Principles of Investing Outline

Transcription

1 Principles of Investing Outline Speaker Background Historical Returns & Market Timing Types of Investment Risk Monte Carlo Asset Allocation Modern Portfolio Theory & Efficient Frontier Systematic Investing Dollar Cost Averaging IRAs 1

2 Speaker Background Bachelor of Physics & Math Minor OSU 1993 US Army Officer Estate & Financial Planner 2001 NASD/SEC Series 7 & 66 License Life, Health, Disability Insurance Licensed Certified in Long-Term Care Enrolled in MBA Program at OSU Currently President of VisionQuest Consulting, LLC Stocks, Bonds, Bills, and Inflation $100 $10 company company Government Treasury bills Inflation Ending wealth Average return $ % $ % $ % $1 $ % $ % $ Hypothetical value of $1 invested at year-end Assumes reinvestment of income and no transaction costs or taxes. 2

3 Hypothetical value of $1 invested from year-end Dangers of market timing $15 $11.50 $10 $5 $2.71 $2.79 $0 S&P 500 S&P 500 minus best 17 months Treasury bills This is for illustrative purposes only and not indicative of any investment. Past performance is no guarantee of future results. 3/1/2004 Types of Investment Risk Inflation purchasing power Capital loss of capital Timing when to invest Interest Rate fluctuation Reinvestment interest rates Call - Market systematic risk Credit - default Liquidity - marketability Legislative changes to law 3

4 Risk Versus Return Stocks, Bonds, and Bills % company 12% company 10% Return 8% 6% 4% Intermediate-term government Treasury bills Long-term government 2% 0% 0% 5% 10% 15% 20% 25% 30% 35% 40% Risk Risk is measured by standard deviation. Return is measured by compound annual return. Monte Carlo Scientific Approach Start with Needs Analysis and Assumptions Run Several Thousand Simulations Analysis of End Results project probability of success 4

5 Asset Allocation What is it? The term refers to allocating money among broad asset classes: Stocks (equities) Bonds (fixed-income) Cash Real estate Precious metals & others The Importance of Asset Allocation Facilitates diversification, which helps identify a balance between rates of return and risk (Ibbotson Associates) 5

6 Modern Portfolio Theory - Diversification Risk reduction through diversification is the predominant objective of asset allocation Done by investing in different asset classes that don t always perform the same By allocating portions of your portfolio in different asset classes, you can decrease the risk and potentially increase the rate of return Emphasis on risk vs. reward of total portfolio rather than individual securities Why Is Asset Allocation Important? Contributing Factors of Portfolio Performance 91.5% Asset Allocation Policy 93.3% Asset Allocation Policy + Market Timing 97.9% Asset Allocation Policy + Market Timing + Security Selection 100% Asset Allocation Policy + Market Timing + Security Selection + Other Percent 6

7 Asset Class Winners and Losers Highest Return Lowest Return Stocks and Bonds: Risk Versus Return % maximum risk portfolio 100% 80% 20% 12% 50% 50% 60% 40% Return 11% 25% 75% minimum risk portfolio 10% 100% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% Risk Risk is measured by standard deviation. Return is measured by arithmetic mean. Risk and return are based on annual data over the period Portfolios presented are based on modern portfolio theory. 7

8 Benefits of Bonds in a Portfolio Potential Growth Historically Lower Risk Diversification Benefits Income Generation Expand Efficient Opportunities % Bonds expand efficient opportunities 16% 15% Stock portfolios Stock and bond portfolios company 14% Return 13% 12% 11% company 10% 9% Bonds 8% 5% 7% 9% 11% 13% 15% 17% 19% 21% 23% 25% Risk Risk is measured by standard deviation. Risk and return are based on annual data over the period Portfolios presented are based on modern portfolio theory. 8

9 Efficient Frontier Scientific approach using historical data Analysis of historical average returns coupled with standard deviation statistics Recommends asset allocation changes based on overall portfolio makeup (reduce risk, increase return, or combination) Dollar-Cost Averaging Periodic purchase of a fixed dollar amount in securities (typically Mutual Funds) Averages out the cost per unit in a fluctuating market Helps reduce risk by controlling the cost 9

10 Individual Retirement Accounts (IRAs) Traditonal IRA Roth IRA Educational IRA - Coverdell Traditional IRA 100% of earned income to max of $5000 ($6000 > 50) Spousal IRA Contributions are tax-deductible (eligibility based on participation in employer sponsored plan 401(k)) Growth is tax-deferred Required Minimum Distributions (RMDs) 70 ½ Early withdrawal penalty < 59 ½ - 10% & taxable Some exceptions Distributions are taxable income 10

11 Roth IRA Created in 1997 Eligibility based on current MAGI 100% of earned income to max of $5000 ($6000 > 50) Spousal IRA Contributions are NOT tax-deductible Growth is tax-free No Required Minimum Distributions (RMDs) Early withdrawal penalty < 59 ½ - 10% & taxable Some exceptions Distributions are NOT taxable income QUESTIONS????? 11