Fundamentals of Investing for Retirement Income. How Diversification Really Works

Transcription

1 Fundamentals of Investing for Retirement Income How Diversification Really Works

2 Mike Miles Founder and Principal Advisor, Variplan, LLC Certified Financial Planner Registered Investment Advisor SEA Benefit Provider Since 1999 Federal Times Money Matters Columnist Ask the Experts Panelist at

3 Course Content 1. Success and Failure in Retirement Investing 2. Defining Retirement Resources, Goals and Constraints 3. Understanding Investment Risk and Return 4. How Diversification Really Works 5. Asset Classes and Types Diversification and Concentration 6. Understanding Asset Allocation and Hedging 7. Setting Investment Performance Expectations 8. Managing Investment Costs 9. The Case for Index Investing 10. Accounting for Inflation in Retirement Planning 11. Managing Portfolio Liquidity 12. Organizing Your Portfolio

4 SEA Member Benefits Free Hour of Consulting / Analysis $250 Vantage Discount Questions to me at mmiles@variplan.com

5 Lesson 3 Review Understanding Investment Risk and Return

6 Investment Risk Investment risk is the possibility that an investment will produce an unexpected return. Investment risk applies to: Average Rate of Return Periodic Returns (Sequence)

7 Investment Return Investment return is the change in value that an investment produces in exchange for taking risk. Investment return consists of: Yield Price Appreciation / Depreciation

8 Investment Risk and Return Risk and return are tied together. Risk is the means to an end. Risk and return can be quantified and managed. You should expect to be paid to take risk.

9 Investment Risk and Return When it comes to investing for retirement income, the primary objective is to realize the expected return in each and every period. Predictability is the most valuable commodity.

10 Quantifying Risk and Return Return is expressed as a percentage of the amount invested. Risk is usually expressed as Standard Deviation.

11 Frequency Standard Deviation Expected -1 SD +1 SD 34.1% 34.1% 2.1% -2 SD +2 SD 2.1% 13.6% 13.6% -3 SD +3 SD Rate of Return

12 Standard Deviation +2 SD +1 SD 2.3% 13.6% Expected 34.1% 84% 98% 34.1% -1 SD -2 SD 13.6% 2.3%

13 Expected Return The Efficient Frontier Unavailable Inefficient Risk

14 Expected Return Designing Efficient Portfolios Unavailable Inefficient Risk

15 Lesson 4 The Way Diversification Really Works

16 Financial Planning and Management Goals Resources Management Performance Success Wants Needs Guaranteed Annuities Insurance At Risk Liquid Assets Cash Marketable Securities Illiquid Assets Real Estate Business Interests Action Constraints Decisions Analysis Assumptions Experience Probabilities Estimates Risk Return Cash Flow Wealth Inflation & Taxes

17 Diversification Intra-Market (Within Markets) Inter-Market (Between Markets)

18 Intra-Market Diversification Security A Specific Risk 1

19 Intra-Market Diversification Security A Specific Risk 1/2 Security B

20 Intra-Market Diversification Security A Specific Risk 1/4 Security B Security C Security D

21 Intra-Market Diversification A

22 Portfolio Risk Intra-Market Diversification Security-Specific Risk Market Risk Number of Securities in the Portfolio

23 Value Intra-Market Diversification Time

24 Inter-Market Diversification Asset A Asset B Portfolio = 50% Asset A + 50% Asset B

25 Inter-Market Diversification

26 Single Small Cap Stock +183% +99% Expected Annual Return: 15% Standard Deviation: 84% +15% 84% 98% -69% -153%

27 Expected Return The Efficient Frontier Inefficient Risk

28 Expected Return The Efficient Frontier Inefficient Risk

29 Single Large Cap Stock +122% +67% Expected Annual Return: 12% Standard Deviation: 55% +12% 84% 98% -43% -98%

30 Expected Return The Efficient Frontier Inefficient Risk

31 Expected Return The Efficient Frontier Inefficient Risk

32 Small Cap U.S. Stocks S Fund +71% +43% Expected Annual Return: 15% Standard Deviation: 28% +15% 84% 98% -13% -41%

33 Expected Return The Efficient Frontier Inefficient Risk

34 Expected Return The Efficient Frontier Inefficient Risk

35 Large Cap U.S. Stocks C Fund +48% +30% Expected Annual Return: 12% Standard Deviation: 18% +12% 84% 98% -6% -24%

36 Expected Return The Efficient Frontier Inefficient Risk

37 Expected Return The Efficient Frontier Inefficient Risk

38 Aggressive Portfolio +46% +29% 55% 26% 9% 1% 9% C Fund S Fund I Fund G Fund F Fund +12% 84% 98% -5% -22%

39 Expected Return The Efficient Frontier Inefficient Risk

40 Expected Return The Efficient Frontier Inefficient Risk

41 Balanced Portfolio +32% +21% 40% 15% 5% 3% 37% C Fund S Fund I Fund G Fund F Fund +10% 84% 98% -1% -12%

42 Expected Return The Efficient Frontier Inefficient Risk

43 Expected Return The Efficient Frontier Inefficient Risk

44 Conservative Portfolio +23% +15% 20% 7% 3% 10% 60% C Fund S Fund I Fund G Fund F Fund +7% 84% 98% -1% -9%

45 Expected Return The Efficient Frontier Inefficient Risk

46 Expected Return The Efficient Frontier Inefficient Risk

47 Diversification Essential for Risk Efficiency Reduces Risk Faster than Return Is Not Arbitrary Is Easily Accomplished in the TSP

48 Next Week s Webinar 1. Success and Failure in Retirement Investing 2. Defining Retirement Resources, Goals and Constraints 3. Understanding Investment Risk and Return 4. How Diversification Really Works 5. Asset Classes and Types Diversification and Concentration 6. Understanding Asset Allocation and Hedging 7. Setting Investment Performance Expectations 8. Managing Investment Costs 9. The Case for Index Investing 10. Accounting for Inflation in Retirement Planning 11. Managing Portfolio Liquidity 12. Organizing Your Portfolio

49 SEA Member Benefits Free Hour of Consulting / Analysis $250 Vantage Discount Questions to me at mmiles@variplan.com

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