Financial Crisis & Your Asset
Allocation Strategy
Developed by Barbara O’Neill, Ph.D., CFP,
Rutgers Cooperative Extension
Adapted by Jean Lown, Ph.D.
Family, Consumer & Human Development, USU
November 12, 2008
Overview
Financial Crisis
 Asset Allocation Principles
 Risk-Return Relationship
 Application to TIAA-CREF Retirement
Investment Options
» 9 new investment choices (as of 2003)
 TIAA-CREF vs. Fidelity
 Taking Action

2
Worldwide Market Meltdown



Worst $ crisis since Depression
Nowhere to hide
» Stocks & Bonds
» Domestic & foreign
» Real estate, too
Should you sell?
» Buy low & sell high
» Market timing doesn’t work
3
Questions? Concerns?
4
Basic Investment Principles
Diversification
 Asset Allocation
 Market volatility
 Time horizon
» Retirement v. life span

5
Investment Goals?
6
Asset Allocation

Diversifying portfolio multiple investment
categories to reduce investment risk

Ex: 50% stock, 30% bonds, 20% cash
assets (e.g., Treasury bills)

Lower risk by reducing volatility

Loss in one investment offset by gains in
another
7
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.
8
Callan Periodic Table of
Investment Returns

http://www.callan.com/research/institute/
periodic/

Benefits of asset allocation

20 years asset class performance

Best performing asset class changes

This year’s “winner” = next year’s “loser”

Invest in them all
9
Market Timing is Futile


$100 invested in large company stocks (S&P
500 index): June 1980 - June 2000
»
$2,456 IF invested entire time
»
$613 if you missed the best 15 months
Biggest market gains concentrated in short
periods
10
More Market Timing Futility

S&P 500 stock market index 1998-2000

If investor stayed fully invested: 41.4%
return

If investor missed top 10 trading days of
1998, 1999, & 2000: - 41.7% return

Stay invested in both bull & bear
markets
11
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
 Study repeated numerous times by
different researchers with similar results

12
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; other 4 earn 0%, 5%,
10%, and 15% average annual returns
»
Diversified portfolio = $962,800 over 25
years
13
Factors to Consider

Investment objective (e.g., retirement)

Time horizon (e.g., life expectancy for
retirement)

Amount of money you have to invest

Your risk tolerance and experience
»
Caution about risk tests!
14
Downside of Asset Allocation

In short run… diversified portfolio MAY
generate lower return compared to a
“hot” asset class (e.g., growth stocks
from 1995-99) BUT

No one knows the next “hot” asset class
(i.e., Callan table)

Asset allocation reduces volatility to
provide a competitive rate of return
15
Major Asset Classes


Stocks
» Large company
growth & value
» Mid cap growth &
value
» Small growth & value
» International
Real estate (e.g.,
REITs)

Bonds
» Domestic
» International
» Corporate
» Municipal

Cash (CDs, I-bonds,
MMMFs, Treasury bills)
16
Stock Capitalization

Large Cap companies: valued at >$5
billion
»

Mid-Cap: $1-5 billion
»

ExxonMobil, General Electric, Microsoft
Bath & Beyond, Monsanto, Hilton Hotels
Small-Cap: <$1 billion
»
Earthlink, FirstFed Financial, Vintage
Petroleum
17
Historical Average Annual
Rates of Return
Small Co. U.S. stocks = 12.6%
 Large Co. U.S. stocks = 10.4%
 Government Bonds = 5.1%
 Treasury Bills = 3.8%
 Inflation = 3.1%

18
Why Invest Internationally?





Low correlation among world markets
» (e.g., U.S. & 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
Benefits of diversification outweigh currency,
market, & political risks
U.S.: <1/3 of the world’s stock markets
» Big 4: BRIC
19
Asset Allocation Process

Define goals and time horizon

Assess your risk tolerance

Identify asset mix of current portfolio

Create target portfolio (asset model)

Select specific investments

Review and rebalance portfolio yearly
20
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

21
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%)
or yearly (automatic rebalancing)

No one sector > 10%- 30%
22
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 U.S. stocks lost 49% (after
incredible run-up in prices in 1990s)
» October 2007 to Oct 2008 lost 40%+

23
Stocks are Risky in Short Run
Very volatile in sort run (1-5 years)
» annual returns -50% to +50%!!
» 2003 was a great year to buy stocks
when all news was gloom & doom
» Today is buying opportunity
 Large Co. U.S. stocks = 10.7% (avg.
returns since 1926)

24
“Safe” Investments are Risky in
the Long Run
Inflation = 3.1%
 Government Bonds = 5.1% -3.1% = 2%
 Treasury Bills = 3.8% - 3.1% = 0.7%
 Subtract the impact of taxes
» ‘safe’ investments = negative returns
 You will not reach long term goals

25
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
High
For illustrative purposes only. Not indicative of any specific investment.
26
Diversification From Combining
Investments
No Diversification
Complete
Diversification
Portfolio
Investment A1
Investment
C
Portfolio
2
Investment
D
Investment B
Some Diversification
Portfolio 3
Investment E
Investment F
For illustrative purposes only. Not indicative of any specific investment
27
2000-2003 was a gut check
Thank goodness some of my portfolio
was in bonds & real estate!
» Stocks tanked
» Bonds held steady
» Real estate saved the day
 Here we go again!

28
Invest for Growth
There is no such thing as a risk-free
investment!
 Retirement $ must grow faster than
inflation to provide financial security
 Risk is relative
» Short term volatility=long term growth
» Diversified portfolio needs stocks for
growth

29
Understand Risk Tolerance
Beware of taking risk tests and settling
for a conservative portfolio
 Conservative investors risk outliving
their assets
 Life expectancy calculators
» http://www.ces.purdue.edu/retirement/
Module1/module1b.html

30
Time Horizon for Retirement?
Until the day you retire?
 Until the day you die?

31
Envision your dream
32
Retirement Growth Portfolio
10-15% International stocks
 10-15% Small-cap stocks
 10-15% Mid-Cap stocks
 10-15% Real Estate
 10-15% Bonds

33
Tips For Funding a TaxDeferred Employer Plan

Diversify across asset classes

Avoid market timing

Choose investments with solid historical
performance

»
Past returns are NO guarantee for the
future!!
»
<10 year track record is too short!
Choose funds with low fees
34
Your “Action” List
Review your current asset allocation
 Consider your other retirement accounts
 Use the TIAA-CREF web site
» Risk tolerance quiz
» Asset allocation calculators
 Talk with a representative
 Reallocate, Rebalance, Re-visit

35
Before You Decide
Read the website
 Understand the risks
 Make careful choices
 Don’t be afraid to change asset allocation
» You can always change your mind

36
Expense Ratios %
1.00
0.90
0.80
0.70
%
0.60
TIAA-CREF
Fidelity Funds
0.50
0.40
0.30
0.20
0.10
0.00
1
2
3
4
5
6
7
8
9
10
11
12
Funds
37
Compare Expense Ratios
TIAA-CREF Funds
Expense
Ratio
%
Fidelity Funds
Expense
Ratio
%
1
Retirement Income
0.61
Retirement Income
0.55
2
Lifecycle 2010
0.62
Freedom 2010
0.68
3
Lifecycle 2025
0.64
Freedom 2025
0.78
4
Lifecycle 2040
0.65
Freedom 2040
0.82
5
Money Market Retire
0.39
Money Market Retire
0.42
6
Inflation-Linked Bond
0.60
Inflation-Protected Bond
0.45
7
S&P 500 Index
0.32
Spartan 500 Index
0.10
8
Small-Cap Blend Index
0.34
Small Cap Index
0.23
9
Large-Cap Value Index
0.32
Large-Cap Value
0.87
10
Real Estate
0.91
Real Estate
0.83
11
CREF Global Equities
0.61
Global Equity
0.72
12
International Equity Index
0.40
International Index
0.20
38
The Big Picture

Same principles can be applied to
» 401(k) plans
» Individual retirement accounts (IRAs)
» Other retirement plans
39
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
40
Before You Decide
Read the TIAA-CREF website
 Understand risk
 Make choices based on solid investment
principles
 Don’t be afraid of making mistakes; you
can always change your asset allocation

41
Questions? Comments?
Experiences?
42
43
5 TIAA-CREF Asset Classes
Guaranteed (low risk; low return)
 Fixed-Income (bonds)
 Equities (stocks)
» High return; volatile in the short run
 Real Estate
» Inflation protection; reduce volatility
 Money Market (safe; low return)

44
TIAA-CREF Options (pre-2003)
TIAA Traditional
 TIAA Real Estate
 CREF Money
Market
 CREF Social
Choice

CREF Stock
 Global Equities
 Growth
 Equity Index

45
9 New Fund Choices (2003)





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
46
Global vs. International
Global: U.S. and foreign investments
 International: “all” foreign

47
Murky Mixture
Few of the funds are “pure”
 CREF Stock
» 80% Large-, 15% Mid-, 5% Small-Cap
» Some foreign stocks
 Mid-Cap Growth
» 59% Large-! 39% Mid-, 2% Small-Cap
 Read Prospectus (or at least the summary)

48
Growth Portfolio
STOCKS
» Large-cap Domestic
» 10-15% Mid-Cap
» 10-15% Small-cap
» 10-15% International
 10-15% Real Estate
 10-15% Bonds (to dampen volatility)

49
Adjusting Your Allocation
You can change future allocations
 You can transfer current balances
among funds
 Use TIAA-CREF.org web site
 Sign up for automatic rebalancing

50
Tips for Allocating Your
Retirement Contributions

Diversify across asset classes
»
Stocks, bonds, real estate

Avoid market timing

Choose investments with strong
historical performance (stocks)
»
>10 year track record
51
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 for a specific
investment is too short.

52
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
53
Your “Action” List
Review your current asset allocation
 Consider your other retirement accounts
 Use the TIAA-CREF web site
» Risk tolerance quiz
» Asset allocation calculators
 Talk with a representative
 Reallocate, Rebalance, Re-visit

54
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.

55
Financial Planning for Women
No December meeting
 Topics for 2009?
 send email to Jean.Lown@usu.edu

56
Questions? Comments?
Experiences?
57