JAN_12_FPW_asset_allocation_strategy.ppt

Developing A Personal Asset Allocation Strategy- UTAH STATE UNIVERSITY

1. 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, USU

2. 2
Financial Planning for Women
Second Wednesday of the month
»12:30-1:30 in Family Life 318
– bring your lunch
»7-8:30 at Family Life Center (500 N &
700 E – bottom of Old Main Hill)
»Same program
For email reminder: Sign up sheet or
send email to [email protected]

3. 3
Overview
Asset Allocation Principles
Risk-Return Relationship
Application to Utah Retirement System
(URS) options
Application to TIAA-CREF Retirement
Investment Options
»9 new investment choices (as of 2003)

4. 4
What Is Asset Allocation?
Process of diversifying portfolio
investments among several investment
categories to reduce investment risk
Example: 50% stock, 30% bonds, 20%
cash assets (e.g., Treasury bills)
Objective: lower investment risk by
reducing portfolio volatility
Loss in one investment may be offset by
gains in another

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Determinants of Portfolio Performance
Asset
Allocation
91.5%
Other
2.1%
Market
Timing
1.8%
Security
Selection
4.6%
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 Callan Periodic Table of
Investment Returns
Illustrates the need for asset allocation
Shows how various asset classes
performed during the last 20 years
Best performing asset class changes
(e.g., large company growth stocks:
1995-99 versus 2000)
One year’s “winner” can be next year’s
“loser,” so you invest in them all

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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
If investor stayed fully invested, return
was 41.4%
If investor missed top 10 trading days of
1998, 1999, and 2000: -41.7% return
Based on S&P 500 stock market index
Moral: stay invested in both bull & bear
markets

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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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Why Use Asset Allocation? To Increase
Long Term Investment Results
Scenario #1: $100,000 invested at 8%
over 25 years grows to $684,848
Scenario #2: $100,000 divided equally
among 5 investments (One loses
principal and other 4 earn 0%, 5%, 10%,
and 15% average annual returns).
Diversified portfolio will grow to
$962,800 over the long term

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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
Your age and net worth

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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
Asset allocation attempts to reduce volatility
and provide a competitive rate of return

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Major Asset Classes
Large company growth
stocks
Large company value
stocks
Small company growth
stocks
Small company value
stocks
Mid cap growth stocks
Mid cap value stocks
Foreign stocks
»Developed
»Emerging
Bonds
»Domestic
»International
Real estate (e.g., REITs)
Cash assets (e.g., CDs,
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%
»annual returns -50% to +50%!!
Government Bonds = 5.1%
Treasury Bills = 3.8%
Inflation = 3.1%

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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 markets

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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)
Specific investment selection
Review and rebalance portfolio

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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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More Asset Allocation Tips
Stick to your asset allocation model unless
personal circumstances change
Rebalance when asset percentages
change by a certain amount (e.g., 2%)
»TIAA-CREF will rebalance automatically
(sign up for this feature)
Any one sector no > 10%- 30%
Ignore outdated guidelines (100 - age)

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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 stocks lost value

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Relationship Between Risk and Return
Risk HighLow
Expected
Return
High
Low
Cash
Equivalents
U.S. Bonds
Int’l Bonds
Real Estate
U.S. Stocks
Int’l Stocks
For illustrative purposes only. Not indicative of any specific investment.

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Diversification From Combining
Investments
Investment A
Investment B
Portfolio 1
No Diversification
Investment C
Investment D
Portfolio 2
Complete
Diversification
Investment E
Portfolio 3
Investment F
Some Diversification
For illustrative purposes only. Not indicative of any specific investment

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Recent Example
2000-2003
Thank goodness some of my portfolio
was in bonds & real estate!
»Stocks tanked
»Bonds rallied
»Real estate saved the day

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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 = 3-4%
Risk is relative
»Short term volatility=long term growth
»Invest in stocks for growth

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Understand Risk Tolerance
Beware of taking risk tests and settling
for a conservative portfolio
How long are you likely to live?
Conservative investors risk outliving
their assets

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Stock Capitalization
Large Cap companies: valued at >$5
billion
»ExxonMobil, General Electric, Microsoft
Mid-Cap: $1-5 billion
»Bath & Beyond, Monsanto, Hilton Hotels
Small-Cap: <$1 billion
»Earthlink, FirstFed Financial, Vintage
Petroleum

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Asset Allocation Resources
Periodic Table of Investment Returns
»Callan.com
Ibbotson Knowledge Center: Education
»Asset Allocation slide show
»Ibbotson.com

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Utah Retirement System Funds
Income 5.8%
Bond 8.1%
Balanced (stocks, bonds & cash)
8.9%
Large Cap Stock Value 15.5%
Large Cap Stock Index 10.6%
Large Cap Stock Growth 11.0%
International 8.2%
Small Cap 12.4%
10 year returns as of 9/30/04
Low to high risk/return

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URS Horizon Funds
Fixed asset allocation in one fund
One stop shopping
»IF it suits your needs
Automatic rebalancing quarterly

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Time Horizon for Retirement?
Until the day you retire?
Until the day you die?

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Short Horizon Fund
65% bonds
20% income
10% index
5% international
5 year time frame
»5 years to retirement or
until death?
»Conservative
»Low (but +) return (~6%)
–Subtract inflation of
3.5% = 2.5%

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Medium Horizon Fund
45% bonds
15% international
15% index
10% growth
10% value
5% small cap
5-10 year horizon
More diversified
-6.8% to +20.7%
»1998-2003
5 year avg.= 3.8%
5 years is too short
to judge

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Long Horizon Fund
20% bonds
25% international
25% index
10% growth
10% value
10% small cap
10 or more years
Higher risk =
potential for higher
returns
-13.6% to +27.6%
5 year avg.= 2.4%
You’re in it for the
long run

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TIAA-CREF
TIAA Traditional
TIAA Real Estate
CREF Money Market
CREF Social Choice
CREF Stock
Global Equities
Growth
Equity Index

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9 New Fund Choices
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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Global vs. International
Global: U.S. and foreign
International: at least in theory, all
foreign

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Murky Mixture
Few of the funds are “pure”
CREF Stock
»80% LG, 15% Mid, 5% Small-Cap
»Some foreign stocks
Mid-Cap Growth
»59% LG! 39% Mid, 2% Small-Cap
Read Prospectus (or at least the summary)

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Growth Portfolio
10-15% International
10-15% Small-cap
10-15% Mid-Cap
10-15% Real Estate
10-15% Bonds
STOCKS!

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Adjusting Your Allocation
You can change future allocations
You can transfer current balance among
asset classes
Use web sites
Sign up for automatic rebalancing with
TIAA-CREF

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Great Internet Resources
URS.org
Tiaa-cref.org

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Tips For Funding a Tax-
Deferred Employer Plan
Diversify across asset classes
Avoid market timing
Choose investments with good historical
performance
»>10 year track record

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The Big Picture
Same principles can be applied to
»401(k) plans
»Individual retirement accounts (IRAs)
»Other retirement plans
Past returns are NO guarantee for the
future!!
5-10 year track record is too short!

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Key Considerations For
Successful Investing
Establish policies and objectives
Stick to your plan and stay focused
Educate yourself to make informed decisions
Monitor investment performance

If you need help, seek a professional advisor

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Your “Action” List
Review your current asset allocation
Consider your other retirement accounts
Use the URS/TIAA-CREF web sites
»Risk tolerance quiz
»Asset allocation calculators
Talk with a representative
Reallocate, Rebalance, Re-visit

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Before You Decide
Read the website
Understand the risks
Make careful choices
You can always change your mind so
don’t be afraid to change your asset
allocation.

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URS & TIAA-CREF Reps at USU
URS Cache County Offices, 179 N.
Main, 1
st
floor conference room
»Jan 13, Feb 10, March 10, noon-5
»Tuesday, May 10; seminar 9-4:30
TIAA-CREF
»Sign up with Human Resources

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Questions? Comments?
Experiences?
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Ideas for future programs
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Feb. 9 FPW:
Investing on a Shoestring