Bonds, Stocks and Mutual Funds Leslie Lum

DRAFT 3/6/20072 Finding money to invest

DRAFT 3/6/20073 Activity: What will these goals cost? A house A college education Starting your own business Retirement

DRAFT 3/6/20074 The time value of money Future value of a sum of money now Present value of a sum of money in the future Future value of annual savings Annual savings needed for sum of money in the future

DRAFT 3/6/ Future value of sum now Using Table 1 look up the following: – $5000 at 7% over 10 years – $3000 at 5% over 20 years

DRAFT 3/6/20076 A real life example You are a typical employee in your 20s who when you left your job in 2005 cashed out (66% do) your 401K account of less than $10,000. What is the cost of cashing out your account if your balance was $8000?

DRAFT 3/6/ Set aside now for future sum Use table 2. What do I need to set aside for: $10,000 in 10 years at 7% $50,000 in 15 years at 8% $125,000 in 30 years at 6%

DRAFT 3/6/ The effect of saving every year What if you cut out candy and soda/two fast food meals/one sit-down restaurant meal a week/5 fancy coffees a week? Savings $25

Risk and return DRAFT 3/6/2007 9

10 Understanding Returns

DRAFT 3/6/ Some investments can result in a gain

DRAFT 3/6/ Capital Loss

DRAFT 3/6/ Annualized gain or loss Allows you to make an apples-to-apples comparison

Yield – Annual dividend or interest DRAFT 3/6/200714

DRAFT 3/6/ A real life example You will get your paycheck next week but you need $100 now. You arrange for a payday loan paying a fee of $15 for the use of $100. The payday loan company will collect the $100 electronically from your bank account when your pay check is deposited next week. What is the rate charged?

DRAFT 3/6/ Planning for uncertainty

DRAFT 3/6/ Returns are uncertain

DRAFT 3/6/ Investment Risk

DRAFT 3/6/ Major asset classes: Risk & Return

Primer on bonds DRAFT 3/6/200720

Capital gain or loss on bonds DRAFT 3/6/200721

DRAFT 3/6/ Bonds

DRAFT 3/6/ Stocks

DRAFT 3/6/ Historical returns of major asset classes Average annual returns over the 30 years: Cash 7% Bonds 9% Stocks 15% Conclusion: If you need higher returns to reach financial goals, you have to invest in stocks.

DRAFT 3/6/ If you receive an offer of a guaranteed high return, is that possible? Only if they guarantee a high loss as well. There are no guarantees in any investment. All investments go up and down. Higher return means higher risk. Return versus Risk

DRAFT 3/6/ Given the same return, the investment with less risk is better

DRAFT 3/6/ The Northwest is the best.

DRAFT 3/6/ Bonds – Risk Return

DRAFT 3/6/ US Stocks – Risk Return

DRAFT 3/6/ Sectors – Risk Return

DRAFT 3/6/ International – Risk Return

DRAFT 3/6/ Combined – Risk Return

DRAFT 3/6/ Inflation rates are uncertain

DRAFT 3/6/ Inflation is also risk

DRAFT 3/6/ Which is the best return?

DRAFT 3/6/ After inflation, the 6% return is the best!!

DRAFT 3/6/ Year-to-year stock returns

DRAFT 3/6/ Risk gets lower with time

DRAFT 3/6/ Lowest risk over ten years

DRAFT 3/6/ Summary All investments have risk Buy and hold market index funds (doesn’t work for individual stocks) Have an emergency fund (3 to 6 months) to tide you over Have other sources of income so you don’t have to cash out during down markets

DRAFT 3/6/ Asset Allocation

DRAFT 3/6/ All eggs in one basket? 34.6 percent of families had stock in only one company 59.5 percent had stock in three or fewer companies 9.5 percent had stock in fifteen or more companies Source: 2004 Consumer Finance Survey

DRAFT 3/6/ Why asset allocate? It has to do with return and risk

DRAFT 3/6/ Can you predict the best return?

DRAFT 3/6/ Does the risk double with two investments? The key is having two investments which aren’t correlated.

DRAFT 3/6/ Adding a riskier investment to your portfolio decreases overall risk.

DRAFT 3/6/ If you allocate the right amount you reduce risk and increase return!

DRAFT 3/6/ Pension Fund Asset Allocation

DRAFT 3/6/ “Millionaires” Portfolio

50 David Swensen suggests a portfolio

Do we buy at the right time? DRAFT 3/6/200751

Rebalancing Adjusting portfolio based on asset allocation goals DRAFT 3/6/200752

No rebalancing DRAFT 3/6/ Year BondStock %60% %60% %61% %65% %68% %73% %76% %79% %76% %72% %64% %69% %70% %71% %73%

Rebalancing DRAFT 3/6/200754

Summary Don’t put all your eggs in one basket. Rebalance every year to keep your portfolio on track. DRAFT 3/6/200755

Funds DRAFT 3/6/200756

Types of funds Mutual funds Closed-end funds Exchange-traded funds (ETFs)

Mutual fund industry

Closed-end funds

ETFs

Fund evaluation DRAFT 3/6/200761

Evaluating funds 9/12/07 62 Objective Relates to your asset allocation goals Check the portfolio to be sure Fees The lower the better – check against index funds Performance How does it do against the index? How does it do against other funds? Risk Is it lower risk than other funds? Management If you are choosing an actively-managed fund – how experienced is the manager? or for Lipper

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9/12/07 74 Other American Funds Have sales fees

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Fund Fees True or False? 76 All fund fees are charged when you buy. All fund fees have the same effect. A no-load fund has no fees. All funds should have the same level of fees and expense ratios. Expense ratios are such a small part of your investment you shouldn’t worry about them.

Index Funds Index funds are funds that represent certain categories of assets There are index funds for large, medium and small stocks, international stock, bonds, industries, real estate, commodities, and more. They are not actively managed. Their investments don’t change. DRAFT 3/6/200777

Evaluate your fund performance/fees against index funds performance/fees 9/12/07 78 Index Funds Average Return %Risk % Expense Ratio % Emerging markets are international stocks of developing countries European large stocks International stocks of developed countries Real estate Small cap stock - Small US companies $300 M to $2 B Mid cap stock - Medium-sized US companies $1.5B to $5 B S&P Largest US stocks Bonds 430.2

How fees (negatively) impact your return 9/12/07 79 Source: Statement of John C. Bogle to the United States Senate Governmental Affairs Subcommittee, November 3, 2003

The bigger, the not-better 9/12/07 80 Source: Statement of John C. Bogle to the United States Senate Governmental Affairs Subcommittee, November 3, 2003

Investors hold funds for 3 years 9/12/07 81 Source: Statement of John C. Bogle to the United States Senate Governmental Affairs Subcommittee, November 3, 2003

Beating the indices -- negatively 9/12/07 82 Source: Statement of John C. Bogle to the United States Senate Governmental Affairs Subcommittee, November 3, 2003

DRAFT 3/6/ Advice from the pros David Swensen who manages the Yale University endowment, and who is considered one of the best investment managers, has sobering advice to give to individual investors: Individuals shouldn’t pick stocks themselves. The markets are competitive and they don’t have the information to compete nor the clout to negotiate. Beware of actively-managed mutual funds. They allow popular funds to grow too big so they can’t beat the market. They also tend to promote the wrong fund at the wrong time. The vast majority of actively- managed funds underperform the market. Mutual fund monitoring companies don’t help you either. They downgrade funds after the damage has been done. Individuals are best served by index funds with the lowest fees. Have a diversified portfolio and rebalance.