copyright leslie lum six strategic steps roadmap for investing wisely for a lifetime

Copyright Leslie Lum

Six Strategic Steps

Roadmap for Investing Wisely for a Lifetime


The Roadmap

• Focus on financial goals

• Understand returns

• Understand and learn to like risk

• Asset allocation NOT investment selection

• Improve after-tax returns

• Monitor your investments


Finding money to invest


How much does a typical family make?


What happens to your income over your life?


How are we doing at savings?

Net Saving as a Percent of Gross National Income

0

2

4

6

8

10

12

14

16

18

1940 1946 1952 1958 1964 1970 1976 1982 1988 1994 2000


Could we save more?Domestic Savings

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Belgiu

mBra

zil

Canad

a

China

Czech

Republic

Denmar

k

France

Germ

any

Irela

ndIta

ly

Japan

Netherla

nds

Singap

ore

Sweden

Switzerla

ndU.K

.U.S

.

% o

f 19

99 G

DP

Source: World Bank - Genuine Domestic Savings


One Two Three Four Five

Average annual expenditures 23,657 43,693 47,406 55,201 52,565

Food 2,831 5,432 6,173 7,472 8,178

Food at home 1,525 3,128 3,664 4,472 5,157

Food away from home 1,306 2,304 2,509 3,000 3,020

Alcoholic beverages 280 468 419 436 358

Housing 8,768 13,536 15,596 18,322 16,930

Apparel and services 837 1,547 1,916 2,503 2,698

Transportation 3,839 8,683 9,562 10,459 10,185

Health care 1,558 3,093 2,532 2,581 2,379

Entertainment \2 1,041 2,421 2,263 2,821 2,554

Personal care products and services 316 563 603 693 689

Reading 93 159 130 135 110

Education 498 597 938 1,426 1,119

Tobacco products and smoking supplies 193 310 351 329 364

Miscellaneous 423 650 658 801 661

Cash contributions 1,032 1,810 1,179 1,270 1,385

Personal insurance and pensions 1,948 4,424 5,087 5,952 4,956

Personal taxes \1 1,592 3,701 2,332 2,838 1,444


Annual Budget vs Long-Term Financial Goals

• Trade off between spending money now and setting aside money for long-term goals

• How do you make your decision?

• What are the costs?


The time value of money ormaking your money work for you.


Making your money work for you.What would you have if you did the

following with $100 in 1996?

• Bought a round of beer (or a good meal)

• Put it in the bank for 5% interest per year

• Bought a stock index fund


Let’s use compounding another way—to find the (future) cost of a purchase

decision• You want to buy a HDTV set for $1500. What

is this (future) costing you? (Use 20 years and 8% return. We use 8% because it’s historically the rate of return on investments over a long period of time.)– $1785– $3393– $4837– $6991


(Future) costing

You are a typical employee in your 20s who when you left your job in 2005 cashed out (66% do) your 401K account of less than $10,000. What is the cost of cashing out your account if your balance was $8000?


Setting Goals


Lay out your goals

• Down payment on house (The more you put down the less risk to default and less monthly payments)

• Wedding (yours or your kids)• Car (Budget or goal?)• College tuition (you/your kids/your grandkids)(http://cgi.money.cnn.com/tools/collegecost/collegecost.html)

• Starting your own business• Retirement (Rule of thumb – annual income divided by

4%) (http://sites.stockpoint.com/aarp_rc/wm/Retirement/Retirement.asp?act=LOGIN)

• Estate (Inheritance or charity)

http://sites.stockpoint.com/aarp_rc/wm/Retirement/Retirement.asp?act=LOGIN

http://sites.stockpoint.com/aarp_rc/wm/Retirement/Retirement.asp?act=LOGIN


How do you save for big goals?

• $40,000 down payment on a house in 10 years

• $50,000 college tuition for your kid in 15 years

• $800,000 for retirement in 30 years • Just a minute---is it possible to save for big

goals?


For big goals save every year(8% return)

• $40,000 down payment on house in 10 years ($2761 every year)

• $50,000 college tuition in 15 years ($1841 every year)

• $800,000 retirement in 30 years ($7062 every year)


Which is more?

• Saving $4000 a year from 25 to 45 years old and then no more savings

• Saving $8000 (double) a year from 45 to 65 years old

0100000200000300000400000500000600000700000800000900000

25 to 45years

45 to 65years


You’re 25 and plan to retire in 40 years. How much do you save every

year to have a $1 M nest egg.

• If you start at age 45.

• If you start at age 35.

• If you start now.


It’s a moving target

• House in 10 years. Today’s price $200,000

• Kid’s college education in 18 years. Today’s price $50,000

• 2% inflation 3% inflation?


That’s not the only uncertainty

$800,000 retirement goal in 30 years

At 8% returns?

At 10% returns?

Future Investment Returns Are Uncertain

6%

9%

5%6%

14%

8%

-2%

18%19%

-5%

0%

5%

10%

15%

20%

25%

1970's 1980's 1990's 2000's

Av

era

ge

Ye

arl

y R

etu

rn f

or

De

ca

de Cash

Bond

Stock


Katie is 25 and trying to plan her financial future. Here are her financial goals in today’s dollars (black) and inflated to when they are due (red).


Katie does her plan and knows that her heaviest savings will happen in her 30s and 40s.

She also does sensitivity analysis on various inflation and return rates.

She knows that she should save as much as she can when she is younger.


Understanding returns


Returns

Always calculate returns on an annualized basis


Calculate the return

• You will get your paycheck next week but you need $100 now. You arrange for a payday loan paying a fee of $15 for the use of $100. The payday loan company will collect the $100 electronically from your bank account when your pay check is deposited next week. What is the rate charged?


Historical returns of major asset classes

How Stocks Have PerformedAnnual Total Returns 1971-2000

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

T-Bill Total Return

Government Bonds Total Return

Stocks Total Return

Source: Global Financial Data www.globalfindata.com

Average annual returns over the past 30 years:

Cash 7%

Bonds 9%

Stocks 15%

Conclusion: If you need higher returns to reach financial goals, you have to invest in stocks.


Investment Risk


Major asset classes: Risk & ReturnAnnual Return on Cash

(Treasury Bill Total Return 1971-2000)

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

Source: Global Financial Data, www.globalfindata.com

Average 6.7%Standard Deviation 2.7%

About 70% of returns fall within one standard deviation of the average


Annual Return on Bonds (Total Return Government Bonds 1971-2000)

-10%

0%

10%

20%

30%

40%

50%

19

71

19

72

19

73

19

74

19

75

19

76

19

77

19

78

19

79

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

Source: Global Financial Data

Average 9.9%

Standard Deviation 9.3%



Annual Return on Stocks(Total Return S&P 500 1971-2000)

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

Source: Global Financial Data

Average 14.5%

Standard Deviation

16.5%



The more return you need, the more risk you take.The more risk you take, the more return you need.

Major Asset Classes (1971-2000)

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0% 2% 4% 6% 8% 10% 12% 14% 16%

Risk (Standard Deviation)

Return (Annual Return)

T-BillsAverage Return 6.7%


BondsAverage Return 9.9%


StocksAverage Annual Return 14.5%


If you receive an offer of a guaranteed high return, is that possible?

Only if they guarantee a high loss as well.

There are no guarantees in any investment. All investments go up and down. Higher return means higher risk.


Given the same return, the investment with less risk is better


The Northwest is the best.


Bonds – Risk Return


US Stocks – Risk Return


Sectors – Risk Return


International – Risk Return


Combined – Risk Return


Inflation is also risk


Which is the best return?

Year Nominal Return 1980 14% 1996 6% 1974 10%


After inflation, the 6% return is the best!!

Year Nominal Return Inflation Rate Real Return 1980 14% 12.5% 1.3% 1996 6% 3.3% 2.6% 1974 10% 12.3% -2%


Asset Allocation


Can you predict the best return?

0% 20% 40% 60% 80% 100% 120% 140% 160%

1980 Small Stocks

1981 Treasury Bills

1982 Government Bonds

1983 Small Stocks

1984 Corporate Bonds

1985 Europe

1986 EAFE

1987 Emerging Asia

1988 Emerging Asia

1989 Latin America

1990 Corporate Bonds

1991 Latin America

1992 Small Stocks

1993 Emerging Asia

1994 Latin America

1995 S&P 500

1996 S&P 500

1997 S&P 500

1998 S&P 500

1999 Latin America

2000 Mid Cap Stocks

Best-Performing Asset Class(1980-2000)

Based on Index


Does the risk double with two investments?

The key is having two

investments which aren’t correlated.


Adding a riskier investment to your portfolio decreases overall risk.

Adding 10% stock to a T-bill portfolio

6.0%

6.5%

7.0%

7.5%

8.0%

8.5%

2.0% 2.2% 2.4% 2.6% 2.8% 3.0% 3.2% 3.4% 3.6% 3.8% 4.0%

Risk (Standard Deviation)

Ret

urn

(A

vera

ge

An

nu

al %

)

90% T-Bill, 10% Stock

100% T-Bill

Increases return.

Reducesrisk!

Data based on 20 years of returns.


If you allocate the right amount you reduce risk and increase return!

Adding stock to a T-bill portfolio

5.0%

7.0%

9.0%

11.0%

13.0%

15.0%

17.0%

19.0%

21.0%

1.5% 3.5% 5.5% 7.5% 9.5% 11.5% 13.5% 15.5%

10% Stock

0% Stock

20% Stock

30% 40%

50%

60%

70%

80%

90%

100% Stock

Data based on 20 years of returns.

20% stock gives more return with about the same amount of risk

as 0% stock.


Some investors think of risk as the maximum loss they are willing to take. What does asset

allocation do for that?Year-End Close Price Annual Gain

Ford J&J Ford J&J

1990 7.44 15.081991 7.86 24.49 6% 62%1992 11.98 21.99 52% -10%1993 18.03 20.02 51% -9%1994 15.58 25.03 -14% 25%1995 16.14 39.83 4% 59%1996 18.03 47.05 12% 18%1997 27.15 63.18 51% 34%1998 32.82 81.49 21% 29%1999 29.82 91.65 -9% 12%2000 23.19 104.71 -22% 14%

Average annual return 15% 24%Standard deviation 26% 23%


You can reduce your maximum loss by diversifying.

Year-End Close Price Annual Gain Asset Allocation20% Ford , 80% J&J

Ford Year J&J Year Ford J&J

1990 7.44 15.081991 7.86 24.49 6% 62% (20% x 6%) + (80% x 62%) = 51%1992 11.98 21.99 52% -10% (20% x 52%) + (80% x –10%) = 2%1993 18.03 20.02 51% -9% (20% x 51%) + (80% x –9%) = 3%1994 15.58 25.03 -14% 25% (20% x -14%) + (80% x 25%) = 17%1995 16.14 39.83 4% 59% (20% x 4%) + (80% x 59%) = 48%1996 18.03 47.05 12% 18% (20% x 12%) + (80% x 18%) = 17%1997 27.15 63.18 51% 34% (20% x 51%) + (80% x 34%) = 37%1998 32.82 81.49 21% 29% (20% x 21%) + (80% x 29%) = 27%1999 29.82 91.65 -9% 12% (20% x -9%) + (80% x 12%) =8%2000 23.19 104.71 -22% 14% (20% x -22%) + (80% x 14%) = 7%

Average annual return 15% 24% 22%Standard deviation 26% 23% 17%


How “smart money” asset allocates• Calpers is the California pension system

which manages $216 B. Check out their current and target asset allocation (available on their Web site www.calpers.ca.gov under Quick Facts). What differences do you see? What does their target allocation suggest?


Maximize After-Tax Returns


Retirement

Traditional IRAs - $4000 per year (Catch-up for those over 50 years)

Tax deferred. Depending on income, may be able to contribute pre-tax

Taxes are paid at ordinary income rate when money is withdrawn.

Roth IRA - $4000 per year (Catch-up for those over 50 years)

No taxes when withdrawn. Contributions are after-tax.

Limited to those under AGI of $90,000 (single) and $150,000 (couple)

401K Employer may match at typically 50 cents for every dollar. Tax deferred. Contribute with pretax dollars. Tax credits for low-income ($25,000 single, $50,000 couple).

Taxed at ordinary income when money is withdrawn.


Education

529 Up to total of about $300,000 for some plans.

Must be used for tuition, fees, room, board, and graduate school.

Coverdell Contribute up to $2,000 a year.

Post-secondary costs; K-12 costs, some computers. Income limits.

Savings Bonds Interest earned is tax-free if used for qualified higher-education purposes.

Tuition and mandatory fees. Income limits.


Monitor


Monitor Your Investments

• Rebalance periodically – but if you buy and sell a lot you will lose money

• Change allocation if you have different cash flow requirements

• Risk and return - Prune the low return/high risk investments

• Compare your performance to the indexes.• Don’t make whipsaw changes to your asset

allocation

copyright leslie lum six strategic steps roadmap for investing wisely for a lifetime

Documents

copyright leslie lum

charity slide

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longterm goals

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