Asset Allocation The 91.5% Solution

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Asset Allocation The 91.5 Solution

• Presented by
• William H. Keffer
• Certified Financial Planner

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Goals for Today

• Your comfort with basics of asset types
• Your motivation to control the controllable
• Action in your self interest

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Speaker Notes

• Bill Keffer
• Hourly, as-needed financial planner
• Wheaton-based, sole proprietor
• 26-years AIG American General
• Credentials
• Certified Financial Planner
• Registered investment advisor
• MBA in finance
• Contributor Investing in an Uncertain Economy
  for Dummies

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Introduction

• Todays focus Asset allocation
• Prerequisites
• Goals have been carefully quantified
• Adequate savings are systematized
• Most time on why how to allocate
• Briefly
• Distribution planning
• Where how to invest

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Definition of Asset Allocation

• How you divide your money among the different
  classes of investment assets, such as stocks,
  bonds, and cash
• Critical Finding the right mix for your risk
  tolerance, time horizon, and required returns

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PrefaceIMPORTANCE OF ASSET ALLOCATION
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How Asset Allocation Works

• Basic concept Impossible to predict which type
  of asset will do best year-to-year
• Goal A mix formulated for unique risk profile
  and required return
• How Different asset classes returns
  non-correlated reducing overall risk

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Asset Allocation at Work
Portfolio Allocation 0 Stocks 100 Bonds 100 Stocks 0 Bonds 50 Stocks 50 Bonds
5-Year Return 3.8 8.6 6.3
10-Year Return 5.4 3.5 4.8
Risk 2.9 10.4 5.0
Increase Return/Risk (over 100 bonds) N/A Ret 126 Risk 259 Ret 66 Risk 72
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Which Would You Choose?(based on annual returns
shown)
Year A B C D
1 10 50 30 -30
2 10 10 30 50
3 10 -20 30 -10
4 10 20 -20 50
5 10 -10 -20 -10
Arithmetic Average 10 10 10 10
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Which Would You Choose?(based on annual returns
shown)
Year A B C D
1 10 50 30 -30
2 10 10 30 50
3 10 -20 30 -10
4 10 20 -20 50
5 10 -10 -20 -10
Arithmetic Average 10 10 10 10
Value of 1,000 After 5 Years 1,810 1,425 1,406 1,275
Geometric Average 10.0 7.4 7.1 5.0
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Rise of Index Funds

• Importance of asset allocation, as opposed to
  stock selection, helps explain rise of index
  funds.
• With no active stock selection going on, expenses
  decrease

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Examples of Asset Classes

• The Two Major Asset Classes
• Stocks A share of ownership, grows through share
  of profits (dividends) and appreciation in market
  value
• Bonds A loan to a firm or government in return
  for fixed interest payments and promise to return
  principal

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Asset Class Sub-Categories

• Stocks
• By size of company
• Large cap
• Small cap
• By style
• Value
• Growth
• By location
• Domestic U.S.
• Developed international
• Emerging markets

• Bonds
• By length of term
• Short
• Intermediate
• Long
• By riskiness of issuer
• Government
• Investment grade
• Junk
• By frequency of payments

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Other Common Asset Types

• Cash (money markets, CDs, savings)
• Real estate (REITs)
• Commodities
• Currencies
• Precious metals
• Natural resources

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Risk and ReturnWhere Asset Classes Rank

• Asset Class Return Risk

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Sample Portfolios (historical returns risk)
Model portfolios created by Harold Evensky, CFA,
for Money Guide Pro financial planning software,
a product of PIE Technologies.
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Determining Your Allocation3 Factors

• Risk Tolerance
• Willingness to take risk
• Risk Capacity
• Ability to take risk
• Required Return
• Need to take risk

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Risk Tolerance Willingness to Take
RiskQuestionnaire Scoring System
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An Example Clients Answers Target Portfolio

• Questionnaire Answers
• Preserving capital- 6
• Growth- 6
• Low volatility- 4
• Inflation protection- 5
• Current cash flow- 4
• How much risk?- 5

• Indicated Portfolio Allocation
• Stocks 61
• Bonds 35
• Cash 4

Scale 1 to 9, with 1Not Important and 9Very
Important
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Risk Tolerance Willingness to Take RiskStomach
Acid Test
Maximum Tolerable Loss () Maximum Stock Exposure
5 20
10 30
15 40
20 50
25 60
30 70
35 80
40 90
50 100
Larry Swedroe, The Only Guide to a Winning
Investment Strategy Youll Ever Need, St.
Martins Press, New York, NY, 2005
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Risk Capacity Ability to Take RiskThe Liquidity
Test
Years Until Money Will Be Needed Maximum Stock Exposure
0-3 0
4 10
5 20
6 30
7 40
8 50
9 60
10 70
11-14 80
15-19 90
20 100
Larry Swedroe, The Only Guide to a Winning
Investment Strategy Youll Ever Need, St.
Martins Press, New York, NY, 2005
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Required Return Need to Take Risk
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How to Decide When Risk Indicators Are Mixed?

• When risk tolerance, capacity and need indicate
  different levels of stock/risk
• Objectively re-examine tolerance
• Review answers to questions
• Recall what youve done in past bear markets
• Choose level you know you can stick with
• Save more
• Lower or delay the goal

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Sources of Help

• Online tools
• Investment books journals
• Financial planner

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As Retirement Approaches Distribution Planning
Process

• Step 1 Determine retirement needs
• Variables after-tax living expenses, vehicles,
  travel, large gifts, etc.
• Step 2 Project the results
• Variables sources of retirement income, the
  portfolio, expected returns, and life expectancy
• Step 3 Test different options
• Options lower goals, delay goals, find new
  sources of income, alter the portfolio
  allocation, opt for a lump sum rather than a
  pension, use of different tools, such as
  immediate annuities
• Step 4 Implement the best strategy
• Step 5 Monitor spending returns carefully

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Where to Invest

• Accounts
• Basic emergency fund in savings
• Fundamental risk management (insurance)
• Pre-tax retirement plans to extent of match
• Roth IRA, if qualified
• Additional employer plan contributions to max
• Taxable investment account
• Investment Vehicles
• Mutual funds for most
• In taxable accounts
• Exchange traded funds (if amounts justify)
• Municipal bonds (based on after-tax yield)
• Generally, minimize holdings of individual
  securities

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How to Choose Among Investment Options

• Fits allocation need
• Broadly diversified
• Low expense ratio
• Low turnover
• No-load
• Large, established investment company
• Keep it simple!
• Target allocation / lifestyle funds excellent (in
  most cases)

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Summary

• 1. Know your goals
• 2. Put enough in top priority!
• 3. Allocate appropriately (91.5 solution)
• 4. Diversify with broad-based funds
• 5. Maintain discipline in rough times
• 6. Be mindful of costs
• 7. Get help if you need it

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Questions?