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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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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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