Expected Stock Market Returns Page 2. Risk Levels in Retirement Page 5. Stock Market Past Returns Page 7. Asset Class Returns Page 11

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1 Index Expected Stock Market Returns Page 2 Risk Levels in Retirement Page 5 Stock Market Past Returns Page 7 Asset Class Returns Page 11 Bull & Bear Market History Page 13 Expected Returns & Risk January 2019 Investor Returns Page 16 Advisor Returns Page 18 Elections and the Stock Market Page 20 Investor Education Investor Education is Critical to reach your Financial Goals Wealth gives you Freedom and Control of your Life Setup an Auto-Investment Plan to Invest on a Regular Basis in Bull and Bear Markets Create a Diversified Portfolio with the Proper Asset Allocation Purchase Quality Investments Manage your Portfolio Properly PDM Investment Services, LLC A Registered Investment Advisor 5131 Standish Drive, Troy, Michigan * * info@fginvestor.com For complete disclosure see our website 1

2 Expected Stock Market Returns: PDM Annual return predictions should be calculated over the long term of five to ten years. Expected returns are higher after a bear market when valuations are low. Expected returns are lower in mature bull markets when valuations are high, like today. Stock market total return is based on fundamental returns (earnings growth and dividend yield) and speculative return (valuation expansion). Earnings growth can change fast and valuation expansion (speculative return) is impossible to predict. Global growth is now lower in the 3.0% to 4.0% range. Productivity slowed and the population is aging. Developed countries like the United States, Europe and Japan are growing in the 2.0% to 3.0% range. Emerging markets like China, India and Latin America are growing in the 4.0% to 5.0% range. Labor Force Growth + Productivity Growth Expectations = 2.0% Dividend yields over the past 100 years were around 4.0%, but have slowed to around 2.5%. The PE ratio of the S&P 500 (SPY) at the end of 2017 was 22.7 past & 21.7 forward looking. The current PE ratio is higher than the average PE of 18 and could contract 15% to get to the norm. Expected returns of a 70% stock & 30% bond portfolio will be low with less support from stocks and bonds. Stock market contributions will be low because the stock market is over-valued. Bond fund returns will be low from low yields and the potential of rising interest rates. 30-year bond rally over. Since the 1980 s stocks and bonds moved together benefiting from falling interest rates, falling inflation and rising productivity. Alternative investments may fill some of the gap in portfolios. The earnings yield predictor is predicting a 6.6% annual return going forward. (1/21.7 forward PE = 4.6% + 2.0% dividend yield) The forward PE and subsequent 5-yr annualized returns indicator is predicting a 5.4% annual return. Expected Returns are based on past performance, a secular bull market and future expectations from various sources. Returns in the table reflect average annual S&P 500 total returns going forward, but are not guaranteed. For real return, subtract 2.5% for inflation. The global stock market performance, asset allocation and equity selection contribute to portfolio performance. The earnings growth, dividend yield and PE expansion indicator are predicting a 5.0% annual stock market return going forward. (see calculation below) Earning Dividends PE Total Return Expectations Growth Yield Expansion Next 5 Years (Annualized) Past Stock Market 4.0% 4.0% 1.0% 9.0% Future Stock Market 4.0% 2.5% -1.0% 5.5% High volatility, higher risk of loss Moderate Allocation Portfolio (75% stocks / 20% bonds / 5% cash) 5.0% Moderate volatility, less risk of loss Future Bond Mix 3.0% Money Market, CD or Short-Term Bond Fund 2.0% Low volatility and limited risk of loss 2

3 Expected Stock Market Returns: Hays Expected returns for the next 10 years are between 2% and 5% based on the Hays Equity Valuation model. 3

4 Expected Stock Market Returns: Based on Valuations The chart below shows how future expected returns of the stock market drop as valuations rise. Valuation based predictions were more stable over the 5-year period than the 1-year period. Mid 2018 the forward PE of the S&P 500 was 16. This equates to an 8% annual return over the next 5 years. 4

5 Risk Levels in Retirement Risk Tolerance (Risk survey) Risk tolerance is the amount of short-term price volatility and long-term investment loss an investor is willing to withstand before changing their behavior. Risk tolerance also considers the risk level needed to achieve your goals. Risk comes in the form of market risk, security risk, financial risk, valuation risk, economic risk, currency risk, political risk, interest rate risk, inflation risk and liquidity risk. Most investors are not trained to know their risk tolerance. At market tops, most people will say their risk tolerance is high. At market bottoms, they will say they have no tolerance for risk. Volatility is only a problem if you sell. There is long-term risk in not owning equities. Time Horizon The longer your time horizon, the higher the risk you can take. Risk Composure (How did you react in past bull markets, corrections and bear markets?) Risk composure is an investor s ability to consistently understand and correctly perceive the risks they re taking. Risk composure determines whether you are able to effectively stay the course during extreme market volatility, market tops and market bottoms. Unstable perceptions of risk lead to poor investment returns. Achieving goals based on a long-term plan is more important than a benchmark beating returns each year. To participate in bull market gains, you must also endure the risk of corrections and bear markets. Without some risk, reward will likely-be small. Risk Level Considerations Holding large cash amounts is not recommended before or in retirement since cash rarely keeps up with inflation. The more you understand the markets, the more likely you will be comfortable with more risk. If we are in the early or middle stages of a secular bull market, you may want to take on more risk. Over long periods of time the stock market has been on an upward trend and has always recovered. Look at the 100-year stock market graph and see how insignificant corrections were over the long term. Corrections and bear markets should not worry you if you do not need most of the money at the time of the bear market. In most years, the stock market ends higher, even in years with corrections. Good moderate risk portfolios typically have one down year every four years. Look at your total investment allocation and how it will perform in a downturn, not just one of your portfolios. Retirement account value projections with injected bear markets will show you how bear markets affect your total portfolio value. Justification for Higher Risk If you do not need the money for living expenses, you can take on more risk. If you have a large pension, you may be able to take on more investment risk. If you need higher returns to support your income needs. If your job earned income is very stable into your sixties, you may be able to take on more risk. If your investment will be passed on to heirs, it is long term money that should be invested for a 30-year risk level. If you have no debt, you may be able to take on more risk. 5

6 Risk Level: Variables The 35-year bond bull market (falling interest rates) ended in Bond fund returns will likely-be much less in the future. (Past 5.0% 1998 to 2017, MGP Future 3.1%) Bond portfolios will have to have short and intermediate-term bonds, floating rate bonds, high yield bonds alternative investments and money markets to produce higher returns. The 10-year stock bull market has created higher valuations. (S&P 500) Stock fund returns will likely-be less in the future. (Past 7.2% 1998 to 2017, MGP Future 6.8%) Past Returns 60%/40% 7.2% x 60% + 5.0% x 40% = 6.3% (Past) Future Returns 60%/40% 6.8% x 60% + 3.1% x 40% = 5.4% (Future) Inflation (MGP Prediction = 2.25%) Investment Advisor Management Fees (Vary from 0.5% to 1.5%) Needs for your investment portfolio income Will you need the money for living expenses? (Do you have a large pension?) Will you have stable job earned income in your 60 s? If you do not need most of your investment income, it should be invested for its heirs at a higher risk level. How much do you want left at the end of your plan for heirs? Financial Planning Software Projections Net investment worth to rise between 60 and 90 years old Net investment worth to stay the same between 60 and 90 years old Net investment worth to fall between 60 and 90 years old Example Moderate Conservative Portfolio (60%/40%) 5.4% - Inflation 2.25% - Management Fees -0.8% = 2.4% Risk level, portfolio performance/strategy, inflation and fees do matter. Common risk levels for different age groups Annual Return Annual Return Annual Return 5/10/15 Year 10 Year High/Low Projections Moderate-Aggressive Risk 85% Equities/15% Bonds/cash 9.4%/8.8%/8.0% +39%/-38% 6.4% (25 to 45 years old) Fidelity Asset Manager 85% (FAMRX) Moderate Risk 75% Equities/25% Bonds/cash 8.2%/8.0%/6.6% +36%/-35% 6.0% (45 to 60 years old) (45 to end) Fidelity Asset Manager 70% (FASGX) Moderate-Conservative Risk 65% Equities/35% Bonds/cash 7.4%/7.6%/x +33%/-30% 5.5% (60 to end) Fidelity Asset Manager 60% (FSANX) Conservative Risk 55% Equities/45% Bonds/cash 6.6%/6.9%/6.0% +31%/-28% 5.0% (60 to end) Fidelity Asset Manager 50% (FASMX) Fidelity fund performance from Morningstar and annual return projections from Money Guide Pro. (Sept 2018) 6

7 Stock Market Past Returns: Long Term Graph See the secular bear markets during the early 1900 s, 1930 s to 1940 s, 1970 s and 2000 s. Over long periods of time the market has been on an upward trend. 7

8 Stock Market Past Returns: Year-by-Year Returns and Intra-Year Declines Below is a graph of annual returns and the intra-year decline in that year. In most years, the stock market ends higher, even in years with corrections. In order to participate in the bull market gains each year (bars above the lines), we must also endure the intra-year corrections during the year (bars below the line). 8

9 Stock Market Past Returns: Over Time Periods The chart below shows that over longer periods of time stock market returns are less volatile and more positive. Stock only portfolios are the most volatile with the highest returns, next is a mix of stocks and bonds and the least volatile and lowest returns are in an all bond portfolio. 9

10 Stock Market Past Returns: Rolling Returns The worst period in the past 100 years saw a 1% annual return from 2000 to This was a secular bear market. A bubble at the beginning of the period and two devastating bear markets created these poor results. The second worst period saw a 2% annual return from 1930 to This was a secular bear market and the Great Depression. The third worst period saw a 3% annual return from 1966 to This was a secular bear market. The stock market saw an annual return of less than 8% for 43% of the past 10-year rolling periods. The stock market saw an annual return between 8% and 12% for 22% of the past 10-year rolling periods. The stock market saw an annual return of greater than 12% for 35% of the past 10-year rolling periods. Based on history, the stock market will start producing higher annual returns after these bottom lows as a new secular bull market emerges. The secular bull markets of the past produced 18% annual returns over 10-year rolling periods. The S&P 500 (PREIX) has produced a 16.7% annual return from August 2009 thru August Expected returns are much higher after a bear market when PE s are low than in a mature bull market when PE s are high. 10

11 Asset Class Returns Money Guide Pro Asset Class Projections LCG LCV MCB SCB INT EM REAL ESTATE BOND (ITB, STB) CASH 6.5% 6.7% 7.5% 7.3% 7.3% 8.3% 5.0% 3.1% 2.3% 11

12 Asset Class Returns Asset class performance leadership changes each year. 12

13 Bull & Bear Market History Corrections & Bear Markets 13

14 Bull & Bear Market History Below is a chart of bull and bear markets and the macro environment that triggered them. 14

15 Bull & Bear Market History The 1930 s, 1970 s and 2000 s were secular bear market periods. History of U.S. Bear & Bull Markets Since 1926 This chart shows historical performance of the S&P 500 Index throughout the U.S. Bull and Bear Markets from 1926 through May Although past performance is no guarantee of future results, we believe looking at the history of the market s expansions and recessions helps to gain a fresh perspective on the benefits of investing for the long-term. The average Bull Market period lasted 8.5 years with an average cumulative total return of 458%. The average Bear Market period lasted 1.3 years with an average cumulative loss of -41%. From the lowest close reached after the market has fallen 20% or more, to the next market high. From when the index closes at least 20% down from its previous high close, through the lowest close reached after it has fallen 20% or more. 10 S&P 500 Index Return (Logarithmic Scale) 5 1 Duration % Total Return % Annualized 3.7 years 193.3% 34.1% 13.9 years 815.3% 17.2% 6 months -21.8% N/A* 15.1 years 935.8% 16.8% 6 months -22.3% N/A* 6.4 years 143.7% 14.9% 1.6 years -29.3% -19.7% 2.5 years 75.6% 25.3% 1.8 years -42.6% -27.2% 12.9 years 845.2% 19.0% 3 months -29.6% N/A* 12.8 years 816.5% 19.0% 2.1 years -44.7% -24.8% 5.1 years 108.4% 15.5% 1.3 years -50.9% -41.4% 5.3 years 188.1% 22.3% years Bull Market Bear Market Recession -83.4% -47.0% Source: First Trust Advisors L.P., Morningstar. Returns from /31/14. *Periods less than 1 year are not annualized. The S&P 500 Index is an unmanaged index of 500 stocks used to measure large-cap U.S. stock market performance. Investors cannot invest directly in an index. Index returns do not reflect any fees, expenses, or sales charges. This chart is for illustrative purposes only and not indicative of any actual investment. These returns were the result of certain market factors and events which may not be repeated in the future. Past performance is no guarantee of future results. First Trust Portfolios L.P

16 Investor Returns: Diversification and the Average Investor Below you can see how the average investor underperforms the stocks market and a diversified 60% stock/40% bond portfolio. 16

17 Investor Returns: Studies Morningstar Study, the 10-year gap between the average investor and average fund ballooned to 2.5% by the end of The typical investor gained 4.8% annualized over the 10 years ended December 2013 versus 7.3% for the typical fund. The biggest gaps were in the more volatile sectors of international equity at -3.0% gap and sector funds at -3.1% gap. Poor timing was the largest contributor. In 2012, taxable bonds saw the largest inflow of $270 billion, then in 2013 the category returned a -2%, one of the worst performers. In 2012, U.S. equity saw a -$94 billion outflow only to see the category return 34% in Much of the damage is from investors chasing performance and news coverage. Dalbar s Research, the average annual return of the do-it-yourself investor from 1984 to 2013 was 3.7%. Inflation +2.8% Average Investor +3.7% Portfolio Managers +9.1% (If 2% below the S&P 500) S&P % The huge difference between investors returns and market returns is most likely due to individual behavior, particularly during down markets. Also poor diversification, poor timing, performance following, passive portfolio management, poor emotion-based decisions at market tops and bottoms, bad investment strategies, poor asset class allocation, closed architecture, poor security selection and high costs are a drag on their performance. A good Investment Advisor underperforming the S&P 500 by 2% per year and with a 1% management fee still adds +4.4% value over the doit-yourself investor. Advisors add more value than just portfolio performance. They also provide wealth building plans, discipline, peace of mind and investment advice. After reviewing portfolios for the past 10 years, it has become apparent that the individual investor should not try to manage their own investments without the proper training, tools and dedication. The investment world continues to get more confusing and complicated. Most people find it difficult to even construct and maintain a recommended portfolio. They purchase a few investments and create a poorly designed portfolio that underperforms. Buying individual stocks is much more difficult than mutual funds and not recommended for most individuals. You should always seek professional advice unless you get the proper training, invest in the tools and are willing to put the time into portfolio design and management. 17

18 Advisor Returns A good portfolio manager aims to outperform the benchmark that it tracks based on a clients risk level. The Morningstar Conservative, Moderate and Aggressive Risk benchmarks are a good place to start for portfolio managers. Unless you are in an aggressive risk portfolio 100% invested in stocks, you should not judge your portfolio against the large cap S&P 500. A portfolio manager and risk strategy should be judged over a 3, 5 and 10 year period, not over a single year. If a manager can outperform its benchmark 3 out of 4 years with the appropriate risk, they are doing a good job relative to most fund and portfolio managers. Market conditions change during the economic cycle. No strategy can be designed to outperform in every market condition and year of the market cycle. Find a sound strategy and stick with it thru varying market conditions. It is not advisable to make any major changes to a strategy for one year of poor performance, because the market will change back to a normal year that your strategy will outperform again. Do not chase returns. Markets are unpredictable over short periods of time. Achieving goals based on a long-term plan is more important than maximizing returns. Also take into account portfolio management fees. If you are outperforming the benchmark by 2% per year before fees over the long-term and paying a 1% annual portfolio management fee, you can justify the cost. Also consider the other services you are getting from the portfolio manager as part of the fee. Your are paying the management fee for some or all of the following services: Asset allocation, equity selection, portfolio management, tactical market allocation to control risk, a wealth building plan, ongoing investment research, investor education, investment newsletter, behavior coach and portfolio performance reviews. The advantage of a good professional portfolio design is professional diversification, strategic asset allocation, enhanced security selection and discipline. Your portfolio is designed to meet your long-term retirement goals based on your risk tolerance and time horizon. Most investors find it difficult to implement and maintain an asset allocation strategy, reducing the likelihood of investment success on their own. Each quarter a portfolio manager should analyze the performance of the portfolio it manages and explain to the client why the portfolio performed better or worse than the benchmark. Changes should be made to the portfolio as needed. The appropriate asset allocation for your risk tolerance is most important. Risk adjusted return should also be considered in the evaluation. Beta, standard deviation and drawdown are used to measure risk. Of the 40 actively managed U.S. equity funds with Morningstar Analyst Ratings of Gold, 38 suffered at least one year of bottom-quartile performance in the past 10 years. Also compare the asset allocation and holdings of your portfolio to the benchmark it is trying to beat. In order to beat the benchmark, the investments must be better or the asset allocation must be different than the benchmark. A portfolio can beat its benchmark if the investments are superior and it is biased toward the outperforming asset classes. R-squared is a metric used to compare a portfolio s correlation to its benchmark s correlation. If R-squared is 100, it will likely perform at its benchmark. The largest contributor to a portfolio s performance is determined by the world stock markets. The second largest contributor to a portfolio s long-term performance relative to its benchmark is an optimal asset allocation. The third largest contributor to a portfolio s long-term performance relative to its benchmark is equity selection was a difficult market for active portfolio management since most highly rated active mutual funds underperformed their passive ETF benchmark and many asset classes performed poorly. 18

19 The typical money manager underperforms the market averages by 2% annually because they use standard investment strategies like asset allocation, diversification and basic security selection. Their high management fees hurt performance. They spend most of their time looking for new customers and servicing current ones. The smaller your portfolio, the less time they spend managing it. Many money managers are dependent and have a closed architecture. They are pressured into selling high cost investments that benefit them and are limited to selling only sponsored funds. What does a higher annual return mean to you? If you invest in a high performing investment strategy that outperformed the S&P 500 by 5% annually, your returns projected over 25 years would have grown from $100,000 to $1,900,000. The Average investor would have seen their $100,000 grow to $260,000. This equates to outperforming the average investor by $1,640,000 over 25 years. Enhanced Strategy (5% > S&P 500) $ 1,900,000 13% annual return S&P 500 $ 634,000 8% annual return Average Equity Fund & Portfolio Manager $ 405,000 6% annual return Average Investor $ 260,000 4% annual return $2,000,000 $1,500,000 $1,000,000 $500,000 $ Average Investor (4%) Average Mutual Fund & Portfolio Manager (6%) S&P 500 (8%) Enhanced Strategy (+13%) AAII Article 2016 (Top performing money managers (Strong 5-year, 10-year performance). By chasing performance, investors fall into an ongoing pattern of buying after share prices have risen considerably and selling after they have dropped. The top managers make up lost ground and add excess return following periods of weakness. Investors with the patience to stick with top managers through trying times are likely to reap greater rewards than those who chase the latest winner. Even the best investment managers see periods of underperformance with their strategy due to changes in market environment. Approximately 85% of top managers had at least one three-year period in which they underperformed their style benchmark by 1%, 50% by 3% and 25% by 5%. No strategy works all the time in all phases of the market cycle. Management or strategy changes can warrant selling of the fund. 19

20 Elections and the Stock Market How will the stock market react to the election results? The stock market does not like uncertainty, so the market may be volatile up until the election. Watch the stock market performance during the election year to see how it feels about leading candidates. The top issues of most recent elections have been healthcare costs, tax reform, immigration, terrorism & war, international trade, economic growth and help for the middle class. Most of the market gains in election years have been in the second half. The S&P 500 saw positive gains in most of the non-recession years since (InvesTech Research) It is unlikely we will see a recession in Which candidate will help economic growth and earnings grow again? How much power does a president have and how much damage can one person do? A lot will depend on which party gets in and the leadership in the house and senate, and the people they appoint. 20

21 Who was the worst president in the past 50 years and how did the stock market perform during their term? Secular Bear Market (1966 to 1982) Presidents: Johnson (D), Nixon (R), Ford (R), Carter (D) Fed Chairman: Martin and Burns in Vietnam war, Arab Oil Embargo, oil shock, Watergate, Nixon resigns, high inflation and 2 deep recessions. Election years in this period saw returns of 11%, 19%, 24% and 32%. The stock market saw no returns over this period. Secular Bull Market (1982 to 1999) Presidents: Reagan (R), Bush Sr. (R), B Clinton (D) Fed Chairman: Volcker and Greenspan in Black Monday 1987, oil collapse, Savings & Loan Crisis, Gulf War, Asia Currency Crisis, Russian Rubble Collapse, the formation of the Technology Bubble and one short recession. Election years in this period saw returns of 6%, 17%, 8% and 23%. The stock market saw strong returns over this period. Bill Clinton and Greenspan take some of the blame for the Tech Bubble. Secular Bear Market (2000 to 2008) Presidents: Bush Jr. (R) Fed Chairman: Greenspan and Bernanke in Collapse of the Tech Bubble, 911 Attack, Iraq War, Financial Crisis and 2 deep recessions. Election years in this period saw returns of -9% Recession, +11% and -37% recession. The stock market saw no returns over this period. George Bush Jr, and Alan Greenspan take some of the blame for the Financial Crisis. Secular Bull Market (2009 to 2017) Presidents: Obama (D), Trump (R) Fed Chairman: Bernanke and Yellen in Obamacare, Japan earthquake, fiscal cliff, Eurozone debt crisis and collapse of commodity prices. Election years in this period saw returns of 16% and??% in The stock market saw strong returns over this period. 21