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Developing Your Asset Allocation Strategy for Retirement

Developing Your Asset Allocation Strategy for Retirement. Developed by Barbara O’Neill, Ph.D., CFP, Rutgers Cooperative Extension Adapted by Jean Lown, Ph.D. Family, Consumer & Human Development, USU. Financial Planning for Women. Second Wednesday of the month 12:30-1:30 in Family Life 318

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Developing Your Asset Allocation Strategy for Retirement

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  1. Developing Your Asset Allocation Strategy for Retirement Developed by Barbara O’Neill, Ph.D., CFP, Rutgers Cooperative Extension Adapted by Jean Lown, Ph.D. Family, Consumer & Human Development, USU

  2. Financial Planning for Women • Second Wednesday of the month • 12:30-1:30 in Family Life 318 • bring your lunch • 7-8:30 at Family Life Center (500 N & 700 E – bottom of Old Main Hill) • Same program • For email reminder: Sign up sheet or send email to Lown@cc.usu.edu

  3. Overview • Asset Allocation Principles • Risk-Return Relationship • Application to Utah Retirement System (URS) options • Application to TIAA-CREF Retirement Investment Options • 9 new investment choices (as of 2003)

  4. What Is Asset Allocation? • Process of diversifying portfolio investments among several investment categories to reduce investment risk • Example: 50% stock, 30% bonds, 20% cash assets (e.g., Treasury bills) • Objective: lower investment risk by reducing portfolio volatility • Loss in one investment may be offset by gains in another

  5. 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.

  6. The Callan Periodic Table of Investment Returns • Illustrates the need for asset allocation • Shows how various asset classes performed during the last 20 years • Best performing asset class changes (e.g., large company growth stocks: 1995-99 versus 2000) • One year’s “winner” can be next year’s “loser,” so you invest in them all

  7. Why Asset Allocation? Because Market Timing is Futile • Value of $100 invested in large company stocks (S&P 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 (can’t afford to miss)

  8. Second Example: The Futility of Market Timing • If investor stayed fully invested, return was 41.4% • If investor missed top 10 trading days of 1998, 1999, and 2000: -41.7% return • Based on S&P 500 stock market index • Moral: stay invested in both bull & bear markets

  9. 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.

  10. Why Use Asset Allocation? To Increase Long Term Investment Results • Scenario #1: $100,000 invested at 8% over 25 years grows to $684,848 • Scenario #2: $100,000 divided equally among 5 investments (One loses principal and other 4 earn 0%, 5%, 10%, and 15% average annual returns). • Diversified portfolio will grow to $962,800 over the long term

  11. 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 • Your age and net worth

  12. 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 • Asset allocation attempts to reduce volatility and provide a competitive rate of return

  13. Large company growth stocks Large company value stocks Small company growth stocks Small company value stocks Mid cap growth stocks Mid cap value stocks Foreign stocks Developed Emerging Bonds Domestic International Real estate (e.g., REITs) Cash assets (e.g., CDs, Treasury bills) Major Asset Classes

  14. Historical Average Annual Rates of Return • Small Co. U.S. stocks = 12.6% • Large Co. U.S. stocks = 10.4% • annual returns -50% to +50%!! • Government Bonds = 5.1% • Treasury Bills = 3.8% • Inflation = 3.1%

  15. 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 world’s equity markets

  16. The Asset Allocation Process • Define goals and time horizon • Assess your risk tolerance • Identify asset mix of current portfolio • Create target portfolio (asset model) • Specific investment selection • Review and rebalance portfolio

  17. 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

  18. More Asset Allocation Tips • Stick to your asset allocation model unless personal circumstances change • Rebalance when asset percentages change by a certain amount (e.g., 2%) • TIAA-CREF will rebalance automatically (sign up for this feature) • Any one sector no > 10%- 30% • Ignore outdated guidelines (100 - age)

  19. 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 stocks lost value

  20. Relationship Between Risk and Return High Int’l Stocks U.S. Stocks Real Estate Expected Return Int’l Bonds U.S. Bonds Cash Equivalents Low Low Risk High For illustrative purposes only. Not indicative of any specific investment.

  21. 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

  22. Recent Example • 2000-2003 • Thank goodness some of my portfolio was in bonds & real estate! • Stocks tanked • Bonds rallied • Real estate saved the day

  23. 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 = 3-4% • Risk is relative • Short term volatility=long term growth • Invest in stocks for growth

  24. Understand Risk Tolerance • Beware of taking risk tests and settling for a conservative portfolio • How long are you likely to live? • Conservative investors risk outliving their assets

  25. Stock Capitalization • Large Cap companies: valued at >$5 billion • ExxonMobil, General Electric, Microsoft • Mid-Cap: $1-5 billion • Bath & Beyond, Monsanto, Hilton Hotels • Small-Cap: <$1 billion • Earthlink, FirstFed Financial, Vintage Petroleum

  26. Asset Allocation Resources • Periodic Table of Investment Returns • Callan.com • Ibbotson Knowledge Center: Education • Asset Allocation slide show • Ibbotson.com

  27. Income 5.8% Bond 8.1% Balanced (stocks, bonds & cash) 8.9% Large Cap Stock Value 15.5% Large Cap Stock Index 10.6% Large Cap Stock Growth 11.0% International 8.2% Small Cap 12.4% Utah Retirement System Funds 10 year returns as of 9/30/04 Low to high risk/return

  28. URS Horizon Funds • Fixed asset allocation in one fund • One stop shopping • IF it suits your needs • Automatic rebalancing quarterly

  29. Time Horizon for Retirement? • Until the day you retire? • Until the day you die?

  30. 65% bonds 20% income 10% index 5% international 5 year time frame 5 years to retirement or until death? Conservative Low (but +) return (~6%) Subtract inflation of 3.5% = 2.5% Short Horizon Fund

  31. 45% bonds 15% international 15% index 10% growth 10% value 5% small cap 5-10 year horizon More diversified -6.8% to +20.7% 1998-2003 5 year avg.= 3.8% 5 years is too short to judge Medium Horizon Fund

  32. 20% bonds 25% international 25% index 10% growth 10% value 10% small cap 10 or more years Higher risk = potential for higher returns -13.6% to +27.6% 5 year avg.= 2.4% You’re in it for the long run Long Horizon Fund

  33. TIAA Traditional TIAA Real Estate CREF Money Market CREF Social Choice CREF Stock Global Equities Growth Equity Index TIAA-CREF

  34. Real Estate Securities Growth & Income S&P 500 Index Large Cap Value Social Choice Equity Mid-Cap Value Mid-Cap Growth Small-Cap Equity International Equity 9 New Fund Choices

  35. Global vs. International • Global: U.S. and foreign • International: at least in theory, all foreign

  36. Murky Mixture • Few of the funds are “pure” • CREF Stock • 80% LG, 15% Mid, 5% Small-Cap • Some foreign stocks • Mid-Cap Growth • 59% LG! 39% Mid, 2% Small-Cap • Read Prospectus (or at least the summary)

  37. Growth Portfolio • 10-15% International • 10-15% Small-cap • 10-15% Mid-Cap • 10-15% Real Estate • 10-15% Bonds • STOCKS!

  38. Adjusting Your Allocation • You can change future allocations • You can transfer current balance among asset classes • Use web sites • Sign up for automatic rebalancing with TIAA-CREF

  39. Great Internet Resources • URS.org • Tiaa-cref.org

  40. Tips For Funding a Tax-Deferred Employer Plan • Diversify across asset classes • Avoid market timing • Choose investments with good historical performance • >10 year track record

  41. The Big Picture • Same principles can be applied to • 401(k) plans • Individual retirement accounts (IRAs) • Other retirement plans • Past returns are NO guarantee for the future!! • 5-10 year track record is too short!

  42. Key Considerations For Successful Investing • Establish policies and objectives • Stick to your plan and stay focused • Educate yourself to make informed decisions • Monitor investment performance • If you need help, seek a professional advisor

  43. Your “Action” List • Review your current asset allocation • Consider your other retirement accounts • Use the URS/TIAA-CREF web sites • Risk tolerance quiz • Asset allocation calculators • Talk with a representative • Reallocate, Rebalance, Re-visit

  44. Before You Decide • Read the website • Understand the risks • Make careful choices • You can always change your mind so don’t be afraid to change your asset allocation.

  45. URS & TIAA-CREF Reps at USU • URS Cache County Offices, 179 N. Main, 1st floor conference room • Jan 13, Feb 10, March 10, noon-5 • Tuesday, May 10; seminar 9-4:30 • TIAA-CREF • Sign up with Human Resources

  46. Questions? Comments? Experiences? Feb. 9 FPW: Investing on a Shoestring Please fill out evaluation form Ideas for future programs Sign up for baby boomer retirement study

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