Transcript Six Strategic Steps

Roadmap for Investing
Wisely for a Lifetime
Leslie Lum
Bellevue Community College
1
The Roadmap
•
•
•
•
•
•
Save
Focus on financial goals
Understand returns
Understand risk
Asset allocation
Monitor your investments
2
Rule #1: You can make more
money saving aggressively than
you can investing aggressively
3
How much does a typical family make?
4
What happens to your income over your life?
5
How are we doing at savings?
Savings rate as a percent of disposable income
30
25
20
15
10
5
0
1929
1934
1939
1944
1949
1954
1959
1964
1969
-5
Source: http://www.bea.gov/bea/dn/nipaweb/TableView.asp#Mid
6
1974
1979
1984
1989
1994
1999
2004
Could we save more?
2004 Household Saving Rates
(as a percent of disposable income)
United States
Switzerland
Sweden
Norway
Netherlands
Korea
Japan
Italy
Ireland
Germany
France
Finland
Canada
Austria
Australia
-4.0
-2.0
0.0
2.0
4.0
6.0
http://stats.oecd.org/WBOS/default.aspx?DatasetCode=REFSERIES
7
8.0
10.0
12.0
14.0
Rule #2: If you don’t have goals,
you won’t achieve them.
8
Annual Budget vs Long-Term Financial Goals
• Trade off between spending money now
and setting aside money for long-term
goals
• How do you make your decision?
• What are the costs?
9
Lay out your goals
•
•
•
•
•
•
Down payment on house
Wedding
College tuition
Starting your own business
Retirement
Estate (Inheritance or charity)
10
Rule #3: Know how to
measure returns.
11
Returns
Always calculate returns on an annualized
basis
12
Calculate the annualized return
• You have an outstanding balance of
$500 on your credit card. You are late in
paying and were only able to pay the
minimum $10. Your APR on the card is
22% above prime. The late payment
charge is $35. Assume the prime rate is
7% now.
13
Calculating returns – time value of money
14
Calculating lost return
• You want to buy a HDTV set for $1500. What
is this (future) costing you? (Use 20 years
and 8% return. We use 8% because it’s
historically the rate of return on investments
over a long period of time.)
–
–
–
–
$1785
$3393
$4837
$6991
15
Calculating lost return
You are a typical employee in your 20s
who when you left your job in 2005
cashed out (66% do) your 401K account
of less than $10,000. What is the cost of
cashing out your account if your
balance was $8000?
16
Which is more?
• Saving $4000 a year
from 25 to 45 years
old and then no
more savings but
hold in account
• Saving $8000
(double) a year from
45 to 65 years old
900000
800000
700000
600000
500000
400000
300000
200000
100000
0
25 to 45
years
17
45 to 65
years
It’s a moving target
• House in 10 years.
Today’s price
$200,000
• Kid’s college
education in 18
years. Today’s price
$50,000
• 2% inflation 3%
inflation?
18
That’s not the only uncertainty
$800,000
retirement
goal in 30
years
At 8% returns?
At 10%
returns?
Future Investment Returns Are Uncertain
25%
Cash
Average Yearly Return for Decade
20%
Bond
19%
18%
Stock
15%
14%
9%
10%
8%
6% 6%
5%
5%
0%
1970's
1980's
1990's
2000's
-2%
-5%
19
The financial plan
Katie is 25 and
trying to plan her
financial future.
Here are her
financial goals in
today’s dollars
(black) and
inflated to when
they are due
(red).
20
Katie does her plan
and knows that her
heaviest savings
will happen in her
30s and 40s.
She also does
sensitivity analysis
on various inflation
and return rates.
She knows that she
should save as
much as she can
when she is
younger.
21
Rule #4: Understand risk
22
Investment Risks
•
•
•
•
•
•
Market risk
Business risk
Interest rate
Inflation risk
Political risk
Fraud risk
23
Major asset classes
Annual Return on Cash
(Treasury Bill Total Return 1971-2000)
50%
45%
40%
35%
30%
25%
20%
About 70% of returns fall within one
standard deviation of the average
15%
10%
Standard Deviation 2.7%
Average 6.7%
5%
Source: Global Financial Data, www.globalfindata.com
24
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
1972
1971
0%
Bonds
Annual Return on Bonds
(Total Return Government Bonds 1971-2000)
50%
40%
30%
About 70% of returns fall within one
standard deviation of the average
20%
Standard
Deviation
9.3%
Average 9.9%
10%
-10%
Source: Global Financial Data
25
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
1972
1971
0%
Stocks
Annual Return on Stocks
(Total Return S&P 500 1971-2000)
50%
40%
30%
Standard
Deviation
16.5%
20%
Average 14.5%
10%
-10%
-20%
About 70% of returns fall within one
standard deviation of the average
-30%
Source: Global Financial Data
26
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
1972
1971
0%
Return versus Risk
Lessons to learn:
The more return you need, the more risk you take.
The more risk you take, the more return you need.
If you want a higher
return, you need to
invest in riskier
assets (stocks)
Return
Major Asset Classes (1971-2000)
18%
16%
Stocks
Average Annual Return 14.5%
Standard Deviation 16.5%
14%
12%
(Annual Return)
The more return, the
more risk.
322% gain
guaranteed?
Only if 322% loss
guaranteed!
10%
Bonds
Average Return 9.9%
Standard Deviation 9.3%
8%
6%
4%
T-Bills
Average Return 6.7%
Standard Deviation 2.7%
2%
0%
0%
2%
4%
6%
8%
Risk
(Standard Deviation)
27
10%
12%
14%
16%
Given the same return,
the investment with less risk is better
28
The Northwest is the best.
29
Bonds – Risk Return
7%
Long Corporate
Return (Average Annual Return)
6%
5%
Long Term
Treasuries
Intermediate Corporate
Bonds
4%
3%
2%
Short term
T-Bills
1%
0%
0%
1%
2%
3%
4%
5%
Risk (Standard Deviation)
Source: Morningstar.com (3 years of data ending Nov 2006)
30
6%
7%
8%
9%
Stock – Risk Return
31
Sectors – Risk Return
35%
Energy
Return (Average Annual Return)
30%
25%
Real Estate
20%
15%
Telecom
Materials
Financial
10%
Consumer
Health
5%
0%
0%
2%
4%
6%
8%
10%
12%
Risk (Standard Deviation)
Source: Morningstar.com (3 years of data ending Nov 2006)
32
14%
16%
18%
20%
International – Risk Return
50%
Brazil
45%
Return (Average Annual Return)
Mexico
40%
35%
Spain
30%
25%
Emerging Markets
Australia
20%
Germany
UK
15%
Japan
Hong Kong
10%
5%
Taiwan
0%
0%
5%
10%
15%
20%
Risk (Standard Deviation)
Source: Morningstar.com (3 years of data ending Nov 2006)
33
25%
30%
35%
Combined – Risk Return
Rank the
categories
in order of
return
Rank the
asset
classes in
order of risk
34
How do you get both a good
return and low risk?
35
Risk of loss in stocks is high year to year
Annual Stock Price Changes from 1900 to 2006
(Percent change year to year in S&P 500)
45%
25%
5%
1900
1910
1920
1930
1940
1950
-15%
-35%
-55%
36
1960
1970
1980
1990
2000
Over 5 years, risk of loss is lower
Average Previous Five Years S&P 500 Gains
30%
25%
20%
15%
10%
5%
0%
1900
1910
1920
1930
1940
1950
-5%
-10%
-15%
37
1960
1970
1980
1990
2000
Over 10 years, risk of loss is small
Average Previous Ten Years S&P 500 Gains
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
1900
-2%
1910
1920
1930
1940
1950
-4%
38
1960
1970
1980
1990
2000
Lesson?
• Buy and hold market index funds
(doesn’t work for individual stocks)
• Have an emergency fund (3 to 6
months) to tide you over
• Have other sources of income so you
don’t have to cash out during down
markets
39
Rule #5: Asset allocate
40
All eggs in one basket?
• 34.6 percent of families had stock in
only one company
• 59.5 percent had stock in three or fewer
companies
• 9.5 percent had stock in fifteen or more
companies
Source: 2004 Consumer
Finance Survey
41
Can you predict the best return?
2000 Mid Cap Stocks
1999 Latin America
1998 S&P 500
Best-Performing Asset Class
1997 S&P 500
1996 S&P 500
(1980-2000)
Based on Index
1995 S&P 500
1994 Latin America
1993 Emerging Asia
1992 Small Stocks
1991 Latin America
1990 Corporate Bonds
1989 Latin America
1988 Emerging Asia
1987 Emerging Asia
1986 EAFE
1985 Europe
1984 Corporate Bonds
1983 Small Stocks
1982 Government Bonds
1981 Treasury Bills
1980 Small Stocks
0%
20%
40%
60%
80%
42
100%
120%
140%
160%
Does the risk double with two investments?
The key is
having two
investments
which aren’t
correlated.
43
Adding a riskier investment to your portfolio
decreases overall risk.
Adding 10% stock to a T-bill portfolio
8.5%
Reduces
risk!
90% T-Bill, 10% Stock
Return (Average Annual %)
8.0%
Increases
return.
7.5%
100% T-Bill
7.0%
6.5%
6.0%
2.0%
2.2%
2.4%
2.6%
2.8%
3.0%
3.2%
Risk (Standard Deviation)
Data based on 20 years of returns.
44
3.4%
3.6%
3.8%
4.0%
If you allocate the right amount you reduce risk
and increase return!
Adding stock to a T-bill portfolio
21.0%
100% Stock
19.0%
90%
80%
17.0%
70%
60%
15.0%
50%
40%
13.0%
30%
11.0%
20% stock gives more
return with about the
same amount of risk
as 0% stock.
20% Stock
9.0%
10% Stock
7.0%
5.0%
1.5%
0% Stock
3.5%
Data based on 20 years of returns.
5.5%
7.5%
9.5%
45
11.5%
13.5%
15.5%
Pension Fund Portfolio
California Pension
System $230.3 Billion
Direct
Partnership, 6%
Real Estate, 8%
Cash, 1%
International
Equities, 23%
Global Fixed
Income, 23%
Domestic
Equities, 40%
Source: www.calpers.ca.gov Investment Portfolio Market Value as of Dec. 31, 2006
46
“Millionaires” Portfolio
Households with
investable assets
of
$1 million to $10
million
Hedge Funds, 1%
Commodities, 1%
Other, 2%
Private Equity, 5%
Investment real
estate, 7%
45%
Source: Fortune, 3/5/2007
International
equities, 11%
15%
Cash, 13%
47
401K Allocations by Age
Fixed Income
Company stock
Asset allocation for participants in their
20s
Balanced funds
Equity funds
20%
52%
Asset allocation for participants in
their 60s
13%
13%
Equity funds, 37%
Balanced funds, 10%
Source: Investment Company Institute
48
Fixed Income, 38%
Company stock, 13%
Rule # 6: Always watch your
money.
49
Investment Advice
• Take care in choosing your advisor
–
–
–
–
Experienced
Relevant education
Certified by professional body
Check for disciplinary actions (www.dfi.wa.gov)
• Don’t invest in anything you don’t understand
• Watch what your advisor does
50
Use indices to monitor your portfolio
Philadelphia
GoldSilver
Annual Returns of Selected Asset Classes
S&P Midcap
50%
Russell 2000 Small
Cap
40%
S&P 500
30%
EAFE International
Developed
20%
NAREIT Real
Estate
10%
0%
2002
2003
2004
-10%
-20%
-30%
51
2005
2006
Monitor Your Investments
• Rebalance periodically – but if you buy and
sell a lot you will lose money
• Change allocation if you have different cash
flow requirements
• Risk and return - Prune the low return/high
risk investments
• Don’t make whipsaw changes to your asset
allocation
52
The Roadmap
•
•
•
•
•
•
Save
Focus on financial goals
Understand returns
Understand risk
Asset allocation
Monitor your investments
53