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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3
Welcome to FPW
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4
• Please ask questions or ask for
clarification as we go along.
Overview
• Asset Allocation Principles
• Risk-Return Relationship
• Application to Utah Retirement System
(URS) options
• Application to TIAA-CREF Retirement
Investment Options
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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
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What Is Asset Allocation?
• Objective: lower investment risk by
reducing portfolio volatility
• Loss in one investment may be offset by
gains in another
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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)
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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)
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Determinants of Portfolio Performance
Security
Selection
4.6%
Market
Timing
1.8%
Other
2.1%
Asset
Allocation
91.5%
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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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
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The Callan Periodic Table of
Investment Returns
• https://www.callan.com/research/files/989.pdf
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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)
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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%
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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
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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
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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
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Global vs. International
• Global: U.S. & foreign
• International: all foreign
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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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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
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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
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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
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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)
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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
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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
Low
Risk
For illustrative purposes only. Not indicative of any specific investment.
High
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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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Utah Retirement System
Target Date Funds
• Diversified asset allocation in one fund
– 11 asset classes
• https://www.urs.org/mango/pdf/urs/Target
DateFunds/TargetDate.pdf
• One stop shopping
– Asset allocation gets gradually more
conservative over time
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Utah Retirement System
Target Date Funds
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
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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)
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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
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Tips For Funding a TaxDeferred 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 investments
• Past returns are NO guarantee for the
future!!
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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
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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 quizzes
– 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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Questions? Comments?
Experiences?
Nov. 11 FPW
Investing: Women do it
better!
Bring a friend
45
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• Searchable Blog:
http://fpwusu.blogspot.com/
• Facebook:
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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=5z9SWt9Ku-A
– Index vs. active fund management