asset allocation the 91.5% solution presented by william h. keffer certified financial planner™
TRANSCRIPT
Asset AllocationAsset Allocation The 91.5% SolutionThe 91.5% Solution
Presented byPresented by
William H. KefferWilliam H. Keffer
Certified Financial Planner™Certified Financial Planner™
April 16, 2009 2www.KefferFinancialPlanning.com
Goals for TodayGoals for Today
Your comfort with basics of asset Your comfort with basics of asset typestypes
Your motivation to ‘control the Your motivation to ‘control the controllable’controllable’
Action in your self interestAction in your self interest
April 16, 2009 3www.KefferFinancialPlanning.com
Speaker NotesSpeaker Notes
Bill KefferBill Keffer Hourly, as-needed financial plannerHourly, as-needed financial planner Wheaton-based, sole proprietorWheaton-based, sole proprietor 26-years AIG American General26-years AIG American General
CredentialsCredentials Certified Financial Planner®Certified Financial Planner® Registered investment advisorRegistered investment advisor MBA in financeMBA in finance Contributor: Contributor: Investing in an Uncertain Investing in an Uncertain
Economy for DummiesEconomy for Dummies
April 16, 2009 4www.KefferFinancialPlanning.com
IntroductionIntroduction
Today’s focus: Asset allocationToday’s focus: Asset allocation Prerequisites:Prerequisites:
Goals have been carefully quantifiedGoals have been carefully quantified Adequate savings are systematizedAdequate savings are systematized
Most time on why & how to allocateMost time on why & how to allocate Briefly:Briefly:
Distribution planningDistribution planning Where & how to investWhere & how to invest
April 16, 2009 5www.KefferFinancialPlanning.com
Definition of Asset Definition of Asset AllocationAllocation
How you divide your money among How you divide your money among the different classes of investment the different classes of investment assets, such as stocks, bonds, and assets, such as stocks, bonds, and cashcash
Critical: Finding the right mix for Critical: Finding the right mix for your risk tolerance, time horizon, your risk tolerance, time horizon, and required returnsand required returns
April 16, 2009 6www.KefferFinancialPlanning.com
PrefacePrefaceIMPORTANCE OF ASSET IMPORTANCE OF ASSET
ALLOCATIONALLOCATION
2% 4.6% 2.1%
91.5%
0%
20%
40%
60%
80%
100%
Drivers of Returns
Market Timing Stock Selection Other Asset Allocation
April 16, 2009 7www.KefferFinancialPlanning.com
How Asset Allocation How Asset Allocation WorksWorks
Basic concept: Impossible to predict Basic concept: Impossible to predict which type of asset will do best year-which type of asset will do best year-to-yearto-year
Goal: A mix formulated for unique Goal: A mix formulated for unique risk profile and required returnrisk profile and required return
How: Different asset classes’ returns How: Different asset classes’ returns non-correlated reducing overall risknon-correlated reducing overall risk
April 16, 2009 8www.KefferFinancialPlanning.com
Asset Allocation at WorkAsset Allocation at WorkPortfolio Portfolio AllocationAllocation
0% Stocks0% Stocks
100% Bonds100% Bonds100% Stocks100% Stocks
0% Bonds0% Bonds50% Stocks50% Stocks
50% Bonds50% Bonds
5-Year 5-Year ReturnReturn 3.8%3.8% 8.6%8.6% 6.3%6.3%
10-Year 10-Year ReturnReturn 5.4%5.4% 3.5%3.5% 4.8%4.8%
RiskRisk 2.9%2.9% 10.4%10.4% 5.0%5.0%
% Increase % Increase Return/Risk Return/Risk (over 100% (over 100% bonds)bonds)
N/AN/ARet: 126%Ret: 126%
Risk: 259%Risk: 259%Ret: 66%Ret: 66%
Risk: 72%Risk: 72%
April 16, 2009 9www.KefferFinancialPlanning.com
Which Would You Choose?Which Would You Choose?(based on annual returns shown)(based on annual returns shown)
YearYear AA BB CC DD
1110%10% 50%50% 30%30% -30%-30%
2210%10% 10%10% 30%30% 50%50%
3310%10% -20%-20% 30%30% -10%-10%
4410%10% 20%20% -20%-20% 50%50%
5510%10% -10%-10% -20%-20% -10%-10%
Arithmetic Arithmetic AverageAverage 10%10% 10%10% 10%10% 10%10%
April 16, 2009 10www.KefferFinancialPlanning.com
Which Would You Choose?Which Would You Choose?(based on annual returns shown)(based on annual returns shown)
YearYear AA BB CC DD
11 10%10% 50%50% 30%30% -30%-30%
22 10%10% 10%10% 30%30% 50%50%
33 10%10% -20%-20% 30%30% -10%-10%
44 10%10% 20%20% -20%-20% 50%50%
55 10%10% -10%-10% -20%-20% -10%-10%Arithmetic Arithmetic AverageAverage 10%10% 10%10% 10%10% 10%10%Value of Value of $1,000 After $1,000 After 5 Years5 Years $1,810$1,810 $1,425$1,425 $1,406$1,406 $1,275$1,275Geometric Geometric AverageAverage 10.0%10.0% 7.4%7.4% 7.1%7.1% 5.0%5.0%
April 16, 2009 11www.KefferFinancialPlanning.com
Rise of Index FundsRise of Index Funds
Importance of asset allocation, as Importance of asset allocation, as opposed to stock selection, helps opposed to stock selection, helps explain rise of index funds.explain rise of index funds.
With no active stock selection going With no active stock selection going on, expenses decreaseon, expenses decrease
April 16, 2009 12www.KefferFinancialPlanning.com
Examples of Asset Examples of Asset ClassesClasses
The Two Major Asset ClassesThe Two Major Asset Classes StocksStocks: A share of ownership, grows : A share of ownership, grows
through share of profits (dividends) through share of profits (dividends) and appreciation in market valueand appreciation in market value
BondsBonds: A loan to a firm or : A loan to a firm or government in return for fixed government in return for fixed interest payments and promise to interest payments and promise to return principalreturn principal
April 16, 2009 13www.KefferFinancialPlanning.com
Asset Class Sub-Asset Class Sub-CategoriesCategories
StocksStocks By size of companyBy size of company
Large capLarge cap Small capSmall cap
By styleBy style ValueValue GrowthGrowth
By locationBy location Domestic U.S.Domestic U.S. Developed Developed
internationalinternational Emerging marketsEmerging markets
BondsBonds By length of termBy length of term
ShortShort IntermediateIntermediate LongLong
By riskiness of By riskiness of issuerissuer
GovernmentGovernment Investment gradeInvestment grade ““Junk”Junk”
By frequency of By frequency of paymentspayments
April 16, 2009 14www.KefferFinancialPlanning.com
Other Common Asset Other Common Asset TypesTypes
Cash (money markets, CDs, savings)Cash (money markets, CDs, savings) Real estate (REITs)Real estate (REITs) CommoditiesCommodities
CurrenciesCurrencies Precious metalsPrecious metals Natural resourcesNatural resources
April 16, 2009 15www.KefferFinancialPlanning.com
Risk and ReturnRisk and ReturnWhere Asset Classes RankWhere Asset Classes Rank
Asset ClassAsset Class Return Return RiskRisk
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%
April 16, 2009 16www.KefferFinancialPlanning.com
Sample Portfolios*Sample Portfolios* (+historical returns & risk)(+historical returns & risk)
*Model portfolios created by Harold Evensky, CFA, for Money Guide Pro financial planning software, a product of PIE Technologies.
Portfolio Name
Conservative (38% Stocks) 9.01% 6.93% 8% 24% 30% 10% 10% 5% 13% 0%Moderate (61% Stocks) 9.92% 10.04% 4% 15% 20% 17% 14% 9% 18% 3%Aggressive (82% Stocks) 10.76% 13.20% 2% 6% 10% 23% 20% 15% 20% 4%
April 16, 2009 17www.KefferFinancialPlanning.com
Determining Determining YourYour Allocation:Allocation:3 Factors3 Factors
Risk ToleranceRisk Tolerance Willingness to take riskWillingness to take risk
Risk CapacityRisk Capacity Ability to take riskAbility to take risk
Required ReturnRequired Return Need to take riskNeed to take risk
April 16, 2009 18www.KefferFinancialPlanning.com
Risk Tolerance: Willingness to Take RiskRisk Tolerance: Willingness to Take RiskQuestionnaire & Scoring SystemQuestionnaire & Scoring System
April 16, 2009 19www.KefferFinancialPlanning.com
An Example: Client’s An Example: Client’s Answers & Target PortfolioAnswers & Target Portfolio
Questionnaire Questionnaire Answers*Answers*
1.1. Preserving capital-Preserving capital- 66
2.2. Growth-Growth- 66
3.3. Low volatility-Low volatility- 44
4.4. Inflation protection-Inflation protection- 55
5.5. Current cash flow-Current cash flow- 44
6.6. How much risk?-How much risk?- 55
Indicated Portfolio Indicated Portfolio AllocationAllocation Stocks:Stocks:
61%61% Bonds:Bonds:
35%35% Cash:Cash: 4% 4%
*Scale: 1 to 9, with 1=Not Important and 9=Very Important
April 16, 2009 20www.KefferFinancialPlanning.com
Risk Tolerance: Risk Tolerance: WillingnessWillingness to Take to Take RiskRisk
Stomach Acid Test*Stomach Acid Test*Maximum Tolerable Loss (%)Maximum Tolerable Loss (%) Maximum Stock ExposureMaximum Stock Exposure
5%5% 20%20%
10%10% 30%30%
15%15% 40%40%
20%20% 50%50%
25%25% 60%60%
30%30% 70%70%
35%35% 80%80%
40%40% 90%90%
50%50% 100%100%
*Larry Swedroe, The Only Guide to a Winning Investment Strategy You’ll Ever Need, St. Martin’s Press, New York, NY, 2005
April 16, 2009 21www.KefferFinancialPlanning.com
Risk Capacity: Risk Capacity: AbilityAbility to Take Risk to Take RiskThe Liquidity Test*The Liquidity Test*
Years Until Money Years Until Money Will Be NeededWill Be Needed
Maximum Stock Maximum Stock ExposureExposure
0-30-3 0%0%
44 10%10%
55 20%20%
66 30%30%
77 40%40%
88 50%50%
99 60%60%
1010 70%70%
11-1411-14 80%80%
15-1915-19 90%90%
20+20+ 100%100%
*Larry Swedroe, The Only Guide to a Winning Investment Strategy You’ll Ever Need, St. Martin’s Press, New York, NY, 2005
April 16, 2009 22www.KefferFinancialPlanning.com
Required Return: Required Return: NeedNeed to to Take RiskTake Risk
Years Until Money Needed
Current Balance
Amount Needed
Required Return
Minimum Stock
Exposure
5 115,000$ 150,000$ 5.5% 0%10 68,000$ 157,500$ 8.8% 38%15 43,000$ 165,375$ 9.4% 55%20 25,000$ 173,644$ 10.2% 72%25 12,000$ 182,326$ 11.5% 100%
April 16, 2009 23www.KefferFinancialPlanning.com
How to Decide When Risk How to Decide When Risk Indicators Are Mixed?Indicators Are Mixed?
When risk tolerance, capacity and need When risk tolerance, capacity and need indicate different levels of stock/risk:indicate different levels of stock/risk: Objectively re-examine toleranceObjectively re-examine tolerance
Review answers to questionsReview answers to questions Recall what you’ve done in past bear marketsRecall what you’ve done in past bear markets
Choose level you Choose level you knowknow you can stick with you can stick with Save moreSave more Lower or delay the goalLower or delay the goal
April 16, 2009 24www.KefferFinancialPlanning.com
Sources of HelpSources of Help
Online tools Online tools Investment books & journalsInvestment books & journals Financial plannerFinancial planner
April 16, 2009 25www.KefferFinancialPlanning.com
As Retirement As Retirement Approaches…Approaches…
Distribution Planning ProcessDistribution Planning Process Step 1: Determine retirement needsStep 1: Determine retirement needs
Variables: after-tax living expenses, vehicles, travel, large Variables: after-tax living expenses, vehicles, travel, large gifts, etc.gifts, etc.
Step 2: Project the resultsStep 2: Project the results Variables: sources of retirement income, the portfolio, Variables: sources of retirement income, the portfolio,
expected returns, and life expectancyexpected returns, and life expectancy Step 3: Test different optionsStep 3: Test different options
Options: lower goals, delay goals, find new sources of Options: lower goals, delay goals, find new sources of income, alter the portfolio allocation, opt for a lump sum income, alter the portfolio allocation, opt for a lump sum rather than a pension, use of different tools, such as rather than a pension, use of different tools, such as immediate annuitiesimmediate annuities
Step 4: Implement the best strategyStep 4: Implement the best strategy Step 5: Monitor spending & returns carefullyStep 5: Monitor spending & returns carefully
April 16, 2009 26www.KefferFinancialPlanning.com
Where to InvestWhere to Invest AccountsAccounts
Basic emergency fund in savingsBasic emergency fund in savings Fundamental risk management (insurance)Fundamental risk management (insurance) Pre-tax retirement plans to extent of matchPre-tax retirement plans to extent of match Roth IRA, if qualifiedRoth IRA, if qualified Additional employer plan contributions to maxAdditional employer plan contributions to max Taxable investment accountTaxable investment account
Investment VehiclesInvestment Vehicles Mutual funds for mostMutual funds for most In taxable accountsIn taxable accounts
Exchange traded funds (if amounts justify)Exchange traded funds (if amounts justify) Municipal bonds (based on after-tax yield)Municipal bonds (based on after-tax yield)
Generally, minimize holdings of individual securitiesGenerally, minimize holdings of individual securities
April 16, 2009 27www.KefferFinancialPlanning.com
How to Choose Among How to Choose Among Investment OptionsInvestment Options
Fits allocation needFits allocation need Broadly diversifiedBroadly diversified Low expense ratioLow expense ratio Low turnoverLow turnover No-loadNo-load Large, established investment companyLarge, established investment company Keep it simple!Keep it simple!
Target allocation / lifestyle funds excellent Target allocation / lifestyle funds excellent (in most cases)(in most cases)
April 16, 2009 28www.KefferFinancialPlanning.com
SummarySummary
1. Know your goals1. Know your goals 2. Put enough $ in: top priority!2. Put enough $ in: top priority! 3. Allocate appropriately (91.5% 3. Allocate appropriately (91.5%
solution)solution) 4. Diversify with broad-based funds4. Diversify with broad-based funds 5. Maintain discipline in rough times5. Maintain discipline in rough times 6. Be mindful of costs6. Be mindful of costs 7. Get help if you need it7. Get help if you need it