Transcript Developing A Personal Asset Allocation Strategy

Developing Your Asset Allocation
Strategy for Retirement
Developed by Barbara O’Neill, Ph.D., CFP,
Rutgers Cooperative Extension
Adapted by Jean Lown, Ph.D.
Family, Consumer & Human Development
[email protected]
Overview
 Asset Allocation
Principles
 Risk-Return Relationship
 Application to TIAA-CREF
Retirement Investment Options
» 9 new investment choices (as of
2003)
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What Is Asset Allocation?

Process of diversifying portfolio
investments among several investment
categories to reduce investment risk

Example: 50% stock, 30% bonds, 10%
real estate, 10% cash assets

Objective: lower investment risk by
reducing portfolio volatility

Loss in one investment may be offset by
gains in another
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The Callan Periodic Table of
Investment Returns

http://www.callan.com/resource/periodic_
table/pertbl.pdf

Illustrates the need for asset allocation

Shows how various asset classes
performed during the last 20 years

Best performing asset class changes

One year’s “winner” can be next year’s
“loser,” so invest in a variety of assets
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Why Asset Allocation?
Because Market Timing is Futile


Value of $100 invested in large company
stocks (S&P 500 index) from June 1980 to
June 2000:
»
$2,456 stayed invested entire time
»
$613 if you missed the best 15 months
Biggest market gains are often concentrated
in short periods (can’t afford to miss)
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Second Example: The Futility
of Market Timing

Based on S&P 500 stock market index

If investor stayed fully invested, return
was 41.4%

If investor missed top 10 trading days of
1998, 1999, and 2000: -41.7% return

Moral: stay invested in both bull & bear
markets
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Determinants of Portfolio Performance
Security
Selection
4.6%
Market
Timing
1.8%
Other
2.1%
Asset
Allocation
91.5%
Source: “Determinants of Portfolio Performance II, An Update” by Gary Brinston, Brian D. Singer and Gilbert L.
Beebower, Financial Analysts Journal May-June 1991
For illustrative purposes only. Not indicative of any specific investment.
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The Importance of Asset
Allocation
Asset allocation is the MOST important
decision an investor makes (i.e., buying
some stock, NOT Coke versus Pepsi)
 Asset allocation determines about 90%
of the return variation between portfolios
 This study has been repeated numerous
times, by different researchers, with
similar results.

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Downside of Asset Allocation

A diversified portfolio MAY generate a
lower rate of return when compared to a
single “hot” asset class (e.g., growth
stocks from 1995-99) BUT

You never know the “hot” asset class in
advance (i.e., Callan table)

Asset allocation reduces volatility to
provide a competitive rate of return
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Factors To Consider

Investment objective (e.g., retirement)

Time horizon for a goal (e.g., life
expectancy for retirement)

Amount of money you have to invest

Your risk tolerance and experience
»

Caution about risk tests
Your age and net worth
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Major Asset Classes

Stocks
» Large company
growth & value
» Mid cap growth &
value
» Small growth & value
» International



Bonds
» Domestic
» International
» Corporate
» Municipal
Real estate (e.g., REITs)
Cash (CDs, I-bonds,
MMMFs, Treasury bills)
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Historical Average Annual
Rates of Return
Small Co. U.S. stocks = 12.6%
 Large Co. U.S. stocks = 10.4%
 Government Bonds = 5.1%
 Treasury Bills = 3.8%
 Inflation = 3.1%

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Stock Capitalization

Large Cap companies: valued at >$5
billion
»

Mid-Cap: $1-5 billion
»

ExxonMobil, General Electric, Microsoft
Bath & Beyond, Monsanto, Hilton Hotels
Small-Cap: <$1 billion
»
Earthlink, FirstFed Financial, Vintage
Petroleum
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Why Invest Internationally?
Correlations among world markets are
low (e.g., U.S. and foreign stocks)
 World markets (especially small
companies) are driven by local
dynamics
 Investing in U.S. multinationals does not
deliver the same level of diversification
 The benefits of diversification outweigh
currency, market, & political risks
 U.S. accounts for less than 1/3 of the
world’s equity (stock) markets
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
Other Things to Know About
Asset Allocation
Portfolio risk decreases as the # of
asset classes increases
 Best results are achieved over time
 Diversify holdings within each asset
category
» Stock: different industry sectors
» Bonds: different types and maturities

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RISK


Is a 4 letter word
Remember 20002003?
» S&P 500 lost 40%
of its value
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Risk-Return Relationship
Low risk = low return
 High risk = possibility of high return
 Risk: chance of loss of principal in the
short run
» 2000-2003 most U.S. stocks lost
value (after incredible run-up in prices
in 1990s)

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Relationship Between Risk and Return
High
Int’l Stocks
U.S. Stocks
Real Estate
Expected
Return
Int’l Bonds
U.S. Bonds
Cash
Equivalents
Low
Low
Risk
High
For illustrative purposes only. Not indicative of any specific investment.
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Diversification From Combining
Investments
No Diversification
Complete
Diversification
Portfolio
Investment A1
Investment
C
Portfolio
2
Investment
D
Investment B
Some Diversification
Portfolio 3
Investment E
Investment F
For illustrative purposes only. Not indicative of any specific investment
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Stocks are Risky in Short Run
Very volatile in sort run (1-5 years)
» annual returns -50% to +50%!!
» Remember 2000-2003?
» 2003 was a great year to buy stocks
when all news was gloom & doom
 Large Co. U.S. stocks = 10.7% (avg.
returns since 1926)

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Time Horizon for Retirement?
Until the day you retire?
 Until the day you die?

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Invest for Growth
There is no such thing as a risk-free
investment!
 Retirement $ must grow faster than
inflation to provide financial security
» Average inflation = 3.1%
 Risk is relative
» Short term volatility=long term growth
» Invest in stocks for growth

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Recent Example
2000-2003 was a gut check
 Thank goodness some of my portfolio
was in bonds & real estate!
» Stocks tanked
» Bonds held steady
» Real estate saved the day

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“Safe” Investments are Risky in
the Long Run
Inflation = 3.1%
 Government Bonds = 5.1% -3.1% = 2%
 Treasury Bills = 3.8% - 3.1% = 0.7%
 Subtract the impact of taxes and ‘safe’
investments yield negative returns
 You will not reach your goal with low risk
investments

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Understand Risk Tolerance
Beware of taking risk tests and settling
for a conservative portfolio
 Conservative investors risk outliving
their assets
 Life expectancy calculators
» http://www.ces.purdue.edu/retirement/
Module1/module1b.html

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The Asset Allocation Process

Define goals and time horizon

Assess your risk tolerance

Identify asset mix of current portfolio

Create target portfolio (asset model)

Select specific investments

Review and rebalance portfolio yearly
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Tips For Funding a TaxDeferred Employer Plan

Diversify across asset classes

Avoid market timing

Choose investments with good historical
performance

»
Past returns are NO guarantee for the
future!!
»
<10 year track record is too short!
Choose funds with low fees
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The Big Picture

Same principles can be applied to
» 401(k) plans
» Individual retirement accounts (IRAs)
» Other retirement plans
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Questions?
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5 TIAA-CREF Asset Classes
Guaranteed (low risk; low return)
 Fixed-Income (bonds)
 Equities (stocks)
» High return; volatile in the short run
 Real Estate
» Inflation protection; reduce volatility
 Money Market (safe but very low return)

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Global vs. International
Global: U.S. and foreign investments
 International: “all” foreign

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TIAA-CREF Options (pre-2003)
TIAA Traditional
 TIAA Real Estate
 CREF Money
Market
 CREF Social
Choice (bond &
stock)

CREF Stock
 Global Equities
 Growth
 Equity Index
» LOTS of overlap!

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9 New Fund Choices (2003)





Real Estate
Securities
Growth & Income
S&P 500 Index
Large Cap Value
Social Choice
Equity




Mid-Cap Value
Mid-Cap Growth
Small-Cap Equity
International
Equity
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Murky Mixture
Few of the CREF funds are “pure”
 CREF Stock
» 80% Large-, 15% Mid-, 5% Small-Cap
» Some foreign stocks
 Mid-Cap Growth
» 59% Large-! 39% Mid-, 2% Small-Cap
 Read Prospectus (or at least the summary)

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Growth Portfolio: 3 asset classes
STOCKS for growth
» Large-cap Domestic
» 10-15% Mid-Cap
» 10-15% Small-cap
» 10-15% International
 10-15% Real Estate (to beat inflation)
 10-15% Bonds (to dampen volatility)

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New Funds Offer Diversity
Lots of different stock accounts DO NOT
mean diversification (overlapping)
 International Equity
 Small-cap Equity
 Real Estate Securities (to complement
TIAA Real Estate)

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Your “Action” List
Review your current asset allocation
 Consider your other retirement accounts
 Use the TIAA-CREF web site
 Understand risk-return relationship
 Talk with a TIAA-CREF rep (at USU)
 Sign up for automatic rebalancing
» Limits on moving $ out of TIAA
 Re-visit, Reallocate, Rebalance

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Key Considerations For
Successful Investing

Educate yourself to make informed decisions

Establish policies and objectives

Monitor investment performance

Stick to your plan and stay focused

If you need help, seek professional advice
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Financial Planning for Women


Second Wednesday of the month
» 12:30-1:30 in Family Life 318
– bring your lunch
» 7-8:30 p.m. at Family Life Center (500 N &
700 E – bottom of Old Main Hill)
» February 8 FPW: Investment Basics
For mo. email news & reminder: Sign up
sheet or send email to [email protected]
40
Questions? Comments?
Experiences?
February 8 FPW:
Investment Basics
Baby Boomer Women Retirement Study
USU IRB approved research
Step 1: Survey- return by Feb 3 for prize drawing
Step 2: Focus Group ($25 compensation)
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