STRATEGIES FOR ACHIEVING YOUR INVESTMENT GOALS. Asset Allocation, Diversification, and Risk

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1 STRATEGIES FOR ACHIEVING YOUR INVESTMENT GOALS Asset Allocation, Diversification, and Risk

2 WHAT IS ASSET ALLOCATION? WHAT IS DIVERSIFICATION? UNDERSTANDING RISK AND RETURN DIVERSIFICATION HELPS MANAGE RISK IMPROVE YOUR CHANCES FOR SUCCESSFUL INVESTING INVESTOR CASE STUDIES PG 2 3 PG 4 5 PG 6 7 PG 8 9 PG PG Mutual Funds: ARE NOT INSURED BY THE FDIC OR ANY FEDERAL GOVERNMENT AGENCY MAY LOSE VALUE ARE NOT A DEPOSIT OF OR GUARANTEED BY ANY BANK OR ANY BANK AFFILIATE

3 Your guide to asset allocation, diversification, and risk 1 Like many aspects of life in the 21st century, the financial markets have become increasingly complex. With thousands of investment products to choose from, including about 8,300 mutual funds, 1 how do you decide which ones can help you achieve your long-term goals? Is there a way to make sense of the market s information overload so you can invest with more confidence? The most sophisticated investors, such as the professionals who manage pension plans and institutional accounts, use the time-tested strategies of asset allocation and diversification. They ve found that this approach helps them select suitable investments and manage risk in any market environment. The same strategies can work as well for an individual investor like you. In one study, 75% of investors who used asset allocation achieved higher returns than those who invested equally in six different asset classes. 2 We believe that your asset allocation should be developed with the assistance of an experienced financial professional who can help define your goals, time horizon, and risk tolerance, then narrow the universe of investment choices so you can select suitable ones. This can be a powerful advantage in reaching your investment goals. 1 Investment Company Institute, Hulbert Financial Digest as cited on CBS.Marketwatch.com, June 6, 2002.

4 Your Guide to A SSET A LLOCATION, DIVERSIFICATION, and R ISK 2 What is asset allocation? People invest for a variety of reasons, such as capital growth, current income, and preservation of capital. There are various ways to reach these goals for example, by investing specifically in large-company stocks or in long-term bonds. Asset allocation is the process by which you spread assets across different types of investments whose characteristics match your specific needs. It can help you identify an appropriate mix of investments by balancing your goals, time horizon, and risk tolerance, taking into account the historical returns of various investments. THREE BASIC TYPES OF INVESTMENTS Most investors include three types of investments in their asset allocation. The allocation proportion will vary according to the investors needs. STOCKS (equities) represent an ownership interest in a corporation. Prices of stock shares rise and fall according to the market s appraisal of their value. Stocks offer the greatest long-term growth potential, but are also subject to the greatest shortterm price swings. For this reason you may wish to decrease your stock holdings and increase holdings in bonds and cash equivalents as you get closer to retirement. BONDS (fixed income investments) represent loans that investors extend to a corporation, government entity, or other institution in exchange for interest payments. At the end of the bond term, the issuer returns the principal to the investor. Long-term returns on bonds have been lower than stocks, but bonds have usually done well during weak economies when stocks are falling. In your portfolio, bonds help to provide stable income with relatively less risk than stocks. CASH EQUIVALENTS (such as bank accounts and money markets) barely keep pace with inflation, but cash holds its value even when stocks and bonds are falling. In your portfolio, cash equivalents provide stability in bad times and liquidity for near-term expenses.

5 PERIODICALLY REBALANCE 3 In time your portfolio may shift out of balance as some market segments outperform others. It s wise to periodically check your portfolio and realign your investments, if necessary, to stay in step with your plan. And if your needs, time horizon, or risk tolerance have changed, your asset allocation may need to be adjusted. COMPARATIVE RETURNS OF $10,000 INVESTED IN JANUARY Your investment choices and annual inflation rate determine your ultimate return. $50,000 S&P 500 Small-Cap Stocks Long-term Bonds 30-day Treasury Bills Inflation $40,000 $30,000 $20,000 $10, Source: Ibbotson Associates. This chart is for illustrative purposes only, and is not indicative of the past, present, or future performance of any asset class or any mutual fund. Generally, stock returns are due to capital appreciation and the reinvestment of any gains. Bond returns are due to reinvesting interest. Stock prices are usually more volatile than bond prices over the long term. Common stock is based on the S&P 500 Composite Index, a market-weighted, unmanaged index of 500 companies in a variety of industries. It is often used as a broad measure of stock market performance. An investment cannot be made directly in an index. Government bonds and Treasury bills are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest. Long-term government bond returns are measured using a constant one-bond portfolio with a maturity of roughly 20 years. Treasury bill returns are for a one-month bill. Inflation is measured by the consumer price index (CPI). Inflation source: U.S. Department of Labor, Bureau of Labor Statistics.

6 Your Guide to A SSET A LLOCATION, DIVERSIFICATION, and R ISK 4 What is diversification? Diversification further refines your asset allocation and helps you manage risk by spreading your holdings among a variety of industries, companies, and investment types. In this way, diversification can help smooth any wide fluctuations in your returns. There are several ways in which investments may be diversified: BY ASSET TYPE: Stocks, bonds, and cash. WITHIN ASSET CLASSES: Small companies vs. large companies, corporate bonds vs. government bonds. BY INVESTMENT STYLE: Value vs. growth. BY INDIVIDUAL SECURITIES: Companies A, B, and C; Bonds X, Y, and Z. Investors can take various routes to develop a portfolio. Some choose an assortment of individual securities that they believe will provide diversification and help achieve their financial goals. Others invest in mutual funds (or a combination of individual securities and mutual funds), which are professionally managed portfolios that pool shareholders money to invest in a variety of securities. Your financial professional can help you select mutual funds based on your financial goals and diversification needs. Other alternatives are: MUTUAL FUND WRAP ACCOUNT. A structured investment program in which a financial professional helps you develop a personalized asset allocation and choose appropriate investments from a predetermined list of mutual funds in exchange for an annual asset-based fee. INDIVIDUALLY MANAGED ACCOUNTS. 3 Personalized investment programs for investors with substantial assets. They combine the benefits of professional investment management, the guidance of a financial professional, a select menu of investment options, and attention to your specific investment needs in return for an annual asset-based fee. Individual securities are purchased on your behalf by professional portfolio managers, which can provide important tax advantages. 3 Professional money management might not be appropriate for all investors.

7 ASSET CLASSES 5 Mutual funds and portfolios are commonly categorized using the asset classes shown below. As a rule of thumb, equities are more volatile than bonds; small- and mid-cap funds are more volatile than large-cap funds; and international investing involves added risks compared with domestic investments. Short- and Intermediate-Term Bond Looks for current income and reasonable stability of principal using government and corporate bonds subject to credit risk. Shorter maturities help reduce interest-rate risk. Large-Capitalization Equity Seeks long-term capital growth by investing in large, well-established companies with good prospects for capital appreciation. Small- and Mid-Capitalization Equity Looks for more dramatic long-term capital growth from smaller companies that may have substantial growth potential and may be subject to greater swings in share price. Balanced (or Allocation) Seeks to invest for capital growth and current income through a portfolio of both stocks and bonds. Longer-Term Bond Strives for high returns using bonds with longer maturities. May invest in lower-quality bonds. Subject to both credit risk and price fluctuation, and tends to be more volatile than shorter-term bonds. International Bond Seeks income and price appreciation by investing in bonds issued by foreign corporations and governments. Subject to credit risk, the impact of currency fluctuation, and political, social, and economic changes. Municipal Bond Provides income free from federal income tax by investing in bonds issued by state and local governments. 4 4 Income for some investors may be subject to alternative minimum tax (AMT). International Equity Seeks long-term capital growth from foreign companies, which may offer more dramatic growth potential than the U.S. market, but with risks related to currency fluctuation and political, social, and economic changes. Money Market Provides current income while offering liquidity and capital preservation. Offers minimal risk with modest returns. Not insured or guaranteed by the U.S. government (unlike bank CDs). 5 5 There is no assurance each money market fund will be able to maintain a stable $1 NAV per share or that its objective will be achieved. Although money market funds seek to preserve the value of your investment at $1 per share, it is possible to lose money by investing in these types of funds.

8 Your Guide to A SSET A LLOCATION, DIVERSIFICATION, and R ISK 6 Understanding risk and return In its simplest terms, risk is the possibility of loss. All investments involve a certain amount of risk: there is risk in the type of mutual fund or stock you choose, risk in the stocks or bonds a fund invests in, and even risk in trying to avoid risk. Risk and return go hand in hand. As an investor, risk is the price you pay for potential return. The more potential return an investment offers, the more at risk your money is; lower potential return, lower risk. Just as there are no guarantees in life, there is no such thing as a risk-free investment. All investments are exposed to market-wide or systematic risks, such as interest-rate changes, dips in the business cycle, inflation, and drops in consumer confidence. Professional investment managers often use complex techniques to recognize, measure, and manage such risks to the extent possible, but they cannot completely eliminate them. YOUR RISK TOLERANCE An investment will perform the same way regardless of who owns it. But no two investors will view the riskiness of that investment in precisely the same way. Suppose two investors agree completely on the risk of a particular investment. They also agree there is a chance of the stock returning 10% or more over the next year. Does that mean that the two investors will be equally willing to own the stock? The answer is no. There is a difference between the riskiness of an investment and your personal tolerance for risk. Risk tolerance is your willingness or unwillingness to expose your money to possible loss. SPEAK WITH A PROFESSIONAL Any investment that causes you to lose sleep is too risky for you. Your financial professional has tools to help you balance your expectations of return with your risk tolerance, and choose an appropriate asset allocation.

9 ANNUAL TOTAL RETURNS We recommend that you develop a diversified asset allocation with the Year 94 Value Stocks 2 Growth Stocks 3 Small- Company Value Stocks 1 Small- Company Growth Stocks 2 Foreign Stocks 8 Bonds 3 7 help of a financial professional. The chart shows how the best perform ing asset classes often change from year to year, and how difficult it is to predict the market s next move Diversification improves your chances of participating in whatever market segment is currently performing well, while reducing the risk from any single investment performing poorly Source: Lipper Analytical New Applications (LANA). This chart is for illustrative purposes only, and is not intended to represent the past, present, or future performance of any particular security. Value stocks are represented by the Russell 1000 Value Index, an unmanaged index containing 1,000 securities with a less-than-average growth orientation and lower price-to-book and price/earnings ratios. Growth stocks are represented by the Russell 1000 Growth Index, an unmanaged index containing 1,000 securities with a greater-than-average growth orientation and higher price-to-book and price/earnings ratios. Smallcompany stocks are represented by the Russell 2000 Index, an unmanaged index of 2,000 smallcompany stocks. Foreign stocks are represented by the Morgan Stanley EAFE Index, an unmanaged, market capitalization-weighted index that reflects stock price movements in Europe, Australasia, and the Far East. Bonds are represented by the Lehman Brothers Aggregate Bond Index, an unmanaged, weighted index of 5,355 bonds, including government, corporate, and mortgage- and asset-backed securities. All issues have at least a one-year maturity and an outstanding par value of at least $100 million. Past performance is not indicative of future results. Investors cannot buy or invest directly in market indexes or averages. Things to consider: Have you divided your assets among stocks, bonds, and cash? What portion of your portfolio is in each? In what ways are your assets diversified?

10 Your Guide to A SSET A LLOCATION, DIVERSIFICATION, and R ISK 8 Diversification helps manage risk Imagine you have invested all your money in the stock of a single company. Your retirement or your children s education would depend entirely on how well that company performed. You might do well, but you might also have many sleepless nights. You are vulnerable to company risk. What if you buy the stocks of three or four companies, such as auto manufacturers? Your investments might do well after all, everyone has to drive. But if Congress imposed a high gasoline tax or the price of steel tripled unexpectedly, auto company stocks your entire portfolio would probably suffer. By investing in only one industry, you are exposed to sector risk. Suppose you spread your money around, investing in oil companies, healthcare, computer makers, clothing, fast food, trucking, electronics, and banks. You may be okay unless the economy slows down and consumers stop buying, which may cause most of your stocks to grind to a halt. You are diversified among many industries, but are still exposed to market risk. All types of securities are exposed to market risk. During a time when your stocks were falling in value, the bond market was probably doing well, as it often does in times of recession. Putting some of your money in bonds might have given you a cushion and helped reduce the impact of a stock market downturn on your overall portfolio. This would help you limit asset class risk.

11 LIMITING RISK BY DIVERSIFYING YOUR PORTFOLIO 9 It s important to spread your holdings among companies, sectors, and asset classes. In this way you can manage or limit certain types of risks to your investment. A PORTFOLIO WITH... LIMITS... COMPANY RISK SECTOR RISK STOCKS OF ONE COMPANY STOCKS OF A NUMBER OF COMPANIES IN THE SAME INDUSTRY STOCKS FROM A VARIETY OF INDUSTRIES STOCKS AND BONDS FROM VARIOUS ASSET CLASSES MARKET RISK ASSET CLASS RISK Your financial professional can help you understand the risks you are exposed to before you invest money. Things to discuss with your financial professional: Are you uncomfortable with one or more of the asset classes? How many mutual funds should you own? Are particular stocks or bonds duplicated throughout your portfolio?

12 Your Guide to A SSET A LLOCATION, DIVERSIFICATION, and R ISK 10 Improve your chances for successful investing The combined strategies of asset allocation and diversification are part of an overall process that offers investors a disciplined, time-tested approach to investing. We also believe that every investor should take advantage of the expertise and services that a financial professional offers. 1. IDENTIFY YOUR GOALS Your financial professional will ask specific questions to determine your reasons for investing, the time you have to reach your goals, and the amount of risk you re comfortable assuming. These are components of your investor profile. 2. DEVELOP AN ASSET ALLOCATION STRATEGY Based on your investor profile, your financial professional will develop an appropriate asset allocation. He or she may use a variety of financial planning tools to do so. To be effective, this should take into account all your invested assets, including other retirement and investment accounts you may have, so it s a good idea to share all your quarterly statements with your financial professional. 3. SELECT A DIVERSIFIED GROUP OF INVESTMENTS Your financial professional will recommend specific investments to implement your asset allocation, taking into account your need for growth, income, and stability. The performance of investment managers can greatly affect your progress toward long-term goals. 4. MONITOR YOUR PROGRESS Your portfolio should be reviewed periodically and rebalanced, if necessary, to keep it aligned with your strategy. It may need adjustment, for instance, if your goals or risk tolerance change as you get closer to retirement. Through periodic contact with your financial professional, you can also gain valuable insight into market developments and review manager performance, so don t hesitate to call when you have questions or concerns.

13 1 Identify your goals 2 Develop an asset allocation strategy 11 4Monitor your progress 3 Select a diversified group of investments

14 Your Guide to A SSET A LLOCATION, DIVERSIFICATION, and R ISK 12 Investor case studies READY FOR THE GOOD LIFE With children grown and the mortgage paid off, Pete and Marie are looking forward to a long, comfortable retirement. They need a sizable income to supplement Social Security, but are concerned about depleting their nest egg too early in retirement, which they hope will last 20 or 25 years. They decide to seek the help of Tom Dow, a financial professional. Tom suggests a combination of stocks, bonds, and cash equivalents to help meet their needs and goals: stocks for growth to stay ahead of inflation, bonds for stable income, and cash for everyday expenses and emergencies. With Tom s guidance, Pete and Marie decide to invest their portfolio as follows: Case 1 50% 20% (10% HIGH YIELD, 20% MUNI, 20% GOVT) 30% IN A MONEY MARKET FUND to avoid having to sell other investments in case of emergency. IN TWO LARGE-COMPANY STOCK FUNDS, one managed in a value style and the other managed in a growth style. Tom has explained that the two approaches often perform better at different times. IN BONDS with 10% in a high yield bond fund (which offers greater potential for income but with greater risk), 20% in a municipal bond fund (for tax-exempt income), and 20% in a government bond fund (for stability and security).

15 13 MAKING PROGRESS Laura has 30 more years to invest before she is ready for retirement. She is a single mother with an eight-year-old son who should be ready for college in 10 years. Laura knows her portfolio needs growth and her time horizon is long enough to ride out market swings. With the help of her financial adviser, she develops an investment program concentrated in stocks. As her son approaches college age, Laura plans to shift some of her portfolio away from stocks to bonds and cash. When she is in her fifties, she will gradually shift more assets out of stocks and into fixed income. Case 2 65% 20% (25% LARGE-CAP, 20% SMALL-CAP, 20% INTL) 15% IN A HIGHER-QUALITY BOND FUND as a cushion against stock market swings and to provide a small amount of income. IN A MONEY MARKET FUND for liquidity. IN STOCKS, spreading the risk among several asset classes (25% in a large-company stock fund, 20% in a small-company fund, and 20% in an international fund).

16 For more information about a JennisonDryden Mutual Fund, call your financial professional for a free prospectus. You should consider the Fund s investment objectives, risks, and charges and expenses carefully before investing. The prospectus will contain this and other information about the investment company. Mutual Funds: ARE NOT INSURED BY THE FDIC OR ANY FEDERAL GOVERNMENT AGENCY MAY LOSE VALUE ARE NOT A DEPOSIT OF OR GUARANTEED BY ANY BANK OR ANY BANK AFFILIATE Financial professionals are not tax or legal advisers. Please consult your tax or legal adviser regarding your particular situation. Shares of JennisonDryden mutual funds are distributed by Prudential Investment Management Services LLC (PIMS), Three Gateway Center, 14th Floor, Newark, NJ JennisonDryden is a registered trademark of The Prudential Insurance Company of America. IFS-A JD1479 Ed. 02/01/2005