Developing Your Asset Allocation Strategy for Retirement

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Developing Your Asset Allocation Strategy for
Retirement

• Developed by Barbara ONeill, Ph.D., CFP, Rutgers
  Cooperative Extension
• Adapted by Jean Lown, Ph.D.
• Family, Consumer Human Development
• Lown_at_cc.usu.edu

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Overview

• Asset Allocation Principles
• Risk-Return Relationship
• 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, 10 real estate,
  10 cash assets
• Objective lower investment risk by reducing
  portfolio volatility
• Loss in one investment may be offset by gains in
  another

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The Callan Periodic Table of Investment Returns

• http//www.callan.com/resource/periodic_table/pert
  bl.pdf
• Illustrates the need for asset allocation
• Shows how various asset classes performed during
  the last 20 years
• Best performing asset class changes
• One years winner can be next years loser,
  so invest in a variety of assets

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Why Asset Allocation? Because Market Timing is
Futile

• Value of 100 invested in large company stocks
  (SP 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 (cant afford to miss)

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Second Example The Futility of Market Timing

• Based on SP 500 stock market index
• If investor stayed fully invested, return was
  41.4
• If investor missed top 10 trading days of 1998,
  1999, and 2000 -41.7 return
• Moral stay invested in both bull bear markets

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Determinants of Portfolio Performance
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 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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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
  (i.e., Callan table)
• Asset allocation reduces volatility to provide a
  competitive rate of return

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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
• Caution about risk tests
• Your age and net worth

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Major Asset Classes

• Stocks
• Large company growth value
• Mid cap growth value
• Small growth value
• International

• Bonds
• Domestic
• International
• Corporate
• Municipal
• Real estate (e.g., REITs)
• Cash (CDs, I-bonds, MMMFs, 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
• Government Bonds 5.1
• Treasury Bills 3.8
• Inflation 3.1

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Stock Capitalization

• Large Cap companies valued at gt5 billion
• ExxonMobil, General Electric, Microsoft
• Mid-Cap 1-5 billion
• Bath Beyond, Monsanto, Hilton Hotels
• Small-Cap lt1 billion
• Earthlink, FirstFed Financial, Vintage Petroleum

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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 worlds
  equity (stock) markets

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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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RISK

• Is a 4 letter word
• Remember 2000-2003?
• SP 500 lost 40 of its value

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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 most U.S. stocks lost value (after
  incredible run-up in prices in 1990s)

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Relationship Between Risk and Return
High
Intl Stocks
U.S. Stocks
Real Estate
Expected Return
Intl Bonds
U.S. Bonds
Cash
Equivalents
Low
Risk
High
Low
For illustrative purposes only. Not indicative of
any specific investment.
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Diversification From Combining Investments
No Diversification
Complete Diversification
Portfolio 1
Portfolio 2
Investment A
Investment C
Investment D
Investment B
Some Diversification
Portfolio 3
Investment E
Investment F
For illustrative purposes only. Not indicative of
any specific investment
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Stocks are Risky in Short Run

• Very volatile in sort run (1-5 years)
• annual returns -50 to 50!!
• Remember 2000-2003?
• 2003 was a great year to buy stocks when all news
  was gloom doom
• Large Co. U.S. stocks 10.7 (avg. returns since
  1926)

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Time Horizon for Retirement?

• Until the day you retire?
• Until the day you die?

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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 3.1
• Risk is relative
• Short term volatilitylong term growth
• Invest in stocks for growth

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Recent Example

• 2000-2003 was a gut check
• Thank goodness some of my portfolio was in bonds
  real estate!
• Stocks tanked
• Bonds held steady
• Real estate saved the day

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Safe Investments are Risky in the Long Run

• Inflation 3.1
• Government Bonds 5.1 -3.1 2
• Treasury Bills 3.8 - 3.1 0.7
• Subtract the impact of taxes and safe
  investments yield negative returns
• You will not reach your goal with low risk
  investments

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Understand Risk Tolerance

• Beware of taking risk tests and settling for a
  conservative portfolio
• Conservative investors risk outliving their
  assets
• Life expectancy calculators
• http//www.ces.purdue.edu/retirement/Module1/modul
  e1b.html

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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)
• Select specific investments
• Review and rebalance portfolio yearly

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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
• Past returns are NO guarantee for the future!!
• lt10 year track record is too short!
• Choose funds with low fees

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The Big Picture

• Same principles can be applied to
• 401(k) plans
• Individual retirement accounts (IRAs)
• Other retirement plans

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Questions?
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5 TIAA-CREF Asset Classes

• Guaranteed (low risk low return)
• Fixed-Income (bonds)
• Equities (stocks)
• High return volatile in the short run
• Real Estate
• Inflation protection reduce volatility
• Money Market (safe but very low return)

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Global vs. International

• Global U.S. and foreign investments
• International all foreign

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TIAA-CREF Options (pre-2003)

• TIAA Traditional
• TIAA Real Estate
• CREF Money Market
• CREF Social Choice (bond stock)

• CREF Stock
• Global Equities
• Growth
• Equity Index
• LOTS of overlap!

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9 New Fund Choices (2003)

• Real Estate Securities
• Growth Income
• SP 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 CREF funds are pure
• CREF Stock
• 80 Large-, 15 Mid-, 5 Small-Cap
• Some foreign stocks
• Mid-Cap Growth
• 59 Large-! 39 Mid-, 2 Small-Cap
• Read Prospectus (or at least the summary)

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Growth Portfolio 3 asset classes

• STOCKS for growth
• Large-cap Domestic
• 10-15 Mid-Cap
• 10-15 Small-cap
• 10-15 International
• 10-15 Real Estate (to beat inflation)
• 10-15 Bonds (to dampen volatility)

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New Funds Offer Diversity

• Lots of different stock accounts DO NOT mean
  diversification (overlapping)
• International Equity
• Small-cap Equity
• Real Estate Securities (to complement TIAA Real
  Estate)

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Your Action List

• Review your current asset allocation
• Consider your other retirement accounts
• Use the TIAA-CREF web site
• Understand risk-return relationship
• Talk with a TIAA-CREF rep (at USU)
• Sign up for automatic rebalancing
• Limits on moving out of TIAA
• Re-visit, Reallocate, Rebalance

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Key Considerations For Successful Investing

• Educate yourself to make informed decisions
• Establish policies and objectives
• Monitor investment performance
• Stick to your plan and stay focused
• If you need help, seek professional advice

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Financial Planning for Women

• Second Wednesday of the month
• 1230-130 in Family Life 318
• bring your lunch
• 7-830 p.m. at Family Life Center (500 N 700 E
  bottom of Old Main Hill)
• February 8 FPW Investment Basics
• For mo. email news reminder Sign up sheet or
  send email to Lown_at_cc.usu.edu

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Questions? Comments? Experiences?
February 8 FPW Investment Basics
Baby Boomer Women Retirement Study USU IRB
approved research Step 1 Survey- return by Feb 3
for prize drawing Step 2 Focus Group (25
compensation)