INVESTING STRATEGIES

1
INVESTINGSTRATEGIES

• Common Sense Approaches
• To Help You Risk Less
• and Earn More with Your Investments

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Points for Discussion

• Traditional investment approaches are too
  risky, too costly or both
• Diversification reduces risk
• Low-cost indexed strategies beat high-cost
  active management
• Structured or enhanced indexing can optimize
  performance

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Returns Are More VolatileThan Many Had Thought
SP 500 Past 10 Years
YEAR RETURN CUM
RETURN 1994 1.3 101.3 1995 37.4 139.2 1996
23.1 171.3 1997 33.4 228.6 1998 28.6 2
93.9 1999 21.0 355.7 2000
-9.1 323.3 2001 -11.9 284.8 2002 -22.1 2
21.9 2003 28.7 285.6
Compound Annual Return for 10 year Period
11.1
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Historical Security Annual Returns
SP LT GOV TREASURY 500
BONDS BILLS
Good Times 1995 37.4 31.7 5.6
1997 33.4 15.9 5.3 1990-1999 18.2
8.9 4.9 Bad Times 1974 -26.4
4.4 8.0 2002 -22.1 17.8 1.6
1973-1982 6.7 5.8 8.5
2000-2002 -14.6 14.1 3.8 Long-Term
1926-2003 10.4 5.4 3.7 1973-2003
11.2 9.1 6.4
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Standard Deviation A Measure of Investment
Risk
Defined
Standard deviation is the probable range of
returns, two-thirds of the time, for a given
investment or portfolio. It is usually measured
annually but can relate to other time periods.
Example
A portfolio with an average return of 10 and a
standard deviation of 12, will, two-thirds of
the time, show returns between 22 and 2. One
third of the time, they will be higher or lower.
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Investment Risk Over Time
1 Year 5 Years 10 Years 15 Years
20 Years
54.0
28.6
20.1
18.9
17.9
Annualized Return-Percent
3.1
.6
-.9
-12.5
-43.3
Annualized returns for the SP 500 Index for
overlapping periods as indicated for the 77 years
from 1926 through 2003
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Distribution of SP 500 Returns
Overlapping Periods from 1926 - 2003
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Asset Classes
Defined
A group of securities that have similar
characteristics
Examples
Stocks vs. Bonds US Equities vs. International
Equities Large Cap Stocks vs. Small Cap
Stocks Value Stocks vs. Growth Stocks
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Determinants of Portfolio Performance
Almost all of a portfolios performance is
determined by asset class selection. Market
timing and security selection are not
significant. In fact, they have a negative
impact.

Asset Class Selection
Asset Class Selection Investing in types of
assets such as stocks and bonds.
94.0
Source Study of 91 large pension plans over a 10
year period. Gary T. Brinson, L. Randolph Hood
and Gilbert L. Beebower, Determinants of
Portfolio Performance, Financial Analysts
Journal, July-August, 1986, pp. 39-44 and Gary
T. Brinson, Brian D. Singer and Gilbert L.
Beebower, Revisiting Determinants of Portfolio
Performance An Update, 1990 Working Paper.
Security Selection Choosing individual
securities.
Security Selection
Market Timing
Market Timing Shifting portfolio assets in and
out of the market, or between asset classes.
4.0
2.0
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Building an Investment Portfolio - 1
January 1975 - December 2003
Annual Annualized Standard
Growth of Return () Deviation a
Dollar
40 Lehman Gov/Corp Index
Portfolio 1 12.3 11.0
28.75
60 SP 500
This approximates the make-up of a typical large
institutional portfolio
Lehman DFA Two DFA US DFA US DFA US DFA
Intl DFA Intl Gov/Corp Year Fixed SP
500 Micro Cap Small Cap Large Cap Small Cap Large
Cap Index Income Index Fund
Fund Value Fund Fund Value Fund
Portfolio 1 40.0 60.0
Note The illustrations on this and the following
four pages show the relative advantages of
diversification. The returns are from a period of
strong market performance and are not meant to to
be a prediction of future returns. Most fees,
transaction costs and taxes are excluded.
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Building an Investment Portfolio - 2
January 1975 - December 2003
Annual Annualized Standard
Growth of Return () Deviation a
Dollar
40 DFA 2-year Fixed Income Fund
Portfolio 1 12.3 11.0
28.75 Portfolio 2 11.9 10.3
26.19
60 SP 500
Substituting short-term fixed income for
long-term fixed income can reduce risk more than
it lowers returns.
Lehman DFA Two DFA US DFA US DFA US DFA
Intl DFA Intl Gov/Corp Year Fixed SP
500 Micro Cap Small Cap Large Cap Small Cap Large
Cap Index Income Index Fund
Fund Value Fund Fund Value Fund
Portfolio 1 40.0 60.0 Portfolio
2 40.0 60.0
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Building an Investment Portfolio - 3
January 1975 - December 2003
Annual Annualized Standard
Growth of Return () Deviation a
Dollar
30 DFA US Micro-Cap
30 SP 500
Portfolio 1 12.3 11.0
28.75 Portfolio 2 11.9 10.3
26.19 Portfolio 3 13.7
10.8 40.94
40 DFA 2-year Fixed Income Fund
Adding small company stocks can increase expected
return with a modest increase in risk
Lehman DFA Two DFA US DFA US DFA US DFA
Intl DFA Intl Gov/Corp Year Fixed SP
500 Micro Cap Small Cap Large Cap Small Cap Large
Cap Index Income Index Fund
Fund Value Fund Fund Value Fund
Portfolio 1 40.0 60.0 Portfolio
2 40.0 60.0 Portfolio 3 40.0 30.0 30.0
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Building an Investment Portfolio - 4
January 1975 - December 2003
Annual Annualized Standard
Growth of Return () Deviation a
Dollar
15 DFA US Large Cap Value
15 SP 500
15 DFA US Small Cap Value
Portfolio 1 12.3 11.0
28.75 Portfolio 2 11.9 10.3
26.19 Portfolio 3 13.7
10.8 40.94 Portfolio 4 14.2
10.9 47.40
15 DFA US Micro-Cap
40 DFA 2-year Fixed Income Fund
Adding value stocks can also improve the expected
return with a small impact on risk
Lehman DFA Two DFA US DFA US DFA US DFA
Intl DFA Intl Gov/Corp Year Fixed SP
500 Micro Cap Small Cap Large Cap Small Cap Large
Cap Index Income Index Fund
Fund Value Fund Fund Value Fund
Portfolio 1 40.0 60.0 Portfolio
2 40.0 60.0 Portfolio 3 40.0 30.0 30.0 Por
tfolio 4 40.0 15.0 15.0 15.0 15.0
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Building an Investment Portfolio - 5
January 1975 - December 2003
Annual Annualized Standard
Growth of Return () Deviation a
Dollar
10 DFA Intl Value
10 SP 500
10 DFA Intl Small Co.
Portfolio 1 12.3 11.0
28.75 Portfolio 2 11.9 10.3
26.19 Portfolio 3 13.7
10.8 40.94 Portfolio 4 14.2
10.9 47.40 Portfolio 5
14.5 9.9 50.34
10 DFA US Large Cap Value
10 DFA US Small Cap Value
40 DFA 2-year Fixed Income Fund
10 DFA US Micro-Cap
Adding international stocks can further improve
the risk/return relationship
Lehman DFA Two DFA US DFA US DFA US DFA
Intl DFA Intl Gov/Corp Year Fixed SP
500 Micro Cap Small Cap Large Cap Small Cap Large
Cap Index Income Index Fund
Fund Value Fund Fund Value Fund
Portfolio 1 40.0 60.0 Portfolio
2 40.0 60.0 Portfolio 3 40.0 30.0 30.0 Por
tfolio 4 40.0 15.0 15.0 15.0 15.0 Portfolio
5 40.0 10.0 10.0 10.0 10.0 10.0 10.0
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Portfolio DiversificationLevel I
U.S. Large Cap Stocks U.S. Mid-Cap and Small Cap
Stocks Foreign Stocks U.S. Short-Term Bond
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Portfolio DiversificationLevel II
U.S. Large Cap Stocks U.S. Mid-Cap and Small Cap
Stocks Foreign Stocks (include large, small, and
emerging markets) Real Estate Investment Trusts
(REITs) U.S. Short-Term Bond
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Determinants of Portfolio Performance -II
Almost all of a portfolios performance is
determined by asset class selection. Market
timing and security selection are not significant.

Asset Class Selection
Asset Class Selection Investing in types of
assets such as stocks and bonds.
94.0
Source Study of 91 large pension plans over a 10
year period. Gary T. Brinson, L. Randolph Hood
and Gilbert L. Beebower, Determinants of
Portfolio Performance, Financial Analysts
Journal, July-August, 1986, pp. 39-44 and Gary
T. Brinson, Brian D. Singer and Gilbert L.
Beebower, Revisiting Determinants of Portfolio
Performance An Update, 1990 Working Paper.
Security Selection Choosing individual
securities.
Security Selection
Market Timing
Market Timing Shifting portfolio assets in and
out of the market, or between asset classes.
4.0
2.0
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Active vs. Indexed Management
Active
The notion that careful individual security
analysis and selection and market timing
(shifting in and out of equities and between
sectors) can beat market averages.
Indexed
Because the markets for publicly-traded
securities are highly to relatively efficient,
the ability to outperform market averages,
especially after the high investment costs and
the tax impact of active management are
considered, is a matter of luck.
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Reasons for Active Management

• Traditional investment practices
• Self-interest of vendors
• Self-interest of the financial press
• Average results arent exciting
• Its more fun for many people so is gambling

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Reasons for Indexed Approach

• High odds of better net returns
• Lower costs
• Reduced taxes
• Avoid high risk of underperformance
• Active managers, as a group, cant top market
  averages, less expenses
• Past good results tend not to repeat
• Indexing may be easier to understand

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The Case for IndexingTop Actively Managed Funds
Fade in the Long RunPast Performance is No Basis
for Future Predictions
Source William Bernstein, The Four Pillars of
Investing, McGraw Hill, 2002, p. 80
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The Case for IndexingThe Extra Costs of Active
Management
Source William Bernstein, The Four Pillars of
Investing, McGraw Hill, 2002, p. 95
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The Case for IndexingThe Extra Tax Cost of
Active Managementfor Taxable Accounts

• Mutual fund portfolio turnover for active funds
  averages over 100
• High portfolio turnover causes
• faster recognition of capital gains
• more gains taxed as ordinary income at 35
  rather than 15
• Taxes reduce returns an additional 100 to 200
  basis points
• Increased availability of tax-managed index funds

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Additional Support for Indexed Management
from Peter Lynch
All the time and effort that people devote to
picking the right fund, the hot hand, the great
manager, have in most cases led to no advantage.
Source
Peter Lynch, Beating the Street, 1993, Simon and
Schuster, p. 60
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Additional Support for Indexed Management
from Warren Buffet
Most investors, both institutional and
individual, will find that the best way to own
common stocks is through an index fund that
charges minimal fees. Those following this path
are sure to beat the net results (after fees and
expenses) delivered by the great majority of
investment professionals.
Source
Chairmans letter, Berkshire Hathaway Corp., 1996
Annual Report
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Additional Support for Indexed Management
from Benjamin Graham, pioneer in fundamental
security analysis
I am no longer an advocate of elaborate
techniques of security analysis in order to find
superior value opportunities. This was a
rewarding activity, say, 40 years agobut the
situation has changedI doubt whether such
efforts will justify their costsIm on the side
of the efficient market school of thought.
Source
Quoted from a 1970s interview in Financial
Analysts Journal by Burton Malkiel, A Random Walk
Down Wall Street, 8th ed., W.W. Norton Company,
2003, p. 198
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Implications for Trust InvestmentsDuty to
Control Fees Costs
Restatement Third of Trusts
(T)rustees have a duty to avoid fees,
transaction costs and other expenses that are not
justified by the needs and realistic objectives
of the trust investment program.
Observation
The commentary to this basic rule of trust law
makes it clear that any trustee incurring fees
above those required for indexing may have legal
difficulty in justifying them.
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Structured or Enhanced Indexing
Structured or Enhanced Indexing adds extra value
to an indexing approach by three means First,
tilting the equity portfolio towards the small
cap and value sectors that have produced higher
returns over time than a pure equity index
weighted in exact proportion to the existing
market. Second, timing the purchases and sales of
lightly-traded securities to save on trading
costs. Third, in the case of tax-managed index
funds, trading is also timed and undertaken to
take advantage of tax savings or to minimize tax
costs.
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The 3 Factors for Equity Returns

• The Market Premium
• -Equity returns vs. T-bills
• The Size Premium
• -Small stocks vs. large stocks
• The Price or Value Premium
• - Low book-to-market (BTM) value stocks vs.
  those with high BTM

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The 3 Equity Premiums 1964-2001
Information and data from Dimensional Fund
Advisors, Inc.
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Portfolio DiversificationLevel III
U.S. Large Cap Stocks value tilt U.S. Small Cap
Stocks microcap/value Foreign Stocks
(smallcap/value tilt) Real Estate Investment
Trusts (REITs) U.S. Short-Term Bond
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Some Suggested Readingabout the Advantages of
Indexed Investing

• A Random Walk Down Wall Street, Burton Malkiel
• The Four Pillars of Investing, William Bernstein
• Common Sense on Mutual Funds, John C. Bogle
• What Wall Street Doesnt Want You to Know, Larry
  Swedroe
• All About Index Funds, Richard Ferri
• Columns by Jonathan Clements in the Wall Street
  Journal
• appear on Wednesdays
• www.indexfunds.com
• www.dfaus.com (the site of Dimensional Fund
  Advisors)

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Index Investing Approaches
Do It Yourself - Not difficult for those with
some financial savvy and willingness to
devote some time to the job - Easier to set up
and maintain if the asset allocation is
simple Use an Advisor - Should be low cost
(e.g., Forest Financial charges .5) - Needed
for those who are not Do-It-Yourselfers -
Better assures timely portfolio monitoring and
rebalancing - Only certain advisors can
provide access to the most competitive
structured or enhanced index funds
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