Wealth ManagementAn Unbiased Approach to Managing Your Investments Designed for the Affluent Investor

Adam Harding, CFP® InstructorPhone: 480.306.8705

Email: adam@thecfpwm.com

Fax: 480.505.4034

Contact Information

Course Introduction

Six Weeks

Course Material: Online Slides, Discussion Boards, Email Correspondence

Wealth Management Process – Six StepsStep 1

• Understanding Investor Behavior and Setting Goals

Step 2

• Defining Asset Classes and Measuring Different Types of Risk

Step 3

• Understanding Asset Allocation, Diversification, and Volatility

Step 4

• Tax and Estate Planning Considerations

Step 5

• Selecting Investment Managers, Evaluating Advisors, and Preparing Heirs for the Responsibility of Wealth

Step 6

• Collaborating Knowledge and Implementation

Notes of CautionParticipants are strongly urged not to alter their investment structure based on the early classes.

Wealth Management does not provide specific investment or tax advice.

This course covers many subjects relating to investments and certain portions may not coincide with the participant’s perception or experience. Participants are urged to ask questions at any time.

Participants may have questions about subjects not covered in the course material. Instructors are available during breaks and after class to answer questions.

Beta

Academics

Investment SeminarsMutual Fund Companies

NASDAQ

Brokerage Firms

College Costs

AlphaPerformance Reports

Standard Deviation

Correlation

CPAsInvestment Advisors

Books

Real Estate

Diversification

Print Media

Attorneys

Insurance

Pension

Defined Benefit

TelevisionRisk

Relatives

Retirement

S & P 500

CNBC

Discount Brokers

Mortgage Brokers

Money Managers

Liquidity

Internet

Bankers

Friends

Neighbors

Line of Credit

Confusion

?

Example: Calling the bottom is impossible

Boston Globe, Aug 12, 2000 – “…at these undervalued prices…we’re not selling any stock at these prices”. (on Monday, Aug 14, the S&P 500 closed at 1491. Four years later on Aug 12, 2004, the S&P fell a further 29% to close at 1063.)

Wired Magazine, Dec 4 2000 – “Fred Siegel, president of investment management firm Siegel Group, believes that it is unlikely that the Nasdaq will drop more than another 200 points.” (The Nasdaq fell over 1,000 points shortly after Siegel made his prediction.)

Market guru and former hedge fund manager Jim Cramer TheStreet.com said it best in Jan 2001: “I get paid to call bottoms. I don’t see one yet, but in my 18 years of trading I’ve never called one exactly right yet. I don’t see why this time will be any different.”

Wealth Management is More than Investing…

Source: DCA: It Gets You In At the Bottom, Cory JanssenDCA does not assure a profit and does not protect against loss in declining markets.

Cycle of Human Emotions

Point of maximum financial opportunity

Optimism

Excitement

Thrill

EuphoriaAnxiety

Denial

Fear

Desperation

Panic

Capitulation

Despondency Depression

Hope

Relief

Optimism

Point of maximum financial risk

“Wow, I feel great about this

investment.”

“Maybe the markets just aren’t for me.”

“Temporary setback. I’m a long-term investor.”

Source: Westcore Funds/Denver Investment Advisers LLC, 1998

Black Swan Event

We rarely see Black Swans coming, but when they do arrive, they shape our world profoundly.

- World Wars I & II - September 11, 2001 - The Rise of the Internet - The Great Recession

Sourec: http://online.wsj.com/article/SB10001424127887324735104578120953311383448.html

An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult to predict.

The “Guess Right Ratio”

This Chart shows fund inflows and outflows to determine how often investors correctly time the market. Investors make money when the ratio exceeds 50%.

How have institutional portfolios compared to retail portfolios?

*Barclays Aggregate Bond Index“2011 Quantitative Analysis of Investor Behavior” from Dalbar, Inc. 2012

The Institutional Process

S&P

Averag

e Equity

Inve

stor

Averag

e Fixe

d Inco

me Inve

stor

Fixed

Inco

me Ben

chmark

*

Minimum

Mean

Median

Maxim

um

7.81%

3.49%0.95%

6.5%

-4.6%

7.9% 8.0%

41.0%

“Institutional”“Retail”

Many retail investors do not use a disciplined approach.

Result

Investor Behavior tends to be the cause of underperformance

Source: Bemanaged.com

The Institutional Process

Behavioral FinanceWhat is it?

– It is the “study of the influence of psychology on the behavior of financial practitioners and the subsequent effect on markets.”

Why is it important?– It helps explain “why and how markets might be

inefficient.”

Psychological forces motivating the people and institutions that move the stock market daily, weekly and so on.

Traditional vs. Behavioral Finance

Traditional Finance Humans react rationally in the marketplaceDecisions based in fact and exclusive of sentimentDoes not explain the anomaliesBehavioral FinanceBorrows from Cognitive PsychologyExplains those events that are unexplainable by rational means

Behavioral Finance is not an arm of Traditional Finance, it’s a replacement.

Behavioral Finance implies that when greed prevails, markets tend to overshoot their true values, and when fear prevails, markets tend to undershoot their true values.

Tulip Mania• Tulip mania – a period in the Dutch Golden Age

during which contract prices for bulbs of tulips reached extraordinarily high levels

• At the peak, in February 1637, tulip contracts sold for more than 10 times the annual income of a skilled craftsman.

• Some bulbs were traded for as much as 2400 lbs of wheat, or 2 tons of butter.

Tulip Mania is generally considered the first recorded speculative bubble.

Signs of Modern Day Tulip Mania

Biases and Investments• We are biased.• Types:

• Overconfidence• Escalation Bias• Mental Accounting• Anchoring• Confirmation & Hindsight Bias• Regression to the Mean• Herd Behavior• Gambler’s Fallacy• Prospect Theory

Biases lead to misevaluations

Escalation Bias

• Overconfidence can lead to escalation bias• Hedge-funds that took leveraged bets against dot-

com companies in the late 90s• Long-Term Capital Management Hedge Fund

“The market can stay irrational longer than you can stay solvent. “ – John Maynard Keynes

Anchoring

• During normal decision making, individuals anchor, or overly rely, on specific information or a specific value and then adjust to that value to account for other elements of the circumstance.

• Usually once the anchor is set, there is a bias toward that value.

• EG- the status quo for the price of an engagement ring is supposedly 2 months salary. This figure is irrelevant and placed into society by profit maximizing jewelry companies; yet many men compare what they earn in 2 months to the amount they should spend.

The Fiduciary Process

Needs and Goals

Example

In 1953, a study of Yale students was conducted.

3% had written goals and 97% did not.

In the 1973 follow-up, the 3% who had goals had accomplished more than the 97% who had not.

Putting together a plan and setting attainable goals is important to achieve success. Writing out a plan and setting goals forces individuals to think about potential hurdles and how to get past those hurdles.

Performance Goals

• Specific

• Measurable

• Action Oriented

• Realistic

• Time Specific

Goals must be specific, measurable, action oriented, realistic, and time specific. For example, simply setting a goal that you want to 20lbs by the end of the year has little value unless you plan actions that will help you reach that goal.

Financial Life Cycle

Trends In Retirement People are living longer and spending more time in retirement

2012 2025 2050

Men

25

20

15

10

5

0

TIM

E IN

YEA

RS

LIFE EXPECTANCY AFTER AGE 65

10

16

13

19

16

22

Women

Lifestyle InflationLifestyle inflation is the phenomena of expenses actually increasing during retirement. It is not due to inflation or taxation, but to the increase in leisurely pastimes; golf, travel, dining out, attending performances, etc.

How will your retirement spending change?

TRAVEL

66%

DINING OUT

37%

GIFTS

33%

Monetary Needs: Maslow Meets Retirement

IMCA

Dream

Gift

Freedom

Security

Survival

Dream

Gift

Freedom

Security

Survival

Things to own, places to go, goals to accomplish

Charities, church, children, special interests

Hobbies, travel, personal growth, and education

Housing, Food, Clothing, Transportation

Health issues, aging parents, emergency repairs

$

$

$

$

$

Monetary Needs: Maslow Meets Retirement

Total $IMCA

Dream

Gift

Freedom

Security

Survival

Things to own, places to go, goals to accomplish

Charities, church, children, special interests

Hobbies, travel, personal growth, and education

Housing, Food, Clothing, Transportation

Health issues, aging parents, emergency repairs

$

$

$

$

$

Monetary Needs: Maslow Meets Retirement

Total $

1,000/mo

1,500

2,000

2,500

3,000

10,000/monthIMCA

Reaching Your Goals

Financial independence is when you can maintain your desired lifestyle for the remainder of your life

without the worry of money.

LIFESPAN

INCO

ME

PRO

DU

CTIO

N C

APAC

ITY

DESIRED LIFESTYLEFINANCIAL INDEPENDENCE

FINANCIAL DEPENDENCE

Learn To Ask The Question:

“How can I build multiple,

sustainable income streams?”

Bonds (Fixed Income)

Bond Basics

What is a bond?

• A bond, quite simply, is an instrument of debt. I’m sure you are all quite familiar with the general features of bonds, but I‘ll do my best to be thorough so that you feel more comfortable with them as we go forward.

Bond Basics

What is the difference between a stock and a bond?

• Owners of bonds have often have some kind of underlying collateral that secures their interest. Example: if a company goes bankrupt, after selling it’s assets it will pay bondholders and creditors before paying stockholders.

Bond Basics

Who issues bonds?

National Governments

Government Agencies

Supranational Agencies

States and Municipalities

Corporations

Asset Securitization

Bond Basics

Source: Dimensional Fund Advisors

Key Risks of Bond Investing• Interest Rate Risk

–Reinvestment Risk

– Inflation Risk

–Yield Curve Risk

• Credit Risk

• Liquidity Risk

• Currency Risk

Key Risks of Bond Investing

InterestRates

BondPrices

% $

Interest Rate Risk– Reinvestment Risk

Reinvestment Risk – The risk related to what the interest rate will be when income and/or principal from investments is reinvested. If interest rates fall, the investors will be worse off when reinvestment occurs. If they rise, they will be better off.

Two Factors have an effect on the degree of reinvestment rate risk:

Maturity of the Bond – The longer the maturity, the higher likelihood that interest rates will be lower than they were at the time of the bond purchase.

Interest Rate of the Bond – The higher the interest rate, the bigger the coupon payments that have to be reinvested, and consequently, the bigger the reinvestment rate risk.

Interest Rates – Last 30 Years

Source: https://www.google.com/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&cad=rja&docid=3Q5TY1WELBT2_M&tbnid=6gsn2z4I1P4mJM:&ved=0CAMQjhw&url=http%3A%2F%2Ffinance.fortune.cnn.com%2F2012%2F11%2F28%2Fhigh-yield-debt%2F&ei=-e1BUqW3L6aRiAKt9oBw&bvm=bv.53077864,d.cGE&psig=AFQjCNEcybrE27qZ5C_vgVKmTXzn1z5Vgw&ust=1380138855843339

Key Risks of Bond InvestingInterest Rate Risk

– Inflation Risk

Cash flows from future investments won’t be worth as much in the future in real terms.

Nominal & Real Income from Bond in Year 1 = $1,000

Yearly Inflation = 3%

Nominal Income in Year 2 = $1,000

Real Income in Year 2 = $970

Real Income in Year 10 = $744.09

Key Risks of Bond InvestingInterest Rate Risk

– Yield Curve RiskShifting yield curves cause the price of a bond to change.

Interest rates cause the yield curve to shift.

When the yield curve shifts, the price of the bond, which was initially priced based on the initial yield curve, will change in price. If the yield curve flattens, then the yield spread between long- and short-term interest rates narrows, and the price of the bond will change accordingly. If the bond is a short-term bond maturing in three years and the three-year yield decreases, the price of this bond will increase. 

If the yield curve steepens, this means that the spread between long- and short-term interest rates increases. Therefore, long-term bond prices will decrease relative to short-term bonds. Changes in the yield curve are based on bond risk premiums and expectations of future interest rates.

Key Risks of Bond InvestingS&P/Fitch Description

AAA Extremely High QualityAA+AAAA-A+AA-

BBB+BBB BBB-BB+BBBB-B+BB-

CCC+CCC CCC-CCCD Default

Very High Quality

Speculative

Very Speculative/Near Default

High Quality

Credit Risk

Higher perceived risk means that the lender will demand

a higher rate of interest for their capital.

InvestmentGrade

SpeculativeGrade

(“Junk”)

Key Risks of Bond InvestingLiquidity Risk

The ability to easily sell your bonds. The market for bonds is typically “thinner” than the market for stocks; meaning that there are fewer

buyers and sellers.

US Treasuries, historically, have had no liquidity risk. Small market bonds, “callable” bonds, and small face value bonds tend to have higher liquidity risk.

Key Risks of Bond InvestingCurrency Risk

Money must be converted to another currency to make a certain investment, then any changes in the currency exchange rate will cause that investment's value to either decrease or increase when the investment is sold and converted back into the original

currency.

Fixed Income TypeAverage Annualized

Return

Lowest Annual 12 Month Rolling

Return

Highest Annual 12 Month Rolling

Return

Standard Deviation

Ending Value of $10,000

Investment

Treasury Bills 1.90% 0.10% 5.50% 0.39% 12,075.00$

Intermediate Treasury Bonds 4.09% -1.40% 12.00% 3.50% 14,932.00$

Long Treasury Notes 7.64% -12.90% 32.70% 13.50% 20,897.00$

Government Agency Bonds 4.24% -1.60% 10.20% 2.90% 15,147.00$

Treasury Inflation Protected Securities (TIPS) 6.65% -7.50% 19.50% 7.30% 19,042.00$

Mortgage Backed Securities 4.13% -0.10% 10.60% 2.30% 14,997.00$

Asset Backed Securities 5.45% -16.80% 26.30% 8.10% 17,003.00$

Municipal Bonds 5.10% -3.60% 14.80% 5.40% 16,448.00$

Investment Grade Corporate Bonds 8.10% -22.50% 46.60% 12.80% 21,796.00$

High Yield Corporate Bonds 10.61% -31.20% 64.90% 10.61% 27,434.00$

Foreign Bonds 8.03% -9.80% 23.70% 9.40% 21,661.00$

Preferred Stock 4.70% -59.73% 124.00% 23.70% 15,834.00$

Convertible Bonds 7.24% -33.20% 46.20% 14.30% 20,124.00$

Investment ComparisonCharacteristics and Returns – 1/31/2003 to 12/31/2012

Source: Morningstar Advisor Workstation, Hypothetical Illustration. Past performance not indicative of future results.

Suitability

Four general uses for bonds

• Capital preservation

• Equity hedge

• Income generation

• Total return

Short maturity Treasuries High quality short

maturity municipals

Suitability

Long maturity Treasuries High quality long

maturity municipals

Four General Uses for Bonds

• Capital Preservation

• Equity Hedge

• Income Generation

• Total Return

Suitability

May require taking on credit risk

Achieve yield target while minimizing risk of loss

Four General Uses for Bonds

• Capital Preservation

• Equity Hedge

• Income Generation

• Total Return

Suitability

Combine sectors with low correlation

Overweight cheap sectors, avoid rich sectors

Four General Uses for Bonds

• Capital Preservation

• Equity Hedge

• Income Generation

• Total Return

Equities

Principal Features of Stocks

• Limited Liability

• Liquidation Rights

• Voting Rights

• Potential for Dividends

• Potential Appreciation

Major Equity Indices• S&P 500 – Market-weighted index of 500 actively traded large cap US companies

• Dow Jones Composite – Price-weighted average of 30 significant US stocks

• NASDAQ Composite – An index of the stocks traded on the NASDAQ stock exchange

• Russell 3000 – An index that measures the performance of the largest 3000 US stocks

• Russell 1000 – An index that measures the performance of the largest 1000 US stocks.

• Russell 2000 – An index that measures the smallest 2000 stocks of the largest 3000 US stocks.

• MSCI EAFE – An index that measures equity performance outside of the US and Canada.

• Dow Jones US Real Estate– This index measures the performance of US REITs.

Stock Classification

Domestic / International

LargeCap / MidCap / SmallCap / MicroCap / NanoCap

Core (Blend) / Value / Growth

Stock Classification

• Domestic Stocks—issued by a corporation or company headquartered in the United States

• International Stocks—issued by a corporation or company headquartered outside of the United States

Stock Classification• Large Cap Stocks ($10 billion and above)

• Mid Cap Stocks ($2 billion - $10 billion)

• Small Cap Stocks ($300 million - $2 billion)

• Micro Cap Stocks ($50 million – $300 million)

• Nano Cap Stocks (Less than $50 million)

Market Capitalization is the number of shares outstanding times the stock price. In other words, the current market value of the company

Stock Classification

• Growth—companies with higher price-to-book ratios and higher forecasted growth values. In general, earnings chase price

• Value—Companies with lower price-to-book ratios and lower forecasted growth values. In general, price chases earnings.

• Core – When neither Value nor Core is dominant. When referring to equity mutual funds, this is often referred to as “Blend”.

The Power of Compounding

Source: seekingalpha

Dividend Reinvestment is the heart of compounding. You can see on this chart how the effects of investing none, half, or 100% of dividends can have a significant steepening-effect to your income curve. However, reinvesting dividends can end up leading to significant concentration-risk; meaning that your portfolio may be over-exposed to one particular security.

The Power of CompoundingS&P 500 Historical Return

Source: Hays Advisory

Market Cycles and Crisis Events

The following slide shows major events over the last several decades. You can see the effect of these events and how the market has rebounded.

A Chronicle of CrisesS&P 500 Historical Return

Source: Dalbar, Inc. Quantitative Analysis of Investor Behavior

Great Depression

Tech Wreck

Suez Canal Crisis

Black Monday

Nixon Resignation

Great Recession

S&P 500 Cycles Since 1928

Stock ValuationS&P 500 Historical P/E10 Ratio

P/E1

0 Ra

tio

Source: www.multipl.com

Mean: 16.49 Median: 15.89 Min: 4.78 (Dec 1920) Max: 44.20 (Dec 1999)

Stock ValuationS&P 500 Historical Dividend Yield

Yiel

d %

Mean: 4.43% Median: 4.37% Min: 1.11% (Aug 2000) Max: 13.84 (June 1932)

Source: www.multipl.com

Stock ValuationS&P 500 Real Price

Pric

e

Source: www.multipl.com

Annual Stock Market Returns 1926 through 2011

Source: Source: cbsnew.com

Annual Stock Market Returns

Source: Source: Siegel, Jeremy, Stocks for the Long Run (2007). Update 2012

January 1802 – June 2012 Real Returns

Long-Term 1802-2012 6.6%

Major Sub-Periods

I 1802-1870 6.7%

II 1871-1925 6.6%

III 1926-2012 6.4%

Post-War Periods

1946-2012 6.4%

1946-1965 10.0%

1966-1981 -0.4%

1982-1999 13.6%

2000-2012 -0.1%

Annualized Returns From 1/1926 to 12/2011Re

turn

%

Source: Ibbotson and Asociates

Historical Asset Class Returns

US Inflati

on

US 30-D

ay Treasu

ry Bills

US Long T

erm Gove

rnment B

onds

S&P 500

US Small

Cap St

ocks

2.99% 3.59%5.72%

9.77%11.88%