Client Expectation Management Cal Cpa Presentation For July 16 2008

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A presentation I created and gave to a CPA lunch along with a couple accountancy firms this year.

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Behavioral Finance & Client Expectation Management Cal Cpa Presentation For July 16 2008

  1. 1. Larkspur Financial Advisors Asset Management & Financial Planning B E H AV I O R A L F I NA NC E & YOU R C L I E NTS P R E S E N TAT I O N T O : A C A L I F O R N I A C PA S F / M A R I N DISCUS SION GROUP P R E S E N T E D B Y: VINCENT J. CRIVELLO F I N A NC I A L A DV I S O R & P R I NC I PA L J U LY 1 6 , 2 0 0 8
  2. 2. Agenda 2 Background g Introduction to Behavioral Finance Managing Clients & Expectations gg p Q&A For Professional Use Only—Not intended for the public distribution
  3. 3. Background 3 For Professional Use Only—Not intended for the public distribution
  4. 4. Background: About Me 4 Current Financial Advisor and Owner with Larkspur Financial Advisors—an independent advisory firm founded in 1968 Comprehensive Financial Planning and Asset Management for p g g individuals, families, and small businesses Target Market: “Millionaire next door” and the mass affluent Past NorthStar Systems: Wealth Management Consulting Charles Schwab: Business & Product Management in Schwab’s retail advisory di i i (P i il d i division (Private Cli Client, M Managed P f li ) d Portfolios) Marketing & Industry Research: Multi-channel consumer marketing strategies with an emphasis in financial services For Professional Use Only—Not intended for the public distribution
  5. 5. Background: About Investors 5 A 2003 Schwab consumer survey found that “Despite the warnings of economists and money management experts that Americans need to pay more attention to their finances…” 93 percent said they planned to have an annual medical or dental check-up. check up. Nearly half (47 percent) of those polled would rather do laundry than carefully read their investment statement even though many investors may be seeing some improvement in their portfolios. Only 38 percent of those surveyed said they planned an annual face-to-face face to face meeting with their broker or financial advisor. Investors who work with a financial advisor are almost twice as likely to cancel an appointment with their advisor (22 percent) than they are to cancel a car service appointment ( 3 p pp (13 percent). ) Only 22 percent of respondents ranked quot;investmentsquot; as among their top three priorities in 2004. Source: http://www.businesswire.com/portal/site/schwab/index.jsp?ndmViewId=news_view&ndmConfigId=1009915&newsId=20050916005258&newsLang=en For Professional Use Only—Not intended for the public distribution
  6. 6. Background: The Results 6 EQUITY MARKET RETURNS VS VS. EQUITY MUTUAL FUND INVESTOR RETURNS* (1985-2004) 13.2% 3.7% S&P 500 Average Index Equity Fund Investor *SOURCE: Dalbar, Inc. Quantitative Analysis of Investor Behavior - 2005. Represents average annually compounded returns of equity indices vs equity mutual fund investors; based on the length of time shareholders actually remain invested in a fund and the historic performance of the funds appropriate index. Past performance is no guarantee of future results. Investors cannot invest directly in an index. For Professional Use Only—Not intended for the public distribution
  7. 7. Behavioral Finance 7 quot;SHARE PRICES ARE DRIVEN BY FEAR AND GREED.quot; - JOHN MAYNARD KEYNES For Professional Use Only—Not intended for the public distribution
  8. 8. Pop Quiz 8 I would rate my driving abilities as… y g Below average Average Better than average B h Please jot down your answer—we’ll come back to this later in the session For Professional Use Only—Not intended for the public distribution
  9. 9. Standard Theory of Finance (Efficient Markets) 9 The Standard Theory of Finance states: Investors I Are rational beings Consider all information and accurately assess its meaning Make decisions that maximize wealth while minimizing risk Markets Quickly incorporate all known information Reflect the collective actions of rational investors Represent the true value of all securities Industry Developments over the past few decades: Diversification through Asset Allocation g Portfolio Design & Efficient Frontier (MPT) Mutual Funds Index funds and ETFs For Professional Use Only—Not intended for the public distribution
  10. 10. Why Behavioral Finance? 10 If we always behaved rationally… Nobody would ever sell stocks in a panic at the first sign of trouble Nobody would ever buy stocks (or other investments) based on hunches, hot tips or media hype , p yp Nobody would ever keep money in the bank instead of using it to pay off high-interest credit card balances Harvard found that humans are not “wired” to make wired rational decisions: Human beings are simply not good at accurately calculating odds Left to our own regards, we make the same mistakes over and over again. For Professional Use Only—Not intended for the public distribution
  11. 11. Behavioral Finance 11 Behavioral Finance provides an ‘overlay’ to the Standard Theory. Theory It provides a framework to understand ‘non-rational’ investor and market behaviors… Investors Are A not totally rational ll i l Often act based on imperfect information Make “non-rational” decisions in predictable ways Markets M kt May be difficult to beat in the long term In the short term, there are anomalies and excesses The t Th two aspects of b h i l fi t f behavioral finance are: The behavior of investors The behavior of markets For Professional Use Only—Not intended for the public distribution
  12. 12. Our Brains… 12 Dough v. Dope Greed vs. Gain Source: Hans Breiter, Harvard Medical School Brian Knutson, Sanford University, Jason Zweig (Author) Your Money & Your Brain For Professional Use Only—Not intended for the public distribution
  13. 13. Pop Quiz: Guess Who? 13 “Greed, for l k of a G d f lack f better word, i good.” b d is d For Professional Use Only—Not intended for the public distribution
  14. 14. Answer: Gordon Gecko 14 For Professional Use Only—Not intended for the public distribution
  15. 15. Behavioral Characteristics 15 Loss aversion Media response Disposition effect i ii ff Herding di Narrow framing Optimism Mental M t l accountingti Overconfidence O fid Regret Anchoring Hindsight bias Recency For Professional Use Only—Not intended for the public distribution
  16. 16. Loss Aversion: Pop Quiz 16 A friend wants to make a bet with you. If y accept y you p the bet you will have a 50% chance of losing $10,000 and a 50% chance of winning $_______. How much would you want to have a chance of winning before you would take the bet? Please right down your number For Professional Use Only—Not intended for the public distribution
  17. 17. Loss Aversion: The Disproportion of Gain & Loss 17 Most people want to g pp gain between 2 and 2.5 times as 5 much as they put at risk. So most people will want a chance to win $20,000 before they will play. Practical Example: Between 1926 and 2000* Question: Why would anyone invest in bonds? y Stocks returned 8% (real) Bonds returned 2% (real) The answer is loss aversion: The less frequently you evaluate stocks, the less risky they appear. People tend to evaluate stocks as if they had a short time horizon. *Source of data: Stocks, Bonds, Bills, and Inflation 2001 Yearbook. Ibbotson Associates, Chicago (annually updates work by Roger G. Ibbotson and Rex a Sinquefield). Used with permission. All rights reserved. Stocks are represented by the S&P 500 C db h Composite S k I d i Stock Index, an unmanaged i d widely regarded as an i di d index id l dd indicator of d f domestic stock performance. S&P 500 performance i l d reinvestment of di id d b d i k f f includes i f dividends but does not take sales k l charges or taxes into consideration. Bonds represented by long-term government bonds are measured using a one-bond portfolio with a maturity near twenty years. Cash represented by U.S. Treasury bills is measured by rolling over each month a one-bill portfolio containing, at the beginning of each monthly, the bill having the shortest maturity not less than one month. An investment in common stocks will fluctuate with changes in market conditions. An investment in government bonds and Treasury bills are guaranteed by the U.S. Government and, if held to maturity, all bonds offer both a fixed rate of return and fixed principal value. Past performance of stock and bond indexes is no indication of their future results. For Professional Use Only—Not intended for the public distribution
  18. 18. Loss Aversion: How Investors see risk 18 Clients view risk differently than p y professionals Focus on fear of losing money, not mathematics or abstract concepts like ‘time-weighted returns’ Client’s risk profile changes over time Two time horizons Long-term (an abstraction) Short-term (the real standard) Self-assessed vs. actual risk t l S lf d t l i k tolerance For Professional Use Only—Not intended for the public distribution
  19. 19. Loss Aversion: The Importance of Time 19 For Professional Use Only—Not intended for the public distribution
  20. 20. Disposition Effect 20 The disposition effect refers to p p p people’s tendency to: y Hang on to losers Sell the winners This allows them to enjoy the feeling of winning and defer the pain of loss Investors are about 1.5 times more likely t sell I t bt ti lik l to ll winning stocks as they are to sell losing stocks Behaviors: “I’m going to wait for the stock to come back to $15/share.” For Professional Use Only—Not intended for the public distribution
  21. 21. Narrow Framing: Trees vs. Forest 21 Would you accept this gamble… 50% chance to win $15,000 50% chance to lose $10,000 Most people would say “no” because they want a no chance to win at least twice what they might lose. Assume you have a net worth of $ million. Would y $2 you accept the gamble now? 50% chance that your wealth increases $15,000 50% chance that your wealth decreases $10 000 $10,000 Most people say “yes.” They become less risk averse as their frame of reference broadens. For Professional Use Only—Not intended for the public distribution
  22. 22. Narrow Framing: Aggregation 22 Would you flip a coin if… You get $15,000 if you win You pay $10,000 if you lose Again, Again most people would say “no ” but no, but… What if you got to flip the coin 100 times? Most people would say “yes.” Loss aversion is diminished by aggregation. i Implications: Time ‘in the market’ is critical. in market 100 months in the market (like 100 flips of a coin) creates a quasi-aggregation effect For Professional Use Only—Not intended for the public distribution
  23. 23. Mental Accounting: The “House Money Effect” 23 You have just won $30. Choose between: j 3 1. A. 50% chance to win $9 and 50% chance to lose $9 B. No further bets BNf h b 70% of participants chose A 2 You have not won anything. Choose between: anything 2. A. 50% chance to win $39 and 50% chance to win $21 B. A sure gain of $30 43% of participants chose A For Professional Use Only—Not intended for the public distribution
  24. 24. Mental Accounting: 401k Plans 24 In retirement plans that do not offer company stock as an option, the average allocation is: 49% stocks 49% Equities 51% fixed income In plans that do offer company stock, the average allocation is: 42% company stock 71% Equities 29% other stock 29% fixed income Company stock is placed in a separate “mental account” from the other options For Professional Use Only—Not intended for the public distribution
  25. 25. Regret: Omission vs. Commission 25 Q Question: Who is more upset, Mr. Q or Ms. R? p, Omission: Mr. Q owns shares of Company A. He considers selling his shares and buying stock in Company B, but decides against it He now finds he would have been better off by it. $20,000 if he had switched to Company B. Commission: Ms. R owns shares in Company B, but switched to Company A She fi d she would h tC A. Sh finds h ld have b been b tt off b better ff by $20,000 if she had kept her shares of Company B. Answer: Ms. R. People typically regret errors of p yp yg commission more than errors of omission. For Professional Use Only—Not intended for the public distribution
  26. 26. Regret & Hindsight Bias 26 The inevitability of past events Events that happen seem predictable Events that do not happen will seem unlikely People distort their own past beliefs “I always knew…” Past beliefs are reconciled with actual events People take credit for good outcomes and blame others for bad outcomes (this is also related to optimism and overconfidence) For Professional Use Only—Not intended for the public distribution
  27. 27. Media Response 27 For Professional Use Only—Not intended for the public distribution
  28. 28. Media Response 28 Investors often feel the need to react to new information Study of the effects of news on investment decisions: Two groups: one received news and one did not The Th groups with no news outperformed th group th t received news ith tf d the that id News is often irrelevant to long-term performance and is often misinterpreted p News sources are often perceived as ‘authoritative’ sources which impacts behavior Real World: “Put my entire portfolio in cash—this hurricane season is going to kill the market.” For Professional Use Only—Not intended for the public distribution
  29. 29. Media Response: Market Timing 29 For Professional Use Only—Not intended for the public distribution
  30. 30. Herding 30 Investors have a tendency toward “herd behavior” y They may even disregard their own beliefs to follow the herd Study of the effects of herd behavior: Participants were asked to answer easy questions about the lengths of li l th f lines About 1/3 changed their answers to be part of the herd Real World: Disproportionate flow of money into top-rated funds despite ratings’ lack of predictive abilities For Professional Use Only—Not intended for the public distribution
  31. 31. Herding: Reading the ‘stars’ 31 5-Year Performance Next 5-Year Period 6/30/92 – 6/30/97 6/30/97 – 6/30/02 21% Top Quartile Top Quartile 14% 2nd Quartile 14% 3rd Quartile 2nd Quartile 50% Bottom Quartile 3rd Quartile Bottom Quartile Past performance is a very poor predictor of future results. Odds are against top quartile managers performing in top quartile during the next period and only 50/50 pq g p y / to be above the median for the next 5 years. For Professional Use Only—Not intended for the public distribution
  32. 32. Optimism & Overconfidence 32 People believe it is likely that: People are overconfident about what they know Good things will h G d thi ill happen t to them Even when “certain,” they are often wrong… Bad things will happen to others 20% e d up be g incorrect 0% end p being co ec Others are more likely to: (@ 98% certainty level)* 10%-15% end up being Become an alcoholic incorrect when “absolutely Have a heart attack sure sure”* Develop D l cancer They underestimate the Others are less likely to: uncertainty of events Become rich “This time it’s different.” Become famous –1999 B bbl Investor Bubble I Warren Buffet once said, “Optimism is the enemy of the A related tendency is that of overconfidence. Fact is, people are often rational buyer” unjustifiably overconfident in assessing their abilities and what they know about the world around them. Studies show that people are wrong about 20% of the time when asked to estimate things with a 98% confidence level and by 10% to 15% when asked to be “absolutely sure” of their answers. The result is that people often underestimate the uncertainty of events and believe that they are much better at assessing future possibilities than they really are. For Professional Use Only—Not intended for the public distribution
  33. 33. Overconfidence: “We’re all above average” 33 People tend to overestimate their abilities 90% believe they are above average in… Driving ability Sense of humor Getting along with others They misperceive their ability to control events They seek confirmation of their abilities and find it in random events Whoever first said, “Don’t confuse brains with a bull market” probably was a student of behavioral finance. Real World: “Rising tide floats all boats.” The real test of ability is in a sideways or down market market. For Professional Use Only—Not intended for the public distribution
  34. 34. Overconfidence: Real World 34 Two types of client Trader: Speculated on price. Traded often. Investor: Buy & Hold. Fundamental focus. Stocks sold outperformed those purchased by: “Trader” “Investor” After 12 months: 3.2% 3 2% 5.0% 5 0% After 24 months: 3.6% 8.6% The higher the turnover, in general, the worse the results. *Source: American Economic Review 1999, Terrance Odean, Associate Professor of Finance at the University of California at Davis For Professional Use Only—Not intended for the public distribution
  35. 35. Pop Quiz: Anchoring 35 Take the last three numbers of your Social Security number and add 400. Insert the sum i place of [d ] b d dd h in l f [date] below. Attila and the Huns invaded Europe and penetrated deep into what is now France where they were defeated and forced to return eastward eastward. 1. Did these events occur before or after [date] AD? ______ Before ______ After 2 .In what year did Attila s defeat occur? ______ In Attila’s For Professional Use Only—Not intended for the public distribution
  36. 36. Pop Quiz: Anchoring 36 Answer: 451 AD 45 Research Results: Anchor Mean Answer 400-599 626 600-799 600 799 660 800-999 789 1000-1199 865 1200-1399 988 88 For Professional Use Only—Not intended for the public distribution
  37. 37. Anchoring 37 “Anchors” affect an investor’s frame of reference Can you think of common investment anchors? S&P 500 Index Dow Jones Industrials Performance benchmarks CNN Cocktail party chatter Behaviors “I’ll sell the stock when it gets back to $20” “I’m t i to ll “I’ not going t sell my h home f THAT price!” for i !” “I’ll sell the real estate now to lock in the long-term capital gains rate prior to the election.” For Professional Use Only—Not intended for the public distribution
  38. 38. Recency Effect 38 When do people buy burglar alarms? pp y g Behaviors Acting on momentum or a run-up in price (aka chasing returns) Real Estate (2002-2006) Gold Oil BRIC (Brazil, Russia, India, China) Wanting to go to cash in volatile markets the markets will markets—the keep going down. Client has to get into the action For Professional Use Only—Not intended for the public distribution
  39. 39. Pop Quiz: Recency & Overconfidence 39 For the period between 1986 and 2006, which asset classes represent Investments A and B: End value of $ $100 Return Inflation Real Return investment Investment A 11.9% 3.0% 8.9% $951 Investment B 55 5.5% 3 3.0% 2.5% 5 $9 $292 Clue #1: In 2006, the ‘herds’ wanted a piece of this action— many jumped into these markets we’re now hearing about. Clue #2: Homeowners would have answered this wrong back in 2006. Source: JP Morgan, BEA, S&P. S&P includes dividends. Past performance is not indicative of future results. For Professional Use Only—Not intended for the public distribution
  40. 40. Behavioral Finance: Key points 40 Anticipation of gain (greed) is more satisfying than the actual gain Pain of loss has a larger emotional impact than the pleasure of gain Investors lose confidence in markets due to the media response, herding, and anchoring effects g, g Excessive conservatism and aversion to risk is exacerbated by narrow framing, mental accounting and short time horizons Investor overconfidence, optimism and minimization of uncertainties create i fl t d egos t i ti t inflated Investors often repeat predictable, destructive behaviors and don’t learn from past mistakes Bottom line: These behaviors and reacting to ‘recency’ events leads to lower overall returns over the long-term. For Professional Use Only—Not intended for the public distribution
  41. 41. Pop Quiz: Guess who? 41 “I got my mind on my I money and my money on my mind ” mind. For Professional Use Only—Not intended for the public distribution
  42. 42. Answer: Snoop Dogg 42 For Professional Use Only—Not intended for the public distribution
  43. 43. Managing Clients 43 GOALS, OBJECTIVES, & EXPECTATIONS For Professional Use Only—Not intended for the public distribution
  44. 44. Look Inward First 44 Recognize that behavioral issues affect us all— g including financial advisors, institutional money managers, and individual investors Do a self-assessment to determine what behaviors you’ve exhibited and how it may impact the advice you provide clients or the advice your clients have clients—or received from other advisors Challenge the financial advisors you work with—see with see if their advice and recommendations are influenced by latent behavioral biases For Professional Use Only—Not intended for the public distribution
  45. 45. Helping your Clients: Questions to Ask 45 When your clients ask… “How do you think my account did last year? How year?” “What do you think of the job my financial advisor has done?” “How do I know if my investment advisor is doing a good job?” “The market is tanking—should I fire my advisor? Do it on my own?” You should answer… If they’re working with an advisor: What’s does your financial plan state? What are the assumptions? What are your return requirements to meet your financial goals? What are your portfolio’s objectives? What are the return and risk parameters in your IPS? If they’re managing their own investments: What are your benchmarks? How do you define success? How do you know when you’re doing well? Are you using time-weighted returns to measure progress? Do you have a sell strategy in p y gy place? Ask to take a look at your client’s other financial documents: Financial Plan Investment Policy Statement (IPS) Q Quarterly Performance Report y p Consolidated Net Worth Statement For Professional Use Only—Not intended for the public distribution
  46. 46. Reviewing their Financial Plan 46 For Professional Use Only—Not intended for the public distribution
  47. 47. Reviewing the IPS 47 A well-formed Policy Statement should include these items: Goals & Objectives Time Horizon Risk tolerance Liquidity or distribution needs Tax rates Asset Allocation requirements Client preferences or constraints Return Expectations (often inflated): Consumers: 10.4%-14% Institutional Mgrs: 8.0% Expected volatility/risk Methodologies and selection criteria Monitoring, benchmarks, & evaluation criteria The advisor should also factor in other assets: 401k/Qualified Plans Investment Real Estate Non-correlated Assets such as Managed Futures For Professional Use Only—Not intended for the public distribution
  48. 48. Monitoring the Plan 48 What’s relevant: What’s are the return/risk / objectives of the portfolio? What’s “time-weighted performance” (TWR) since inception (net of all fees and expenses)? How has the portfolio performed vs. its benchmark? How are the assets performing h f i vs. the financial plan? What’s irrelevant: Monthly statements Gain/loss reporting Specific winners or losers For Professional Use Only—Not intended for the public distribution
  49. 49. Sample Performance Reports 49 For Professional Use Only—Not intended for the public distribution
  50. 50. Sample Performance Reports 50 For Professional Use Only—Not intended for the public distribution
  51. 51. A word about Benchmarks… 51 Benchmarks are a contentious topic in the industry. There’s no clear accepted means of benchmarking financial or portfolio performance for individual investors (despite what the academics say). The following benchmarks are generally the best ones to help you answer your client’s question, “How am I doing?”: Financial Plan: rate of return required to achieve goal Portfolio’s Expected Return (e.g. CPI + 6%) vs. actual Time-weighted return Standard Deviation or Volatility Composite benchmark (e.g. S&P500, Lehman Aggregate, MSCI EAFE) which could include peers or a ‘passive’ p p p portfolio of index funds and ETFs Remember the ‘qualitative’ benchmark—how a client feels about his or her portfolio is also important. In other words, how is the j h i th journey? ? For Professional Use Only—Not intended for the public distribution
  52. 52. Getting from point A to point B… 52 Mr. Smith’s Mr. Jones’ American Funds Portfolio American Funds Portfolio Washington Mutual 60% Growth Fund of Amer. 60% Intermediate Bond of Am. 40% High Income Fund 40% Beta: 0.43 Beta: 0.74 Standard Deviation: 7.81 Standard Deviation: 12.81 Worst year return: -7.14% Worst Year Return: -21.50% Extra Credit: Based on what you’ve learned, Is Mr. Smith or Mr. Jones more likely to give up on their plan? Analysis based on Morningstar Principia Data from 09/30/1996-9/30/2006. Past performance is not necessarily indicative of future results. For Professional Use Only—Not intended for the public distribution
  53. 53. Summary: Managing Clients 53 The Financial Plan: Helps clients focus on the big picture 1. Strategic, Long-term Strategic Long term goals Reorients them towards goal attainment not reactive portfolio tinkering or trading Achieving the financial goal(s) is ultimately what matters to clients Investment Policy & Design: Drives disciplined, rational decision-making 2. Provides rational guidance and parameters that drive investment decision making and changes Provides a framework through which one can measure ‘success’ Allows the incorporation of strategies or products that mitigate downside volatility (hedging, absolute return, non-correlated assets) and/or approaches that allow for ‘satellite’ or speculative opportunities (e g have your cake and eat it too) satellite (e.g. Plan Monitoring: Tracking towards objectives 3. Consistent, risk-adjusted performance net of fees, expenses, and taxes is presumed—this is not a differentiator. Investment advisors must deliver over the long-term How does the client ‘feel’ about the plan? Can they sleep at night? feel Check-in periodically to determine if their goals and objectives have changed (e.g. annual tax review with the financial advisor). If not, there’s no reason to diverge from the plan. Ultimately, Financial Planning and Asset Management is a process that should factor in both quantitative reviews as well as qualitative (b h i ii i ll li i (behavioral) f l) factors. For Professional Use Only—Not intended for the public distribution
  54. 54. Pop Quiz: Guess who? 54 “I made a big mistake in not selling several of our larger holdings during The Great Bubble. If these stocks are fully priced now, you may wonder what I was thinking four years ago when their intrinsic value was lower and their prices f hi h l l d th i i far higher. So d I.” do ” For Professional Use Only—Not intended for the public distribution
  55. 55. Answer: Warren Buffett 55 For Professional Use Only—Not intended for the public distribution
  56. 56. For further reading… 56 Wikipedia: A great starting point http://en.wikipedia.org/wiki/Behavioural_economics h // iki di / iki/B h i l i Money.com Quiz: A view inside the brain http://money.cnn.com/quizzes/2007/moneymag/wiredforwealth/inde x.html hl Slate.com: A layman’s guide and something to send your clients http://www.slate.com/id/2110977/ UC Berkeley Haas School of Business: Academic perspective http://faculty.haas.berkeley.edu/odean/papers/returns/returns.html Your Brain from CNN Money: Test yourself http://money.cnn.com/pf/features/popups/brain_popup/1.frame.html For Professional Use Only—Not intended for the public distribution
  57. 57. 57 Thank you. y Vincent J. Crivello J 415.924.6703 x5 vcrivello@larkspurfinancialadvisors.com For Professional Use Only—Not intended for the public distribution
  58. 58. Disclosures 58 Before investing in any of the funds or strategies listed in this report, investors should carefully consider a fund’s investment objectives, risks, charges and expenses. Fund prospectuses contain this and other information about the funds, and may be obtained by calling us at 1.415.924.6703 or visiting our website at www.larkspurfinancialadvisors.com. Investors should read prospectuses carefully before investing. Investments are not deposits or obligations of any bank, are not guaranteed by any bank, are not insured by the FDIC or any other agency, and involve investment risks, including the possible loss of the principal amount invested. For Institutional Use Only. This material has been prepared by Vincent J. Crivello of SFA for institutional use only. It has not been filed with NASD and may not be reproduced, shown or quoted to, or used with, members of the public. Stocks, Commodities, Real Estate, and Gold International stocks, real estate, commodities, and gold have traditionally served to l i l k l di i d ld h di i ll d lower the overall risk of a d h ll i k f domestic portfolio. i f li This image illustrates the hypothetical growth of a $1 investment in domestic stocks, international stocks, commodities, real estate, and gold over the time period January 1, 1988 to December 31, 2007. The best performing asset class over this 20-year period was domestic stocks, with $1 growing to approximately $9.33. 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 investment losses. Returns and principal invested in stocks are not guaranteed. International investments involve special risks such as fluctuations i currency, f i taxation, economic and political risks, and diff fl i in foreign i i d li i l i k d differences i accounting and fi in i d financial standards. The smooth slope of the real estate i d li seems to il dd h hl fh l index line indicate stable returns. However, these returns are based on appraisal values rather than actual prices. This method of valuing real estate assets tends to smooth price fluctuations that would be more readily apparent if more frequent transaction data were available. The real estate industry is highly cyclical, and the value of securities issued by companies doing business in that sector may fluctuate widely. The commodities index represents a passive unleveraged investment in commodity futures. The risk of loss in trading commodity futures and options can be substantial. Investors could lose the full balance of their account when trading commodities. 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. U S stocks i this example are represented b the S d d & P ’ 500®, which i an unmanaged group of securities and considered to b representative of the stock market i general. k in hi l d by h Standard Poor’s ® hi h is d f ii d id d be i fh k k in l International stocks are represented by the Morgan Stanley Capital International Europe, Australasia, and Far East (EAFE®) Index, commodities by the Goldman Sachs Commodity Index, real estate by the NCREIF Property Index, and gold by the Federal Reserve (2nd London fix) from 1977–1987 and Wall Street Journal London P.M. closing price thereafter. An investment cannot be made directly in an index. Past performance is no guarantee of future results. The information in this document is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. Securities and advisory services offered th S iti d di i ff d through Th Strategic Fi h The St t i Financial Alli i l Alliance, Inc. (SFA), member FINRA/SIPC which is otherwise unaffiliated with Larkspur Financial Ad i I (SFA) b FINRA/SIPC, hi h i th i ffili t d ith L k Fi i l Advisors or Tributary Advisors, Inc. Ronald Murphy (CA Insurance #0290052) is a Registered Principal and Investment Advisor Representative and Vincent Crivello (CA Insurance #0F54430) is a Registered Representative and Investment Advisor Representative of SFA. For Professional Use Only—Not intended for the public distribution

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