Transcript Six Strategic Steps

Six Strategic Steps
Roadmap for Investing Wisely for
a Lifetime
Copyright Leslie Lum
The Roadmap
•
•
•
•
Focus on financial goals
Understand returns
Understand and learn to like risk
Asset allocation NOT investment
selection
• Improve after-tax returns
• Monitor your investments
Copyright Leslie Lum
Finding money to invest
Copyright Leslie Lum
How much does a typical family make?
Copyright Leslie Lum
What happens to your income over your life?
Copyright Leslie Lum
How are we doing at savings?
Net Saving as a Percent of Gross National Income
18
16
14
12
10
8
6
4
2
0
1940
1946
1952
1958
1964
1970
1976
Copyright Leslie Lum
1982
1988
1994
2000
C
ze
ch
Source: World Bank - Genuine Domestic Savings
hi
na
Ita
ly
.
.S
.
.K
U
U
e
Sw
ed
en
Sw
itz
er
la
nd
Si
ng
ap
or
la
nd
s
Ja
pa
n
he
r
et
Copyright Leslie Lum
N
C
ep
ub
lic
D
en
m
ar
k
Fr
an
ce
G
er
m
an
y
Ire
la
nd
R
ra
zi
l
an
ad
a
B
el
gi
um
C
B
% of 1999 GDP
Could we save more?
Domestic Savings
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
One
Two
Four
Five
23,657
43,693
47,406
55,201
52,565
2,831
5,432
6,173
7,472
8,178
Food at home
1,525
3,128
3,664
4,472
5,157
Food away from home
1,306
2,304
2,509
3,000
3,020
280
468
419
436
358
8,768
13,536
15,596
18,322
16,930
837
1,547
1,916
2,503
2,698
Transportation
3,839
8,683
9,562
10,459
10,185
Health care
1,558
3,093
2,532
2,581
2,379
Entertainment \2
1,041
2,421
2,263
2,821
2,554
316
563
603
693
689
93
159
130
135
110
Education
498
597
938
1,426
1,119
Tobacco products and smoking supplies
193
310
351
329
364
Miscellaneous
423
650
658
801
661
Cash contributions
1,032
1,810
1,179
1,270
1,385
Personal insurance and pensions
1,948
4,424
5,087
5,952
4,956
1,592
3,701
2,332
2,838
1,444
Average annual expenditures
Food
Alcoholic beverages
Housing
Apparel and services
Personal care products and services
Reading
Personal taxes \1
Copyright Leslie Lum
Three
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?
Copyright Leslie Lum
The time value of money or
making your money work for you.
Copyright Leslie Lum
Making your money work for you.
What would you have if you did the
following with $100 in 1996?
• Bought a round of beer (or a good meal)
• Put it in the bank for 5% interest per
year
• Bought a stock index fund
Copyright Leslie Lum
Let’s use compounding another way—to
find the (future) cost of a purchase
decision
• 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
Copyright Leslie Lum
(Future) costing
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?
Copyright Leslie Lum
Setting Goals
Copyright Leslie Lum
Lay out your goals
• Down payment on house (The more you put down the
less risk to default and less monthly payments)
• Wedding (yours or your kids)
• Car (Budget or goal?)
• College tuition (you/your kids/your grandkids)
(http://cgi.money.cnn.com/tools/collegecost/collegecost.html)
• Starting your own business
• Retirement (Rule of thumb – annual income divided by
4%)
(http://sites.stockpoint.com/aarp_rc/wm/Retirement/Retirement.asp?act=L
OGIN)
• Estate (Inheritance or charity)
Copyright Leslie Lum
How do you save for big goals?
• $40,000 down payment on a house in
10 years
• $50,000 college tuition for your kid in 15
years
• $800,000 for retirement in 30 years
• Just a minute---is it possible to save for
big goals?
Copyright Leslie Lum
For big goals save every year
(8% return)
• $40,000 down payment on house in 10
years ($2761 every year)
• $50,000 college tuition in 15 years
($1841 every year)
• $800,000 retirement in 30 years ($7062
every year)
Copyright Leslie Lum
Which is more?
• Saving $4000 a year
from 25 to 45 years
old and then no
more savings
• 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
Copyright Leslie Lum
45 to 65
years
You’re 25 and plan to retire in 40
years. How much do you save every
year to have a $1 M nest egg.
• If you start at age 45.
• If you start at age 35.
• If you start now.
Copyright Leslie Lum
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?
Copyright Leslie Lum
That’s not the only uncertainty
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%
Copyright Leslie Lum
$800,000
retirement
goal in 30
years
At 8% returns?
At 10%
returns?
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).
Copyright Leslie Lum
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.
Copyright Leslie Lum
Understanding returns
Copyright Leslie Lum
Returns
Always calculate returns on an annualized
basis
Copyright Leslie Lum
Calculate the return
• You will get your paycheck next week
but you need $100 now. You arrange for
a payday loan paying a fee of $15 for
the use of $100. The payday loan
company will collect the $100
electronically from your bank account
when your pay check is deposited next
week. What is the rate charged?
Copyright Leslie Lum
Historical returns of major asset classes
How Stocks Have Performed
40%
Average annual
returns over the
past 30 years:
30%
Cash 7%
20%
Bonds 9%
10%
Stocks 15%
Annual Total Returns 1971-2000
50%
-10%
T-Bill Total Return
Government Bonds Total Return
-20%
Stocks Total Return
-30%
Source: Global Financial Data
www.globalfindata.com
Copyright Leslie Lum
2000
1998
1999
1997
1996
1994
1995
1993
1992
1990
1991
1989
1988
1986
1987
1985
1984
1982
1983
1981
1980
1978
1979
1977
1976
1974
1975
1973
1972
1971
0%
Conclusion: If
you need higher
returns to reach
financial goals,
you have to
invest in stocks.
Investment Risk
Copyright Leslie Lum
Major asset classes: Risk & Return
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
Copyright Leslie Lum
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%
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
Copyright Leslie Lum
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%
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%
Copyright Leslie Lum
Source: Global Financial Data
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%
The more return you need, the more risk you take.
The more risk you take, the more return you need.
If you receive
an offer of a
guaranteed
high return, is
that possible?
Major Asset Classes (1971-2000)
18%
16%
Stocks
Average Annual Return 14.5%
Standard Deviation 16.5%
14%
Return
Only if they
guarantee a
high loss as
well.
12%
(Annual Return)
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%
10%
12%
14%
Risk
(Standard Deviation)
Copyright Leslie Lum
16%
There are no
guarantees in
any investment.
All investments
go up and
down. Higher
return means
higher risk.
Given the same return, the
investment with less risk is better
Copyright Leslie Lum
The Northwest is the best.
Copyright Leslie Lum
Bonds – Risk Return
Copyright Leslie Lum
US Stocks – Risk Return
Copyright Leslie Lum
Sectors – Risk Return
Copyright Leslie Lum
International – Risk Return
Copyright Leslie Lum
Combined – Risk Return
Copyright Leslie Lum
Inflation is also risk
Copyright Leslie Lum
Which is the best return?
Year
1980
1996
1974
Nominal Return
14%
6%
10%
Copyright Leslie Lum
After inflation, the 6% return is
the best!!
Year
1980
1996
1974
Nominal Return
14%
6%
10%
Inflation Rate
12.5%
3.3%
12.3%
Copyright Leslie Lum
Real Return
1.3%
2.6%
-2%
Asset Allocation
Copyright Leslie Lum
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%
Copyright Leslie Lum
20%
40%
60%
80%
100%
120%
140%
160%
Does the risk double with two investments?
The key is
having two
investments
which aren’t
correlated.
Copyright Leslie Lum
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.
Copyright Leslie Lum
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% Leslie 9.5%
Copyright
Lum
11.5%
13.5%
15.5%
Some investors think of risk as the maximum
loss they are willing to take. What does asset
allocation do for that?
Year-End Close Price
Ford
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
J&J
7.44
15.08
7.86
24.49
11.98
21.99
18.03
20.02
15.58
25.03
16.14
39.83
18.03
47.05
27.15
63.18
32.82
81.49
29.82
91.65
23.19
104.71
Average annual return
Standard deviation
Annual Gain
Ford
6%
52%
51%
-14%
4%
12%
51%
21%
-9%
-22%
15%
26%
Copyright Leslie Lum
J&J
62%
-10%
-9%
25%
59%
18%
34%
29%
12%
14%
24%
23%
You can reduce your maximum loss by
diversifying.
Year-End Close Price
Ford Year
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Annual Gain
J&J Year
Ford
7.44
15.08
7.86
24.49
11.98
21.99
18.03
20.02
15.58
25.03
16.14
39.83
18.03
47.05
27.15
63.18
32.82
81.49
29.82
91.65
23.19
104.71
Average annual return
Standard deviation
6%
52%
51%
-14%
4%
12%
51%
21%
-9%
-22%
15%
26%
Asset Allocation
20% Ford , 80% J&J
J&J
62%
(20% x 6%) + (80% x 62%) = 51%
-10% (20% x 52%) + (80% x –10%) = 2%
-9%
(20% x 51%) + (80% x –9%) = 3%
25% (20% x -14%) + (80% x 25%) = 17%
59%
(20% x 4%) + (80% x 59%) = 48%
18% (20% x 12%) + (80% x 18%) = 17%
34% (20% x 51%) + (80% x 34%) = 37%
29% (20% x 21%) + (80% x 29%) = 27%
12%
(20% x -9%) + (80% x 12%) =8%
14% (20% x -22%) + (80% x 14%) = 7%
24%
22%
23%
17%
Copyright Leslie Lum
How “smart money” asset allocates
• Calpers is the California pension system
which manages $216 B. Check out their
current and target asset allocation
(available on their Web site
www.calpers.ca.gov under Quick Facts).
What differences do you see? What
does their target allocation suggest?
Copyright Leslie Lum
Maximize After-Tax Returns
Copyright Leslie Lum
Retirement
Traditional IRAs - $4000
per year (Catch-up for
those over 50 years)
Tax deferred. Depending
on income, may be able to
contribute pre-tax
Taxes are paid at ordinary
income rate when money
is withdrawn.
Roth IRA - $4000 per
year (Catch-up for those
over 50 years)
No taxes when withdrawn.
Contributions are after-tax.
Limited to those under
AGI of $90,000 (single)
and $150,000 (couple)
401K
Employer may match at
typically 50 cents for every
dollar. Tax deferred.
Contribute with pretax
dollars. Tax credits for lowincome ($25,000 single,
$50,000 couple).
Taxed at ordinary income
when money is withdrawn.
Copyright Leslie Lum
Education
529
Up to total of about
$300,000 for some
plans.
Must be used for
tuition, fees, room,
board, and graduate
school.
Coverdell
Contribute up to
$2,000 a year.
Post-secondary
costs; K-12 costs,
some computers.
Income limits.
Savings Bonds
Interest earned is
tax-free if used for
qualified highereducation purposes.
Tuition and
mandatory fees.
Income limits.
Copyright Leslie Lum
Monitor
Copyright Leslie Lum
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
• Compare your performance to the indexes.
• Don’t make whipsaw changes to your asset
allocation
Copyright Leslie Lum