Transcript Asset Allocation - Keffer Financial Planning

Asset Allocation
The 91.5% Solution
Presented by
William H. Keffer
Certified Financial Planner™
Goals for Today
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Your comfort with basics of asset types
Your motivation to ‘control the controllable’
Action in your self interest
April 16, 2009
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Speaker Notes
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Bill Keffer
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Hourly, as-needed financial planner
Wheaton-based, sole proprietor
26-years AIG American General
Credentials
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Certified Financial Planner®
Registered investment advisor
MBA in finance
Contributor: Investing in an Uncertain Economy for Dummies
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Introduction
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Today’s focus: Asset allocation
Prerequisites:
Goals have been carefully quantified
 Adequate savings are systematized
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Most time on why & how to allocate
Briefly:
Distribution planning
 Where & how to invest
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Definition of Asset Allocation
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How you divide your money among the
different classes of investment assets, such as
stocks, bonds, and cash
Critical: Finding the right mix for your risk
tolerance, time horizon, and required returns
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Preface
IMPORTANCE OF ASSET ALLOCATION
100%
91.5%
80%
60%
40%
20%
2%
4.6%
2.1%
0%
Drivers of Returns
Market Timing
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Stock Selection
Other
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Asset Allocation
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How Asset Allocation Works
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Basic concept: Impossible to predict which type
of asset will do best year-to-year
Goal: A mix formulated for unique risk profile
and required return
How: Different asset classes’ returns noncorrelated reducing overall risk
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Asset Allocation at Work
0% Stocks
100% Bonds
100% Stocks
0% Bonds
50% Stocks
50% Bonds
5-Year Return
3.8%
8.6%
6.3%
10-Year Return
5.4%
3.5%
4.8%
Risk
2.9%
10.4%
5.0%
% Increase
Return/Risk
(over 100%
bonds)
N/A
Ret: 126%
Risk: 259%
Ret: 66%
Risk: 72%
Portfolio
Allocation
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Which Would You Choose?
(based on annual returns shown)
Year
1
2
3
4
5
Arithmetic
Average
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A
B
C
D
10%
50%
30%
-30%
10%
10%
30%
50%
10%
-20%
30%
-10%
10%
20%
-20%
50%
10%
-10%
-20%
-10%
10%
10%
10%
10%
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Which Would You Choose?
(based on annual returns shown)
Year
A
B
C
D
1
10%
50%
30%
-30%
2
10%
10%
30%
50%
3
10%
-20%
30%
-10%
4
10%
20%
-20%
50%
5
10%
-10%
-20%
-10%
10%
10%
10%
10%
Value of $1,000
After 5 Years
$1,810
$1,425
$1,406
$1,275
Geometric
Average
10.0%
7.4%
7.1%
5.0%
Arithmetic
Average
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Rise of Index Funds
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Importance of asset allocation, as opposed to
stock selection, helps explain rise of index
funds.
With no active stock selection going on,
expenses decrease
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Examples of Asset Classes
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The Two Major Asset Classes
Stocks: A share of ownership, grows through
share of profits (dividends) and appreciation in
market value
Bonds: A loan to a firm or government in return
for fixed interest payments and promise to
return principal
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Asset Class Sub-Categories
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Stocks
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By size of company
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Bonds
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Large cap
Small cap
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Value
Growth
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Domestic U.S.
Developed international
Emerging markets
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Short
Intermediate
Long
By riskiness of issuer
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By location
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By length of term
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By style
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Government
Investment grade
“Junk”
By frequency of
payments
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Other Common Asset Types
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Cash (money markets, CDs, savings)
Real estate (REITs)
Commodities
Currencies
 Precious metals
 Natural resources
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Risk and Return
Where Asset Classes Rank
Asset Class
Return
Risk
Cash Equivalent
5.95%
2.82%
Short Term Bonds
7.43%
4.09%
Intermediate Term Bonds
8.20%
6.49%
Long Term Bonds
8.94%
10.36%
Large Cap Value Stocks
10.65%
15.01%
Large Cap Growth Stocks
10.17%
17.66%
Mid Cap Stocks
12.05%
16.03%
Small Cap Stocks
13.41%
22.26%
International Developed Stocks
11.56%
21.35%
International Emerging Stocks
11.42%
27.72%
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Sample Portfolios*
Av
era
Re ge
tur
n
Sta
De ndard
via
tion
C
Eq ash
uiv
a
Sh lent
o
Te rt
Bo rm
nds
Inte
ate rmed
Bo i
nds
L
Ca arge
pV
Lar alue
g
Ca e
Gro p
wth
Sm
all
De Cap
vel
ope
Inte d
rna
ti
Emnal o
e
Ma rging
rke
ts
(+historical returns & risk)
Portfolio
Name
Conservativ
e (38%
Stocks)
9.01% 6.93%
Moderate
(61%
Stocks)
9.92% 10.04%
Aggressive
(82%
Stocks)
10.76% 13.20%
8%
24%
30%
10%
10%
5%
13%
0%
4%
15%
20%
17%
14%
9%
18%
3%
2%
6%
10%
23%
20%
15%
20%
4%
*Model portfolios created by Harold Evensky, CFA, for Money Guide Pro financial planning software, a product of PIE Technologies.
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Determining Your Allocation:
3 Factors
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Risk Tolerance
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Risk Capacity
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Willingness to take risk
Ability to take risk
Required Return
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Need to take risk
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Risk Tolerance: Willingness to Take Risk
Questionnaire & Scoring System
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An Example: Client’s Answers &
Target Portfolio
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Questionnaire
Answers*
1.
2.
3.
4.
5.
6.
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Preserving capitalGrowthLow volatilityInflation protectionCurrent cash flowHow much risk?-
6
6
4
5
4
5
Indicated Portfolio
Allocation
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Stocks:
Bonds:
Cash:
61%
35%
4%
*Scale: 1 to 9, with 1=Not Important and 9=Very Important
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Risk Tolerance: Willingness to Take Risk
Stomach Acid Test*
Maximum Tolerable Loss (%)
5%
Maximum Stock Exposure
20%
10%
30%
15%
40%
20%
50%
25%
60%
30%
70%
35%
80%
40%
90%
50%
100%
*Larry Swedroe, The Only Guide to a Winning Investment Strategy You’ll Ever Need, St. Martin’s Press, New York, NY, 2005
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Risk Capacity: Ability to Take Risk
The Liquidity Test*
Years Until Money Will
Be Needed
Maximum Stock Exposure
0-3
0%
4
10%
5
20%
6
30%
7
40%
8
50%
9
60%
10
70%
11-14
80%
15-19
90%
20+
100%
*Larry Swedroe, The Only Guide to a Winning Investment Strategy You’ll Ever Need, St. Martin’s Press, New York, NY, 2005
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Required Return: Need to Take Risk
Years Until
Money
Needed
5
10
15
20
25
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Current
Balance
$ 115,000
$ 68,000
$ 43,000
$ 25,000
$ 12,000
Amount
Needed
$ 150,000
$ 157,500
$ 165,375
$ 173,644
$ 182,326
Required
Return
5.5%
8.8%
9.4%
10.2%
11.5%
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Minimum
Stock
Exposure
0%
38%
55%
72%
100%
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How to Decide When Risk
Indicators Are Mixed?
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When risk tolerance, capacity and need indicate
different levels of stock/risk:
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Objectively re-examine tolerance
Review answers to questions
 Recall what you’ve done in past bear markets
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Choose level you know you can stick with
 Save more
 Lower or delay the goal
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Sources of Help
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Online tools
Investment books & journals
Financial planner
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As Retirement Approaches…
Distribution Planning Process
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Step 1: Determine retirement needs
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Step 2: Project the results
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Variables: sources of retirement income, the portfolio, expected returns,
and life expectancy
Step 3: Test different options
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Variables: after-tax living expenses, vehicles, travel, large gifts, etc.
Options: lower goals, delay goals, find new sources of income, alter the
portfolio allocation, opt for a lump sum rather than a pension, use of
different tools, such as immediate annuities
Step 4: Implement the best strategy
Step 5: Monitor spending & returns carefully
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Where to Invest
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Accounts
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Basic emergency fund in savings
Fundamental risk management (insurance)
Pre-tax retirement plans to extent of match
Roth IRA, if qualified
Additional employer plan contributions to max
Taxable investment account
Investment Vehicles
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Mutual funds for most
In taxable accounts
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Exchange traded funds (if amounts justify)
Municipal bonds (based on after-tax yield)
Generally, minimize holdings of individual securities
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How to Choose Among Investment
Options
Fits allocation need
 Broadly diversified
 Low expense ratio
 Low turnover
 No-load
 Large, established investment company
 Keep it simple!
Target allocation / lifestyle funds excellent (in most cases)
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Summary
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1. Know your goals
2. Put enough $ in: top priority!
3. Allocate appropriately (91.5% solution)
4. Diversify with broad-based funds
5. Maintain discipline in rough times
6. Be mindful of costs
7. Get help if you need it
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Questions?
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