asset allocation the 91.5% solution presented by william h. keffer certified financial planner™

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


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


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


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


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


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


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%


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%


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%


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


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


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


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


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%


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%


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


Risk Tolerance: Willingness to Take RiskRisk Tolerance: Willingness to Take RiskQuestionnaire & Scoring SystemQuestionnaire & Scoring System


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


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


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


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%


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


Sources of HelpSources of Help

Online tools Online tools Investment books & journalsInvestment books & journals Financial plannerFinancial planner


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


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


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)


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


Questions?Questions?

asset allocation the 91.5% solution presented by william h. keffer certified financial planner™

Documents

asset allocation todays

asset allocation prerequisites

type of asset

definition of asset

different asset classes

financial planner slide

overall risk slide

basics of asset types