Jan 2012 Miccolis, Investing for Dummies

Advanced
Personal
“Investing for
Financial Dummies”
Planning Examining the Fundamentals
of Successful Long-Term
Conference
Investing
Las Vegas, NV

January 17, 2012 Jerry A. Miccolis, CFA®, CFP®, FCAS

800.364.2468 :: brintoneaton.com

Jerry A. Miccolis
Principal, CIO, Senior Financial Advisor
Brinton Eaton

CFA; CFP; Fellow, Casualty Actuarial Society;
Member, American Academy of Actuaries

Portfolio manager, The Giralda Fund

30 years’ experience in risk management

Co-author: Asset Allocation For Dummies®;
Enterprise Risk Management: Trends and Emerging Practices

Towers Perrin’s global Enterprise Risk Management practice leader

Published in The New York Times, The Wall Street Journal, The Star Ledger,
Business Week, The Baltimore Sun, Market Watch, MSN Money, Market Wire

Appeared as an expert commentator on CBS Radio, ABC TV, NPR, and online
at IRMI.com, the website of the International Risk Management Institute

Company confidential 800.364.2468 :: brintoneaton.com 1

The Fundamentals
of Successful Long-Term Investing
 Asset allocation — being strategic and scientific
 Rebalancing — making volatility work for you
 Tax efficiency — keeping what you earn
 Integration with financial planning — focusing on the
right goals


The Fundamentals of Successful Long-Term Investing

Asset Allocation


Proper asset allocation
is top-down and strategic
 Start with the financial goals you’re trying to achieve
 Select an investment strategy consistent with those
goals
 Execute the strategy via asset allocation


Asset allocation
is more than diversification
 Diversification is simply not putting all your eggs in
one basket
 Asset allocation is a scientific method to:
 Identify the appropriate asset classes to invest in
 Determine the appropriate mix among those asset classes
 Achieve a portfolio with an optimal risk/return profile

 Asset allocation leads to enlightened diversification
 Asset allocation exploits the relationship between
risk and return


High return typically comes
with high risk — and vice versa

1975 - 2009
14%

12%

10%

8%
Return

6%
T-bills
AAA Corp Bonds
4%
S&P 500
2%

0%
0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20%

Risk


Enlightened diversification reduces risk
$270

$250
Asset A

$230

$210

$190
Account Balance

$170

$150

$130

$110

$90

0 1 2 3 4 5 6 7 8 9 10
Year


$270

$250
Asset A

$230 Asset B

$210

$190
Account Balance

$170

$150

$130

$110

$90

0 1 2 3 4 5 6 7 8 9 10
Year


$270

$250
Asset A

$230 Asset B

50/50 Mix
$210

$190
Account Balance

$170

$150

$130

$110

$90

0 1 2 3 4 5 6 7 8 9 10
Year


— in real life too
4000

3500

3000
S&P 500
US RE
2500

2000

1500

1000

500

0



1980 - 2009 Results
11.7%

11.6%
S&P 500
11.5%
US Real Estate
11.4%
Return

11.3%

11.2%

11.1%

11.0%
15.0% 16.0% 17.0% 18.0% 19.0% 20.0%
Risk



1980 - 2009 Results
11.7%

11.6%
S&P 500
11.5%
US Real Estate
11.4% Combined 50/50
Return

11.3%

11.2%

11.1%

11.0%
15.0% 16.0% 17.0% 18.0% 19.0% 20.0%
Risk


The key to the value of asset allocation

 Capture the higher returns that typically accompany
higher-risk asset classes
 While engineering away much of the risk at the
portfolio level



Rebalancing


Rebalancing
starts as a housekeeping chore
 Asset classes in a portfolio will grow at different
rates
 These different growth rates will cause the portfolio
to drift from its intended asset allocation
 Rebalancing restores the portfolio to its original
intent
 But, done opportunistically, it can achieve much
more…


While diversification can reduce risk…
$270

$250
Asset A

$230 Asset B

50/50 Mix
$210

$190
Account Balance

$170

$150

$130

$110

$90

0 1 2 3 4 5 6 7 8 9 10
Year


…rebalancing can improve return
$270

$250
Asset A

$230 Asset B

50/50 Mix
$210
Rebalanced 50/50 Mix
$190
Account Balance

$170

$150

$130

$110

$90

0 1 2 3 4 5 6 7 8 9 10
Year


Rebalancing can improve return

1980 - 2009 Results
11.7%

11.6%
S&P 500
11.5%
US Real Estate
Return

11.3%

11.2%

11.1%

11.0%
15.0% 16.0% 17.0% 18.0% 19.0% 20.0%
Risk


Rebalancing can make 1+1=3

1980 - 2009 Results
11.7%

11.6%
S&P 500
11.5%
US Real Estate
Return

Combined w/ rebalancing
11.3%

11.2%

11.1%

11.0%
15.0% 16.0% 17.0% 18.0% 19.0% 20.0%
Risk


Rebalancing puts the inherent
volatility among assets to work for you
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 YTD 9/30/11

Commodities Real Estate Commodities Emerging Market Real Estate Emerging Market Real Estate Emerging Market Fixed Inc Emerging Market Real Estate Fixed Inc
49.7% 12.4% 32.1% 53.8% 30.9% 32.8% 33.2% 39.1% 5.2% 77.6% 28.9% 6.6%

Real Estate Fixed Inc Fixed Inc Small Cap Stocks Emerging Market Commodities Emerging Market Commodities Small Cap Stocks Mid Cap Stocks Mid Cap Stocks Real Estate
27.8% 8.4% 10.3% 38.8% 24.3% 25.6% 31.7% 32.7% -31.1% 37.4% 26.6% -6.4%

Mid Cap Stocks Small Cap Stocks Emerging Market Mid Cap Stocks Small Cap Stocks Mid Cap Stocks Large Cap Stocks Mid Cap Stocks Mid Cap Stocks Real Estate Small Cap Stocks Large Cap Stocks
17.5% 6.5% 1.6% 35.6% 22.6% 12.6% 15.8% 8.0% -36.2% 27.5% 26.3% -8.7%

Small Cap Stocks Mid Cap Stocks Real Estate Real Estate Commodities Real Estate Small Cap Stocks Fixed Inc Real Estate Large Cap Stocks Emerging Market Commodities
11.8% -0.6% -4.5% 35.3% 17.3% 11.2% 15.1% 7.0% -36.3% 26.5% 18.6% -9.3%

Fixed Inc Emerging Market Mid Cap Stocks Large Cap Stocks Mid Cap Stocks Small Cap Stocks Mid Cap Stocks Large Cap Stocks Large Cap Stocks Small Cap Stocks Large Cap Stocks Mid Cap Stocks
11.6% -4.9% -14.5% 28.7% 16.5% 7.7% 10.3% 5.5% -37.0% 25.6% 15.1% -13.0%

Large Cap Stocks Large Cap Stocks Small Cap Stocks Commodities Large Cap Stocks Large Cap Stocks Fixed Inc Small Cap Stocks Commodities Commodities Commodities Small Cap Stocks
-9.1% -11.9% -14.6% 20.7% 10.9% 4.9% 4.3% -0.3% -46.5% 13.5% 9.0% -13.8%

Emerging Market Commodities Large Cap Stocks Fixed Inc Fixed Inc Fixed Inc Commodities Real Estate Emerging Market Fixed Inc Fixed Inc Emerging Markets
-31.8% -31.9% -22.1% 4.1% 4.3% 2.4% -15.1% -17.4% -52.4% 5.9% 6.5% -21.7%


The more volatile your assets, the more
mileage you get from rebalancing

The more distance your pistons travel, the more powerful your engine



Tax Efficiency


It’s not what you make,
but what you keep, that matters
 Asset location
 A typical portfolio spans several accounts
 Some of those accounts may be tax-deferred
 Place tax-inefficient assets in tax-deferred accounts
 Place tax-efficient assets in taxable accounts
 It’s the total portfolio’s asset allocation that matters

 Tax-loss harvesting
 Via ETFs, not individual securities
 More tax deferral than tax avoidance



Integration with Financial Planning


What’s your client’s situation?

Lifestyle Planning Risk
Requirements Horizon Tolerance

Income Retirement
Sources Objectives

Investable Gifting/estate Tax
Assets Intentions Status

Charitable Investment
Inclinations Constraints


What’s riskier?

Risk doesn’t exist in a vacuum


Lifetime Cash Flow Projections —
Assumptions


Assumptions


Results


The results can be counterintuitive
Effect of Investment Strategy on Confidence Level

90
90
90
90 89
Illustrative Client Example
89
89
89
89 88
89
88
88 87 88
88 87
87

87 87 87 86
87 86
86
86
Confidence Level 86

85 85
85
85
84
E
83 D
C
82 Ending Investment Strategy
B
A
B A
C
D
Beginning Investment Strategy E



Recap


Asset Allocation

 Top-down, strategic, scientific approach to portfolio
construction
 Find high-risk/high-return assets that grow “counter-
cyclically”
 Capture the higher returns that typically accompany
higher-risk asset classes — while engineering away
much of the risk at the portfolio level
 Further reading:
 “Risk and Return” and “Portfolio Magic” Research Briefs,
www.brintoneaton.com
 Asset Allocation For Dummies® (Wiley 2009)


Rebalancing

 Keeps your portfolio true to its intended asset
allocation
 Done opportunistically, can increase portfolio return
with no increase in risk
 Puts volatility to work for you
 “Rebalancing Act” Research Brief, www.brintoneaton.com
 Asset Allocation For Dummies® (Wiley 2009), Chapters 5, 11


Tax Efficiency

 Asset location — matching the tax characteristics of
your investments with the tax features of your
accounts
 Tax-loss harvesting — being opportunistic while
staying true to your asset allocation
 “Tax Efficient Investing” Research Brief, www.brintoneaton.com
 Asset Allocation For Dummies® (Wiley 2009), Chapters 10, 14


Integrating Investing
with Financial Planning
 Customize your investment strategy around your
own unique long-term financial objectives — which is
the real purpose of your investments
 Your financial situation has many moving parts
 Financial planning tools can capture these
complexities in a coherent way
 The right investment strategy is the one that best
secures your own financial future
 “It’s Good to Be Coordinated” Research Brief,
www.brintoneaton.com
 Asset Allocation For Dummies® (Wiley 2009), Chapter 7


For more information on these ideas…

 Read:
 AssetAllocationBook.com
 The Kitces Report
 Advisor Perspectives
 Inside Information
 Journal of Financial Planning

 Visit: www.brintoneaton.com
 Research Briefs/white papers
 Client bulletins
 Podcasts/webinars

 Email: info@brintoneaton.com
 Call: 800-364-2468


Jan 2012 Miccolis, Investing for Dummies

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