Investment Presentation By Professor David M. Sinow University of Illinois

What makes a difference when you invest? Investing Overview What makes a difference when you invest? Equities vs. Fixed Income Volatility Is Your Enemy Longer Term Fixed Income Investments Are Too Risky Three Factor Model Asset Allocation: The Real Key to Investing Dave’s Couch Potato Portfolio

Asset Class Performance 1925-1996

Volatility is Your Enemy!!!! Assume I invest $100.00 for one year & earn 0% at the end of year 1. Assume that the following year I invest the $100.00 and earn 0% again. My average return is 0%. Now Assume that you invest $100.00 for one year and earn 50% at the end of year 1. Assume the following year you invest $150.00 and your second year rate of return is a –50%. We each had an average rate of return of 0% over the two year period.

But……….Who has more money at the end of the 2 years???? A) Me B) You MORAL OF THE STORY: VOLATILITY KILLS PORTFOLIOS IN DOWN YEARS—BECAUSE YOU LOSE A GREATER PERCENTAGE OF YOUR GAINS FROM PREVIOUS YEARS!!!!

Risk/Reward: Does it Pay to Extend Maturities? 1964-1994 (%) Long maturity instruments are riskier. Returns for longer maturity instruments are not consistently greater. Alternative strategies are needed to enhance returns. Annualized Return (%) 6.56 7.43 7.53 7.70 6.89 Annualized Standard Deviation 1.32 1.64 2.16 6.68 11.50

“Out-of-Favor Companies Three Elements That Determine the Majority of an Equity Fund’s Expected Return 5.86% Average Annual Returns 1964-1996 5.13% 3.58% Market Factor All-Equity Universe Minus T-bills Size Factor Small Stocks Minus Large Stocks Style Factor “Out-of-Favor Companies Minus “Glamour” Companies

Porfolio #1 – A Basic Portfolio Passively Invested Expected Return Standard Deviation Portfolio #1 13.6% 10.3 60% S&P 500 Index 40% Lehman Gov/Corp. Index

Porfolio #2 – A Basic Portfolio Substituting Short-Term Fixed Income for Long-Term Fixed Income Expected Return Standard Deviation Portfolio #1 13.6% 10.3 Portfolio #2 13.3% 8.6 60% S&P 500 Index 40% 1-yr Fixed Income

Porfolio #3 – A Basic Portfolio Balancing Equities, S & P, and US Small Cap Index Expected Return Standard Deviation Portfolio #1 13.6% 10.3 Portfolio #2 13.3% 8.6 Portfolio #3 14.9% 9.9 30% S&P 500 Index 40% 1-yr Fixed Income 30% Small Cap

Porfolio #4 – A Basic Portfolio Balancing US Small Cap Value, US Small Cap, US Large Value, and S&P 500 Index Expected Return Standard Deviation Portfolio #1 13.6% 10.3 Portfolio #2 13.3% 8.6 Portfolio #3 14.9% 9.9 Portfolio #4 15.7% 9.8 15% S&P 500 Index 15% US Large Cap Value 40% 1-yr Fixed Income 15% Small Cap Value 15% Small Cap

Porfolio #5 – A Basic Portfolio Adding International Diversification Expected Return Standard Deviation Portfolio #1 13.6% 10.3 Portfolio #2 13.3% 8.6 Portfolio #3 14.9% 9.9 Portfolio #4 15.7% 9.8 Portfolio #5 16.6% 9.1 7.5% S&P 500 Index 7.5% US Large Cap Value 7.5% Small Cap Value 40% 1-yr Fixed Income 7.5% Small Cap 15% Int’l Large Value 15% Int’l Small Value

DAVE’S COUCH POTATO PORTFOLIO Asset Class Percentage Invested 1 S&P 500 10% 2 US Large Value 16.5% 3 US Small Cap 4 US Small Cap Value 5 US Mid-Caps 6 US REIT 7% 7 Total International 25% 8 Emerging Markets 5% Total 100%