developing your asset allocation strategy for retirement developed by barbara o’neill, ph.d., cfp,...
TRANSCRIPT
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
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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 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]
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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)
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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, 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%
Other2.1%
Market Timing1.8%
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
CashEquivalents
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 EPortfolio 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 9/30/04Low 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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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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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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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, 1st 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