From last week 3. Markets are People 5. Diversify 8. Costs Kill Stocks have prices; businesses have value

Chapter 3 Lessons A mix of stocks and bonds is needed To manage risk Provide adequate returns of portfolio growth and income generation. Save your entire life, even after retirement

5. Diversify → 2. Investment Plan Example: At age 60, say… 40% stocks 60% bonds chart on page 77 assumes moderate risk tolerance

Foreign stock ownership risk Risk to currency exposure Foreign stocks are riskier and more expensive to own. Fund fees are higher. Large cap value index fund - does it S.E.C’s oversight not equaled Companies not as well managed

50/50 Stocks and Reits $2000 invested $1000 and $1000 (50/50) in stocks and REITs at the beginning of 1995 End of 1995:   Stocks: $ 1,000 X 37% gain = $ 1,370 REITs: $ 1,000 X 12% gain = $ 1,120 Total: $ 2,490

50/50 Stocks and Reits To rebalance to a 50/50 mix we need Stocks: $ 1,000 X 37% gain = $ 1,370 REITs: $ 1,000 X 12% gain = $ 1,120 Total: $ 2,490   To rebalance to a 50/50 mix we need $ 1,245 (1/2 of 2,490) in each of stocks and REITs.  To do this we sell $1,370 - $ 1,245 = $ 125 of stocks buy $125 of REITs.

50/50 Stocks and Reits Now at the start of 1996 we have $ 1,245 in each of stocks and REITs. At the end of 1996 we have: Stocks: $ 1,245 X 22% gain = $ 1,519 REITs: $ 1,245 X 33% gain = $ 1,655 Total: $ 3,174

50/50 Stocks and Reits To rebalance to a 50/50 mix we need to have Stocks: $ 1,245 X 22% gain = $ 1,519 REITs: $ 1,245 X 33% gain = $ 1,655 Total: $ 3,174 To rebalance to a 50/50 mix we need to have $ 1,587 (1/2 of 3,174) in each of stocks and REITs.   To do this we buy $1,587 - $ 1,519 = $ 68 of stocks and sell $68 of REITs.

Rebalance We buy low and sell high when we rebalance! Portfolio volatility is reduced Done on a periodic schedule

Buy – Hold – Rebalance Investors who trade the most underperform those who trade the least by 7.1% per year. Trading is Hazardous to Your Wealth, Journal of Finance, vol. 55, no. 2 April 2000 5 Diversification

Author’s page 89 example… For moderate 70 year old: 70% bonds 30% stocks 80/20 domestic to foreign mix 24% domestic stocks 6% foreign stocks 70% bonds

Risk tolerance 113 business students filled out risk-tolerance quizzes from six major financial companies The average similarity among the results was only 56% May depend less on who you are than on whose quiz you take

Risk tolerance is an emotional judgment and can and does change with conditions.

Determine the level of return we require Construct one with a reasonable number of asset classes to mitigate risk Compare our result with the author’s chart on page 77 for our age

Next Week’s Key Points Chapter 4 pages 95-125 Avoid investing emotionally Learn to distrust simple narrative explanations of complex economic or financial events Don’t invest for entertainment; dare to be dull. We feel bad about investing because of “risk aversion myopia”.

Next Week’s Key Points Nations with the fastest growing economies often have the lowest stock returns. We are overconfident pattern seeking primates. Plan, don’t panic. Avoid analogies. Remember: life is random. Most of all: Page 98: Anticipation is better than pleasure