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

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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

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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)

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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

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Determinants of Portfolio Performance

Asset Allocation

91.5%

Other2.1%

Market Timing1.8%

Security Selection

4.6%

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.

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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

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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)

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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

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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.

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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

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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

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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

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Major Asset Classes

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)

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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%

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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

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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

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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

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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)

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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

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Relationship Between Risk and Return

Risk HighLow

Expected Return

High

Low

CashEquivalents

U.S. Bonds

Int’l Bonds

Real Estate

U.S. Stocks

Int’l Stocks

For illustrative purposes only. Not indicative of any specific investment.

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Diversification From Combining Investments

Investment A

Investment B

Portfolio 1

No Diversification

Investment C

Investment D

Portfolio 2

Complete Diversification

Investment EPortfolio 3

Investment F

Some Diversification

For illustrative purposes only. Not indicative of any specific investment

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Recent Example

2000-2003 Thank goodness some of my portfolio

was in bonds & real estate!» Stocks tanked» Bonds rallied» Real estate saved the day

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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

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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

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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

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Asset Allocation Resources

Periodic Table of Investment Returns » Callan.com

Ibbotson Knowledge Center: Education» Asset Allocation slide show » Ibbotson.com

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Utah Retirement System Funds

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%

10 year returns as of 9/30/04Low to high risk/return

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URS Horizon Funds

Fixed asset allocation in one fund One stop shopping

» IF it suits your needs Automatic rebalancing quarterly

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Time Horizon for Retirement?

Until the day you retire? Until the day you die?

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Short Horizon Fund

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%

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Medium Horizon Fund

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

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Long Horizon Fund

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

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TIAA-CREF

TIAA Traditional TIAA Real Estate CREF Money Market CREF Social Choice

CREF Stock Global Equities Growth Equity Index

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9 New Fund Choices

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

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Global vs. International

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

foreign

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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)

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Growth Portfolio

10-15% International 10-15% Small-cap 10-15% Mid-Cap 10-15% Real Estate 10-15% Bonds STOCKS!

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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

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Great Internet Resources

URS.org Tiaa-cref.org

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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

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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!

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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

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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

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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.

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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

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Questions? Comments? Experiences?

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Feb. 9 FPW: Investing on a Shoestring