Personal Investing 101
By Curtis Gary Dean FCAS, CFA, ChFC
Distinguished Professor of Actuarial Science,
Ball State University
You’ve Heard It Before
Information is not new. Repeated again
and again.
Even so, most of you have no strategy or
an inferior strategy.
You can beat most investors by wide
margin by following a very simple plan.
Average Annual Returns: 1926-2002
Annual
Return
Standard
Correlation
Deviation Stocks Bonds T-Bills
Large
Company
Stocks
10.19%
20.63%
1.000
.193
-.016
Long-Term
Corp
Bonds
5.88%
8.72%
.193
1.000
.205
T-bills
3.79%
3.15%
-.016
.205
1.000
Compound Growth
Stocks: $10,000 x (1.1019)30 = $183,766
Bonds: $10,000 x (1.0588)30 = $55,516
T-bills: $10,000 x (1.0379)30 = $30,526
Stocks may not be quite as dominant in future,
but still best bet for long-term growth.
Fundamental Principles
Identify goals and select appropriate
investments.
Diversify.
Defer taxes. Keep turnover low.
Keep investing expenses low. Make
yourself rich, not the brokers.
Make a plan and stick to it. Do not chase
yesterday’s winners.
Identify goals and select
appropriate investments
Short-term goals: money market,
certificates of deposit, short-term bonds
Long-term goals: inflation-protected
bonds, intermediate-term bonds, real
estate, stocks
Diversify
Across asset classes: money market,
bonds, real estate, stocks
Within asset classes
– Bonds: municipal, U.S. govt, corporate,
mortgage-backed, inflation-protected
– Stocks: industry, company size, value and
growth, domestic and international
Defer taxes
Selling securities creates taxable events
Use 401(k) and Roth IRA (if available)
Complications
– 15% tax rate on long-term capital gains and
dividends
– 401(k) and regular IRA distributions taxed at
ordinary income tax rates
Use $3,000 capital loss to offset ordinary
income
Investment expenses
Mutual fund operating expenses and
management fees
Loads
Commissions *
Bid-ask spread *
Market impact *
*Harder to identify
Effect of expenses on returns
Average 7% market return for 30 years
If .15% eaten annually by expenses
 $10,000 x (1.0685)30 = $72,985
If 2.00% annual expenses
 $10,000 x (1.050)30 = $43,219
If 3.00% annual expenses
 $10,000 x (1.040)30 = $32,434
Selling Magazines
Money, Kiplinger’s Personal Finance, Smart
Money, Forbes, Fortune, Business Week, etc.
Range of methodologies
Identifying yesterday’s winners
Buy me
– “The 10 Best Funds”
– “Annual Mutual Fund Edition”
– “Best Funds for Today’s Market”
List of “best” regularly changes: taxes if you
switch!
Pretty Efficient Markets
Weak correlation between past and future
performance
But, lousy funds tend to remain bad
Trying to beat market -> probably do
worse than market because of expenses
and chasing trends
Fundamental Principles
Identify goals and select appropriate
investments.
Diversify.
Defer taxes. Keep turnover low.
Keep investing expenses low. Make
yourself rich, not the brokers.
Make a plan and stick to it. Do not chase
yesterday’s winners.
The Magic Bullets: Indexing
Invest in broad indices
– MSCI® US Broad Market Index or Wilshire 5000
– Lehman Brothers Aggregate Bond Index
– Morgan Stanley REIT Index
Diversified, tax efficient (stocks), and low expenses
Consistently beat most actively managed funds and
investors
Use open-end mutual funds or ETFs
Open-end mutual fund vs. ETF
ETF = Exchange Traded Fund
– Traded on stock exchanges
– Arbitrage opportunities keep prices in line with
indices
– Usually lower expense, but must pay
commission
Open-end mutual fund
– Your deposits used to purchase more stock
for fund
Examples: Annual Expense Ratios
ETFs
Vanguard Total Stock Mkt VIPERS: 0.07%*
Vanguard REIT VIPERS: 0.12%
iShares MSCI EAFE Index: 0.35%
Open-end Mutual Funds
Vanguard Total Stock Mkt Adm: 0.10% (0.19%)
Vanguard REIT Index Adm: 0.16% (0.21%)
Vanguard Total Int’l Stock Index: 0.31%
*Average stock fund has expenses more than 25 times
greater!!
Total Stock Market Index
General Electric
ExxonMobil
2.58%
2.24%
Microsoft
Citigroup
Wal-Mart Stores
1.94%
1.67%
1.51%
Pfizer
Bank of America
Johnson & Johnson
1.36%
1.28%
1.26%
AIG
IBM
1.14%
1.13%
16.11%
Sample Portfolio for 40 year old
47.5% - Vanguard Total Stock Mkt Index
17.5%
5.0%
15.0%
15.0%
- Vanguard Total Int’l Stock Index
- Vanguard REIT Index
- Vanguard Total Bond Mkt Index
- Inflation-protected bonds
One Stop Shopping
Personal Investing 102
“Value stocks” produce higher returns over
time
– Low: Price/Book Value
– Low: Price/Earnings
– Reasonable dividends
“Value and Growth Investing: Review and Update,” by
Louis K.C. Chan and Josef Lakonishok, Financial
Analysts Journal, Vol. 60, No. 1
Add Low Cost Value Funds to Mix
30.0% - Vanguard Total Stock Mkt Index
12.5%
5.0%
10.0%
7.5%
5.0%
15.0%
15.0%
- Vanguard Value Index
- Vanguard Small Cap Value Index
- Vanguard Total Int’l Stock Index
- Dodge & Cox Int’l Stock (.77%)
- Vanguard REIT Index
- Vanguard Total Bond Mkt Index
- Inflation-protected bonds
Tax Efficiency
Put REITS and bonds in tax-deferred
accounts
Consider municipal bonds (funds) outside
of tax-deferred accounts
Recommended Reading
A Random Walk Down Wall Street by Burton Malkiel
The Four Pillars of Investing by William J. Bernstein
Common Sense on Mutual Funds by John C. Bogle
Winning the Loser’s Game by Charles D. Ellis
The Future for Investors by Jeremy J. Siegel
The Intelligent Asset Allocator by William J. Bernstein
Master and use what’s in these books and you will beat
most professional money managers
Resources
Online mutual fund research (free)
– www.moneycentral.msn.com
Library
– Stocks: Value Line Investment Survey ($598)
– Funds: Morningstar Mutual Funds ($549)
One Last Time:
Fundamental Principles
Identify goals and select appropriate
investments.
Diversify.
Defer taxes. Keep turnover low.
Keep investing expenses low. Make
yourself rich, not the brokers.
Make a plan and stick to it. Do not chase
yesterday’s winners.