Download Investment Seminar

Successful Investing is both a very
simple and very complex process.
 It is very simple because a broad
range of well diversified mixes of 4 or
5 index funds rebalanced regularly
will out perform the vast majority of
active managers over the long term.
 It is very complex because human
nature makes it very difficult for most
folks to keep it as simple as 4 or 5
index funds.
Investment Seminar Overview
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Perceived Risk and Return go Hand in Hand
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Human Nature and Investment History
You can’t earn higher returns unless you take greater perceived market
risk
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Asset Allocation
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Asset allocation is the art of mixing asset groups that are not well
correlated over time in order to reduce risk and improve returns
The Business of Investing
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Human Nature has resulted in a long history of Market Bubbles followed
by Serious Market Declines. They are part of investing and need to be
anticipated and planned for.
There are serious conflicts of interest in the vast majority of brokers,
investment advisors, mutual funds, and the financial press that can
pose a threat to you meeting your financial objectives.
Implementation
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Thoughts on how to implement a low cost simple asset allocation plan
to maximize the chances of you meeting your financial goals.
Seminar Objectives
 My Objective today is to expose you to some key
concepts of successful investing so you can start your
start your own journey of discovery.
 I am going to cover only the key concepts today and
it is not necessary for you to totally grasp everything
we cover.
 I will have a list of suggested reading throughout the
package and at the end that will further develop the
concepts that we will cover or you can contact me
after the program for additional clarification.
Perceived Risk and Return go Hand
in Hand
 You can’t earn higher returns unless you take
greater perceived market risk
 Stocks and Bonds are good examples of differences
in perceived market risk. It is generally believed that
Stocks are perceived to be riskier than Bonds so you
will generally earn higher long term returns with
stocks than Bonds.
 Numerous studies for both the US and Overseas
markets have shown that groups of stocks with
higher perceived risk (small companies and value
companies the K Marts) have higher returns than
companies with strong growth history (the growth
stocks or the Wal-Marts)
You can’t earn higher returns
unless you take greater
perceived market risk
 When the economy is strong and the
political outlook is favorable perceived risk
is low so stocks and bonds will typically
have strong historical returns, low yields
and long term future returns are likely to
be modest.
 Likewise when we have an economic crisis
and the political outlook is unfavorable
perceived risk is high so yields will fall
increasing long term future returns of risky
assets.
Yield is both a measure of risk and
long term (+10 year) market
returns
 Yield is both a measure of risk and reasonable
measure of long term (+10 year) market returns.
During periods of economic uncertainty investors let
prices of assets fall to a level that the corresponding
yield will compensate them for the level of risk
 Future bond returns are the same as the dividend
yield adjusted for any potential default.
 Long term stock returns = Stock market yield + long
term dividend growth rate + an adjustment for
perceived market risk.
Yield is both a measure of risk and long
term (+10 year) market returns
Project
ed Total
return
Actual
Total
return
Perceived
risk
adjustmen
t
Time
frame
Dividend
Yield
Dividend
Growth
rate
S&P500
20th
Century
4.50%
5%
9.50%
9.60%
0.10%
S&P500
19711998
3.70%
6.1%
9.80%
11.30%
2.10%
High returns during this period were driven by an unprecedented bull
market in the 1980s and 1990s in which stock yields were driven from a
normal 4.7% to very unusual level of 1.1% indicating a low level of
perceived market risk.
Yield is both a measure of risk and
long term (+10 year) market
returns
S&P500
19992008
1.70%
6%
8.00%
1%
-7%
Low returns during the last ten years have been driven by an increased
perceived market risk in which stock yields have increased from 1.1% to
a more normal 2.9%
S&P500
2008
2.90%
6%
8.90%
?
If history can be used as a guide during the next 10 years market returns
are likely to return to more normal levels. A study by John Bogle
indicated that decades of high perceived market risk have been followed
by decades of lower perceived market risk.
The bottom line is this:
 We are faced with the choice of losing
our savings to the threat of inflation
and investment expenses or exposing
ourselves to market risk.
 You can’t earn higher returns (and
avoid inflation) unless you take greater
market risk – that means investing
some of your money in risky assets
such as stocks during times when no
one else seems to want them!!!!!!!!!!!!!!
Twisted Logic ???
 You can be sure that most investors
were not anticipating lower returns of
roughly 6% at the market peak in 1998
when the dividend yield on stocks was
roughly 1% (5% dividend growth rate
+ 1.1% yield).
 Most investors were caught up in the
stock market bubble and thinking that
future returns would likely to be in the
recently historical range of +15%!!!!!
Human Nature and Investment
History
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I am sure that virtually everyone is aware of the recent
market bubbles
Internet/Growth Stock bubble
Oil Bubble
Housing / Leveraged Mortgage backed Securities Bubble
In fact we have had a long history of Market Bubbles
followed by major declines.
Tulip bubble in the 1600’s
1929 bubble followed by great depression
Nifty 50
Japanese stock Market Bubble
Bubbles and serious declines in markets are a fact of life
that are caused by our Human Nature that need to be
anticipated and planned for.
Key Human Characteristics that
don’t make us Perfect Investors
 We are very social Creatures and feel comfortable
being conventional and doing the same things that
our friends are doing, enjoy following fads, like
discussing common interests with our friends and we
enjoy being entertained, gambling and other forms of
excitement.
 We enjoy finding patterns in our environment that
might help us solve problems and predict the future
and we consider the most recent information more
relevant than older information even if the older
information is more complete.
Key Human Characteristics that
don’t make us Perfect Investors
 This causes us to see trends in short term
performance in asset groups that cause us to favor
and buy asset groups that have recently done well
over groups that have not recently done as well.
 We generally are overconfident of our abilities
compared to everybody else and think we have
special abilities that will allow us to find methods that
will beat the market indexes.
 It is very difficult for some folks to sit by and do
nothing while their buddies/ neighbors/competitors
have all the fun getting rich in the “Dot Com/Growth
Stock/Housing / Leveraged SubPrime Mortgage
backed Securities” Boom
Key Human Characteristics that
don’t make us Perfect Investors
 All of these characteristics cause
us to regularly force the price of
popular investments up to a
point that future positive returns
are diminished or eliminated
especially when there is a source
of cheap money (IE lower
Interest rates by the Fed)
Ways to deal with the Herd Mentality and the
tendency to focus on short term
performance.
Returns for Major Asset Classes for the last 28 years
#1
25
20
The best performing asset class
over the last 10 years is likely to be
the worst performing class over the
next 10 years
#1
#4
15
#1
#1
#4
10
5
#4
0
-5
1970 to 79
S&P 500
1980 to 89
EAFE
Small Stocks
1990 to 99
Reits
Inflation
2000 to 08
Int term Bonds
Ways to deal with the Herd Mentality and the
tendency to focus on short term
performance.
 Recognize that when asset classes
are popular and been performing well
over the past 5 to 10 years they are
likely to be over priced simply
because to many people have
invested in them.
Ways to deal with the Herd Mentality and the
tendency to focus on short term
performance.
 "Be fearful when others are greedy and
greedy when others are fearful." --Warren
Buffet
 “If things seem splendid they will get worse
– Success inspires overconfidence and
excess.”
 “If things seem dismal they will get better –
Crisis spawns opportunity and progress”
 From “The trouble with Prosperity” by
James Grant
Ways to deal with the Herd Mentality and the
tendency to focus on short term
performance.
 Try to identify the eras conventional
wisdom and best performing asset
class and assume the conventional
wisdom is wrong and the best
performing asset class is not likely to
be the best performer over the next
10 years. In fact the best performing
asset class is more than likely to be
the worst performing over the next
10 years.
Try to determine the conventional Wisdom
and assume it is wrong
 Conventional Wisdom of the 1990s
 US stocks have superior returns over
Bonds and Foreign Stocks and are not
really risky assets when held over long
time frames
 Conventional Wisdom today
 ??????
Try to determine the conventional Wisdom
and assume it is wrong
 Conventional Wisdom today
 US and Foreign stocks are very risky
indeed and Government Bonds or Cash
is the place to be to ride out this
storm.
Projected long term returns
from “The Four Pillars of Investing”
Asset Class
US stocks
Foreign Stocks
Reits
Current
Yield
3.1
5.1
9.4
Long term
return (at least
10 years)
8.1
Assumption
Assume 5%
Dividend Growth
10.1
Assume 5%
Dividend Growth
12.4
Assume 3%
Dividend Growth
Junk Bonds
10
6.5
Intermediate term
T bill
3.8
3.8
Total Bond index
4.9
4.9
Assume 3 to 4%
Default rate
Asset Allocation
 Asset allocation is the art of mixing asset
groups that are not well correlated over
time in order to reduce risk and improve
returns
 Defining your mix of asset classes should
be the major focus of your investment
strategy since it and investment expenses
are the only two variables that an investor
has control of that impact risk and returns.
Major Asset Groups
Yearly Return
1972 thru
Oct 2008
Risk (Yearly
stdev)
Correlation
to
S&P500
short term t bill
6.7
2.9
-0.1
Intermediate
term gov
bonds
8.4
6.0
0.20
Inflation Indexed
Bonds **
6.2
6.8
0
S&P 500
11.3
18.4
1.00
International
Stock index
12.0
23.5
0.65
Small Cap
stocks
12.9
20.9
0.85
Reits ***
13.1
18.6
0.55
Using Historical returns you can evaluate the impact of
mixing incremental amounts of different asset classes to
evaluate their impact on past returns.
Mixes of Foreign and Large Cap US 1972 Through 2007
13.8
Annualizd return
13.6
13.4
Over long term time frames
Portfolios with 10 to 40%
Foreign stocks have reduced
risk and inproved returns
100 %
Foreign
13.2
Initial steps are in increments
of 10 ie (90%US 10% F thru
60% US 40% Foreign)
13.0
12.8
12.6
100 % US
12.4
15.0
16.0
17.0
18.0
19.0
20.0
Risk Yearly Standard Deviation
21.0
22.0
23.0
Impact of International Stocks
 The amount of international stocks (or any
risky asset class) in your portfolio in highly
dependent on your tolerance for risk, your
comfort level with this asset class, as well
as having performance levels that are
different than most portfolios built around
the S&P500.
 I use 25% International Stocks in my Model
Portfolio -- my take is that International
Stocks should comprise 10% to 40% of
your Stock portion
Reits added to Mix of US & Foreign
Stocks
Reits added to Core mix of Equities
100%
Reits
14.4
Annualized Return
14.2
14
If Reits look to good to be true you are correct.
They have been the best performing asset for
the last 10 years and should be accumulated
gradually
13.8
13.6
13.4
100% mix of US
and Foreign Stocks
13.2
13
14.5
15
15.5
16
16.5
Risk (Standard Deviation)
17
17.5
Impact of Reits on a Portfolio
 Reit’s are excellent diversifiers but I recommend
accumulating them gradually over the next 3 years or so
since they have been the best performing asset class for
the last 10 years. (More on this later)
 Be aware that including them will reduce risk but also
cause your portfolio to underperform at times a standard
mix of Large Cap US stocks and Bonds.
 Credible books on asset allocation recommend including
Reits in a range of 5% to 20% of your total assets when
they are discussed.
 They are 12% of my model portfolio
Comparison of Diversified and
conventional Portfolio
S&P 500
11.3
18.4
1.00
International Stock
index
12.0
23.5
0.65
Small Cap stocks
12.9
20.9
0.85
Reits
13.1
18.6
0.55
Av Return
Risk( Yearly stdev)
Growth of $10M
since 1972
Port Return (Well
diversified portfolio)
10.3
10.6
$ 319,000
Port Return -S&P /Bonds/
Cash
9.9
11.5
$ 271,000
Port Return
S&P/Bonds/Cash with 1%
charge for active Mgt
8.9
11.5
$ 193,000
Comments on Diversification and
expenses
 Note that the addition of risky
assets (International, Reits, etc.
increased returns and reduced
risk even though all of them were
riskier than the S&P 500)
 Note that reducing your expenses
increases return while
maintaining the same risk level
Review of the last 4 decades of
Conventional vs Diversified Portfolio
Annualized Returns over each decade
Model
Portfolio
Conventional
Portfolio
Inflation
1970 to 79
8.4
6.6
1980 to 89
16.1
1990 to 99
2000 to 08
Growth of $100,000 over each
decade
Model Portfolio
Conventional
Portfolio
7
$ 180,584
$
157,527
15.4
5
$ 365,844
$
336,885
11.7
14.5
3
$ 305,621
$
370,260
4.2
1.8
4
$ 132,447
$
112,080
Our Model Portfolio beat both Inflation and the Conventional Portfolio 3 out of 4
decades
However during the US bull Market of the 90s a conventional Portfolio
outperformed our model so if you are prone to peer pressure and wouldn’t want to
be underperforming your buddies you probably should stay with a conventional mix.
Examples of Portfolios with Moderate Risk
Ticker
symbol
Expen
se
ratio
% Rank
over last
Ten
Years
%
Return
over
last
Ten
Years
Vanguard LifeStrategy
Moderate growth
VSMGX
0.23
70%
Vanguard Wellington
VMELX
0.3
NA
0
Scotts Model Port
%
cash
% US
Large &
Small
Stocks
%
Foreign
Stocks
2.9%
6
55
10
**
29
91%
4.6%
2
52
12
?
34
90%
4.8%
10
33
15
12
30
**Market Weight of Reits in US stock portion
* % of all surviving funds that this fund outperformed in its category over 10 year time
frames
%
Reits
%
Bonds
Defining an optimum mix of
assets
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The most important task to do is to decide the mix of risky
assets such as stocks and less risky assets such as bonds
and cash. This decision is influenced by timing on when
you need the assets and your tolerance for sustaining the
pain of market declines.

There is an optimum bend of risky asset classes that will
maximize return and minimize risk known as the “Efficient
Frontier” but since no one can predict how future markets
will perform that mix is beyond the grasp of mere mortals
such as ourselves or any financial advisor.
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But that is not really a problem because any reasonable mix
of the major asset classes if it is consistently maintained
and regularly rebalanced is likely to outperform the vast
majority of active investment managers over the long term.
Defining an optimum mix of
assets
 Asset allocation is merely a
structured way to help you have a
simple well diversified portfolio
that you are comfortable with.
No one as any idea what the next
10 to 20 years will bring so it will
be best not to have all of your
eggs in one or two baskets. Let’s
have them in 3 to 5.
Potential Real Life Portfolios
Ticker
symbol
Expense
ratio
% Rank
over last
Ten Years
% Return
over last
Ten
Years
%
cash
% US
Large &
Small
Stocks
% Foreign
Stocks
%
Reits
% Bonds
Vanguard
LifeStrategy
conservative
growth
VSCGX
0.24
80%
3.3%
8
40
5
**
47
Vanguard
LifeStrategy
growth
VASGX
0.23
76%
3.1%
6
70
14
**
10
Vanguard
LifeStrategy
Moderate growth
VSMGX
0.23
70%
2.9%
6
55
10
**
29
Vanguard
Wellington
VMELX
0.3
91%
4.6%
2
52
12
?
34
NA
0
+90%
4.8%
10
33
15
12
30
Scotts Model
Port
Or you can build your own portfolio
from the individual Indexes below
Ticker
symbol
Expense
ratio
% Rank over
last Ten Years
% of Mix to Follow Model
Portfolio
Vanguard Total Stock
Index
VTSMX
0.15
65%
33%
Vanguard Total Intl Index
VGTSX
0.27
72%
15%
Vanguard REIT Index
VGSIX
0.2
55%
12%
Vanguard Short-Term
Investment Grade Bond
VFSTX
0.21
73%
10%
Vanguard Total Bond
Index
VBMFX
0.19
94%
25%
Vanguard Inflation Index
Bonds
VIPSX
0.2
90%
5%
The Business of Investing
 There are serious conflicts of interest in the vast majority
of brokers, investment advisors, mutual funds, and the
financial press that can pose a threat to you maximizing
your returns.
 It is very difficult to beat the broad market indexes and
even more difficult to predict who will beat the market in
the future so you are better off to investing in index
mutual funds such as Vanguards Total Market index and
strive to minimize your investment expenses and taxes.
 You or anyone else can’t predict or control what the
market does. What you can do is participate in a broad
array of asset classes while minimizing costs and tax
impacts.
The Business of Investing
 If you do elect to try to actively manage your account
consider active allocation methods described in “The
Four Pillars”. This is technique where you overweight
asset classes that have recently had significant declines.
 If you must invest in actively managed funds (Lack of
Index options in 401K) try to keep expense ratios below
0.5%, look for long term consistent performance that
does beat the indexes, are not well correlated with the
rest of its peers (Low R sq), use Morningstar to evaluate
the funds performance (with a good dose of common
sense), and use a core of index funds if you can.
Next Steps
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Evaluate your current situation in regard to your investment goals
(Just exactly what do you want your money to accomplish for
you), your current status in regard to accomplishing those goals,
and your knowledge and experience of investing and investment
history.

Evaluate your current mix of assets. This can easily done with a
Morningstar tool called Portfolio analysis available at
http://portfolio.morningstar.com/NewPort/Free/InstantXRayDEntry.
aspx?dt=0.7055475

Start to educate your self on investing Principles and Investment
History with the list of Books listed below starting with “The Four
Pillars”. Don’t try to hurry through this process it will probably
take a several months to properly absorb the material.
Next Steps
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When you have decided that you are interested in becoming more
diversified (and probably simplify your investments) write down
what your target allocation is in each asset group along with a plan
to gradually move to that allocation over the next couple of years
being careful of the tax implications of your decisions.

Be particularly careful of quickly eliminating the “Dogs” in your
portfolio with something that has recently done well. These easily
could be asset classes that are currently out of favor.

Let me know if you have questions or are interested in getting
additional help from me. I am interested in assisting a limited
number of folks in getting started with this process.
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Scott Larsen
[email protected]
336-760-2877
Suggested Reading
The Four Pillars of Investing
If you read nothing else read
this. Available at Amazon.com
used books for around $17
Devil Take the Hindmost: A
History of Financial Speculation
Public Library or Amazon.com
used books
Random Walk Down Wall Street
Public Library or Amazon.com
used books