Principles

of Asset Allocation

Importance of Asset Allocation

Source: Brinson, Beebower and Singer

Three Components in Determining Allocation of Assets

Component #1

Asset Class Rates of Return

Asset Class RelationshipV

ola

ti li ty

Specialty Stocks

Small Cap Stock

Mid Cap Stock

Foreign Stock

Large Cap Stock

Specialty Bonds

Corporate Bonds

Government Bonds

Foreign Bonds

Real Estate

Commodities

Cumulative Long-term Returns

75 Years

Source: Ibbotson Associates

$0

$1

$10

$100

$1,000

$10,000

1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

Large Cap Stocks Small Cap Stocks Long Term Corp. Bonds Treasury Bills

$9,405

$2,285

$85

$18

Short-Term (1-Year) Returns

Source: Ibbotson Associates

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Large Cap Stocks Small Cap Stocks Long-Term Corp Bonds

Treasury Bills Real Estate Commodities

Three Components in Determining Allocation of Assets

Component #2

Asset Class Volatility[Standard Deviation]

Distribution of Returns by Asset Class

Asset Class Average Return

Volatility (Std.Dev.)

Small Company Stocks

11.6% 35.4%

Common Stocks

10.1% 20.8%

Long-Term Corporate Bonds

5.2% 8.4%

Long-Term Government

Bonds

4.5% 8.5%

U.S. Treasury Bills

3.7% 3.4%

-60% 0%

+80%

Source: Ibbotson Associates

Reduction of Risk Over Time

-75%

-50%

-25%

0%

25%

50%

75%

100%

125%

150%

Small Company Stocks Large Company Stocks Long-Term GovernmentBonds

Treasury Bills

One Year Holding Period

Five Year Holding Period

Ten Year Holding Period

Twenty Year Holding Period

Source: Ibbotson Associates

Three Components in Determining Allocation of Assets

Component #3

Relative Volatility of the Asset Classes[Correlation]

Correlations

Positive Correlation Negative Correlation

Correlations of Asset Classes

Source: Ibbotson Associates

US Bonds

Large Cap Stocks

Small Cap Stocks

Foreign Stocks

Real Estate Commodities

100%24% 100%12% 78% 100%14% 55% 47% 100%16% 53% 65% 35% 100%-5% -3% 2% 0% -1% 100%

Real Estate

US Bonds

Small Cap StocksLarge Cap Stocks

Foreign Stocks

Commodities

Putting It All Together

Minimize volatility by combining different classes of assets

R i s k

Return

Diversifying Risk

100% Stocks

80% Stocks/ 20% Bonds

60% Stocks/ 40% Bonds

40% Stocks/ 60% Bonds

50% Stocks/ 50% Bonds

20% Stocks/ 80% Bonds

100% Bonds

R i s k

Return

Diversifying Risk

Stocks and Bonds

Adds Real Estate and Commodities

Importance of Asset Allocation

Source: Brinson, Beebower and Singer