Asset Allocation Diversification Erica Abbott FPW Developed

Asset Allocation & Diversification Erica Abbott, FPW 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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Overview • Asset Allocation Principles • Risk-Return Relationship • Application to Utah Retirement System (URS) options • Application to TIAA-CREF Retirement Investment Options 6

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 7

What Is Asset Allocation? • Objective: lower investment risk by reducing portfolio volatility • Loss in one investment may be offset by gains in another 8

Why Asset Allocation? Because Market Timing is Futile • Value of $10, 000 invested in large company stocks (S&P 500 index) from 1995 to 2014: – $65, 453 stayed invested entire time – $32, 665 if you missed the best 10 trading days • Biggest market gains are often concentrated in short periods (can’t afford to miss) 9

The Importance of Asset Allocation • Asset allocation is the MOST important decision an investor makes • Buying some stock for example, NOT which stocks you buy (i. e. Coke versus Pepsi) 11

Determinants of Portfolio Performance 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. 12

Downside of Asset Allocation • A diversified portfolio MAY generate a lower rate of return when compared to a single “hot” asset class (e. g. , emerging markets from 2003 -07) BUT • You never know the “hot” asset class in advance 13

The Callan Periodic Table of Investment Returns • https: //www. callan. com/research/files/989. pdf 14

Asset Allocation • Asset allocation attempts to reduce volatility & provide a competitive rate of return

Major Asset Classes • • Large company stocks Mid cap stocks Small company stocks Foreign stocks – Developed – Emerging • Bonds – Domestic – International • Real estate (e. g. , REITs) • Cash assets (e. g. , CDs, Ibonds) 16

Historical Average Annual Rates of Return • Small Co. U. S. stocks = 11. 4% • Large Co. U. S. stocks = 9. 4% – annual returns -50% to +50%!! • Government Bonds = 5. 1% • Treasury Bills = 0. 1% • Inflation = 3. 1% 17

Growth Portfolio • • • 10 -15% International stocks 10 -15% Small-cap stocks 10 -15% Mid-Cap stocks 10 -15% Real Estate 10 -15% Bonds (U. S. & international) 25 -50% large cap US stocks 18

Why Invest Internationally? • Low correlation among world markets • World markets (esp. small companies) are driven by local dynamics • Investing in U. S. multinationals does not deliver the same level of diversification 19

Why Invest Internationally? • Benefits of diversification outweigh currency, market, & political risks • U. S. accounts for less than 1/2 of the world’s equity markets • For long term goals, invest 10 -20% internationally 20

Global vs. International • Global: U. S. & foreign • International: all foreign 21

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 22

The Asset Allocation Process • Assess your risk tolerance • Identify asset mix of current portfolio • Create target portfolio (asset model) • Specific investment selection • Review & rebalance portfolio 23

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 24

Risk-Return Relationship • Low risk = low return • High risk = possibility of high return – Also possible large short term losses • Risk: chance of loss of principal in the short run – Oct. 2007 – March 2009 S&P 500 stock index lost 57%!! • Recovered by 2013 • Bull market is 6+ years old 25

More Asset Allocation Tips • Stick to your asset allocation model unless personal circumstances change • Rebalance yearly • TIAA-CREF will rebalance automatically (SIGN UP for this feature) 26

Invest for Growth • There is no such thing as a risk-free investment! • Investments must grow faster than inflation & taxes – Average inflation = 3% • Risk is relative – Short term volatility = long term growth – Invest in stocks for growth 27

Relationship Between Risk and Return High Int’l Stocks U. S. Stocks Real Estate Expected Return Int’l Bonds U. S. Bonds Cash Equivalents Low Risk For illustrative purposes only. Not indicative of any specific investment. High 28

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 29

Utah Retirement System Target Date Funds • Diversified asset allocation in one fund – 11 asset classes • https: //www. urs. org/mango/pdf/urs/Target Date. Funds/Target. Date. pdf • One stop shopping – Asset allocation gets gradually more conservative over time 30

Utah Retirement System Target Date Funds

TIAA-CREF (a few of the 55+ funds) • • TIAA Traditional TIAA Real Estate CREF Money Market CREF Social Choice • • CREF Stock Global Equities Growth Equity Index 33

Murky Mixture • Few of the funds are “pure” • CREF Stock – 80% LG, 15% Mid, 5% Small-Cap – Mostly US but some foreign stocks • Mid-Cap Growth – 59% LG! 39% Mid, 2% Small-Cap • Read Prospectus (or at least the summary) 34

TIAA-CREF Expenses • For lowest expense ratios look for: – “institutional” &/or “index” in fund names • Often < 0. 10% • Equity Index Fund -- Institution class. 05% • T-C S&P 500 index fund institutional class: 0. 06%. Compare to Cref Stock fund 0. 46%

TIAA-CREF Expenses • T-C Lifecycle funds (Institutional class) : – Expense Ratios: 0. 37% for 2010 fund • 2035: 0. 43% • 2055: 0. 44% – T-C Real Estate Account charge 0. 87% • Excellent fund with a very low expense ratio considering that they own and manage real estate across the US

TIAA-CREF • Anyone owning TIAA-CREF stock fund should consider moving their money to lower cost funds within TIAA-CREF.

Adjusting Your Allocation • You can change future allocations – Will not affect current allocation • You can transfer current balance among asset classes to adjust allocation • Use web sites • Sign up for automatic rebalancing with TIAA-CREF 38

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 39

The Big Picture • Same principles can be applied to – 401(k) plans – Individual retirement accounts (IRAs) – Other investments • Past returns are NO guarantee for the future!! 40

Focus on what you Can Control • Where you put your money – Diversification – Look at expense ratios! • How much you put in • When you put $ in • When you take $ out

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 42

Your “Action” List • Review your current asset allocation • Consider your other retirement accounts • Use the URS/TIAA-CREF web sites – Risk tolerance quizzes – Asset allocation calculators • Talk with a representative • Reallocate, Rebalance, Re-visit 43

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. 44

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How to win the losers’ game • How to Win the Loser’s Game: Making the case for evidence-based investing (10 episodes) • Part 6: https: //www. youtube. com/watch? v=5 z 9 SWt 9 Ku-A – Index vs. active fund management