fpa nca 2012 winter educational symposium asset dedication slides
DESCRIPTION
Slide presentation from the 2012 FPA National Capital Area Winter SymposiumTRANSCRIPT
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ENGINEERIN
G
INCOME P
ORTFO
LIOS
FP
A N
CA
20
12
WI N
TE
R E
DU
CA
TI O
NA
L S
YM
PO
SI U
M
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…economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.
Federal Reserve Monetary Policy Release January 25th, 2012
WHERE ARE INTEREST RATES GOING?
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$16.4 trillion
THE US DEBT CEILING
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10 YEAR US TREASURY BOND YIELDS1800-2010
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CONTRASTING RETURN ENVIRONMENTSRISING = 1950-1981 FALLING = 1981-2011
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SUSTAINED LOW INTEREST RATES
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VOLATILITY DRIVES DOWN TOTAL RETURN
Source: Citigroup World Govt. Bond Index – Japan 1-5 Year
Total Return= 2.9%
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"It's not return on my money I'm interested
in… …it's return of my money“Mark Twain
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THE CRITICAL PATH
• On their way to the moon, the Apollo ships were off course more than 95% of the time
• Because they knew the trajectory the ship should follow, the astronauts could make corrections along the way so that the ships could make it to the moon and back
• In the same way, the financial plan provides the trajectory that clients’ portfolios need to follow to reach their goals
• The Critical Path serves as a customized benchmark to guide each client’s portfolio to make corrections and decisions approaching and through retirement
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LIFETIME CRITICAL PATH®
Accum
ulat
ion
Tra
nsi
tion Decumulation
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LIFETIME CRITICAL PATH®
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RETIREMENT CRITICAL PATH®
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BRINGING INVESTMENTS AND PLANS TOGETHER• The financial plan articulates how investors plan to spend
their money
• Investments ought to reflect the goals they are funding instead of risk tolerance that is not tied to the goals
• There are numerous behavioral benefits for having the investments flow from the plan
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Portfolio
Financial Plan
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SPLITTING THE PORTFOLIO TO REFLECT GOALS• Sub-portfolios are dedicated to specific purposes – Income
and Growth
• Each sub-portfolio is made up of asset classes best suited to their purpose
• The Income Portfolio is dedicated to protecting principal and providing predictable cash flows using individual bonds
• The Growth Portfolio is tasked with delivering long-term growth using equities and other growth oriented assets
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Portfolio
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Growth Portfolio
Income Portfolio
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Equities + Others
Individual Bonds
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Protected Principal and
Predictable Income
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Protected Principal and
Predictable Income
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Higher Expected Returnbut
Short-term Volatility
Protected Principal and
Predictable Income
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Protected Principal and
Predictable Income
Higher Expected Returnbut
Short-term Volatility
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Predictability Uncertainty
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Systematically transfer uncertainty of equities to predictability of bonds
to reduce the volatility of funding retirement spending.
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DE-RISKING THE PORTFOLIO
1. Protect Principal
2. Reduce uncertainty of funding spending needs
3. Reduce sensitivity to market risks• Interest rate risk• Equity market risk
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BEHAVIORAL BENEFITS 1. Mental accounting
2. Dedicate assets to the purpose they best serve
3. Tie portfolio performance to the goals outlined in the financial plan
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CASE STUDIES
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Helen and George:
Age: 67
Assets: $2,000,000
Income need: $100,000
Expected Inflation: 3%
Plan Horizon: 30 Years
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LIFETIME SPENDING NEEDS$2MM PORTFOLIO, $100K/YR, 3% INFLATION
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INITIAL 8 YEARS OF SPENDING NEEDSYEAR 1
8 Years of Income
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Year Issue Principal Interest
Portfolio Cash Flows
Target Cash Flows
2012 CD $77,000 $22,905 $99,905 $100,000
2013 CD $82,000 $21,416 $103,416 $103,000
2014 CD $86,000 $20,035 $106,035 $106,090
2015 CD $91,000 $17,818 $108,818 $109,273
2016 CD $98,000 $14,855 $112,855 $112,551
2017 CD $104,000 $11,713 $115,713 $115,927
2018 CD $112,000 $7,455 $119,455 $119,405
2019 Agency Bond $121,000 $2,496 $123,496 $122,987
$889,692 $889,234
BUILDING AN INCOME MATCHING PORTFOLIO
Quotes: 9/6/2011
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Year Issue Principal Interest
Portfolio Cash Flows
Target Cash Flows
2012 CD $77,000 $22,905 $99,905 $100,000
2013 CD $82,000 $21,416 $103,416 $103,000
2014 CD $86,000 $20,035 $106,035 $106,090
2015 CD $91,000 $17,818 $108,818 $109,273
2016 CD $98,000 $14,855 $112,855 $112,551
2017 CD $104,000 $11,713 $115,713 $115,927
2018 CD $112,000 $7,455 $119,455 $119,405
2019 Agency Bond $121,000 $2,496 $123,496 $122,987
$889,692 $889,234
TARGET INCOME STREAM
Quotes: 9/6/2011
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Year Issue Principal Interest
Portfolio Cash Flows
Target Cash Flows
2012 CD $77,000 $22,905 $99,905 $100,000
2013 CD $82,000 $21,416 $103,416 $103,000
2014 CD $86,000 $20,035 $106,035 $106,090
2015 CD $91,000 $17,818 $108,818 $109,273
2016 CD $98,000 $14,855 $112,855 $112,551
2017 CD $104,000 $11,713 $115,713 $115,927
2018 CD $112,000 $7,455 $119,455 $119,405
2019 Agency Bond $121,000 $2,496 $123,496 $122,987
$889,692 $889,234
MATCHING CASH FLOWS TO SPENDING NEEDS
Quotes: 9/6/2011
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Year Issue Principal Interest
Portfolio Cash Flows
Target Cash Flows
2012 CD $77,000 $22,905 $99,905 $100,000
2013 CD $82,000 $21,416 $103,416 $103,000
2014 CD $86,000 $20,035 $106,035 $106,090
2015 CD $91,000 $17,818 $108,818 $109,273
2016 CD $98,000 $14,855 $112,855 $112,551
2017 CD $104,000 $11,713 $115,713 $115,927
2018 CD $112,000 $7,455 $119,455 $119,405
2019 Agency Bond $121,000 $2,496 $123,496 $122,987
$889,692 $889,234
TIMING THE CASH FLOWS
Quotes: 9/6/2011
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PORTFOLIO COSTS
8 Years = $829,656
Total Income = $889,692
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PORTFOLIO COSTS
8 Years = $829,656 (60/40)
10 Years = $1,035,495 (50/50)
30 Years = $2,753,814 (0/100)
Quotes: 9/6/2011
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PORTFOLIO COSTS
8 Years = $829,656 (60/40)
10 Years = $1,035,495 (50/50)
30 Years = $2,753,814 (0/100)
Quotes: 9/6/2011
30-year portfolio exceeds resources
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PUTT
ING IT
INTO
PRACTI
CE
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Top Investment RisksDefined by Individual Investors
Outliving Savings Not Saving Enough Market Volatility0%
10%
20%
30%
40%
50%
60%
70%
64%54%
36%
Source: Financial Advisor Retirement Income Planning Experiences, Strategies, and Recommendations; FPA Research Center White Paper; December 2011.
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LIFETIME SPENDING NEEDS$2MM PORTFOLIO, $100K/YR, 3% INFLATION
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YEAR 1
8 Years of Income
22 Years of Uncertainty
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YEAR 2
8 Years of Income
21 Years of Uncertainty
? ? ? ?
Roll or Don’t Roll?
8 Years of Income
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YEAR 2
8 Years of Income
21 Years of Uncertainty
Above CP → Roll 1 Year
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YEAR 3
8 Years of Income
20 Years of Uncertainty
Above CP → Roll 1 Year
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YEAR 4
8 Years of Income
19 Years of Uncertainty
Above CP → Roll 1 Year
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YEAR 5
8 Years of Income
18 Years of Uncertainty
Above CP → Roll 1 Year
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YEAR 6
10 Years of Income15 Years of Uncertainty
Well Above CP → Roll 2 Years
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WELL ABOVE CRITICAL PATH
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YEAR 6
10 Years of Income15 Years of Uncertainty
Well Above CP → Roll 2 Years
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YEAR 7
9 Years of Income
15 Years of Uncertainty
Not Above CP → Don’t Roll
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BELOW CRITICAL PATH
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YEAR 7
9 Years of Income
15 Years of Uncertainty
Not Above CP → Don’t Roll
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YEAR 8
8 Years of Income
15 Years of Uncertainty
Not Above CP → Don’t Roll
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STILL BELOW
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YEAR 8
8 Years of Income
15 Years of Uncertainty
Not Above CP → Don’t Roll
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YEAR 9
8 Years of Income
14 Years of Uncertainty
Above CP → Roll 1 Year
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BACK ABOVE CRITICAL PATH
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WHAT
ABOUT
SYSTE
MATIC
WIT
HDRAWAL?
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LONG-TERM PROBABILITY OF SUCCESS
Expected Return Over Rolling 30 Year Periods Since:
1927 1947
Average Return* 7.7% 9.4%
Minimum Return* 0.0% 7.1%
Maximum Return 13.3% 13.3%
Average Longevity (Years) 28 30
Minimum Longevity 13 30
Maximum Longevity 30 30
Probability Portfolio Lasts 30 Years or more 83.6% 100.0%
Prob. Portfolio Above Critical Path Target After 30 Years
83.6% 100.0%
8-year Income Portfolio of US Treasury Bond, Growth Portfolio allocation to CRSP 1-10 Total US Market
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HISTORICAL AUDITROLLING 30-YEAR PERIODS, 1927-2010
8-year Income Portfolio of US Treasury Bond, Growth Portfolio allocation to CRSP 1-10 Total US Market
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TOTAL RETURN IS NOT FOR DECUMULATION
Expected Return Over Rolling 30 Year Periods Since:
1927 1947
Average Return* 6.7% 7.3%
Minimum Return* 0.0% 0.0%
Maximum Return 12.6% 12.6%
Average Longevity (Years) 29 30
Minimum Longevity 14 25
Maximum Longevity 30 30
Probability Portfolio Lasts 30 Years or more 80.0% 85.7%
Prob. Portfolio Above Critical Path Target After 30 Years
80.0% 85.7%
60% CRSP 1-10 Total US Market/40% 10-Year US Treasury Index
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HISTORICAL AUDIT – 60/40 TOTAL RETURNROLLING 30-YEAR PERIODS, 1927-2010
60% CRSP 1-10 Total US Market/40% 10-Year US Treasury Index
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HISTORICAL AUDIT – 8 YEAR ROLLINGROLLING 30-YEAR PERIODS, 1927-2010
8-year Income Portfolio of US Treasury Bond, Growth Portfolio allocation to CRSP 1-10 Total US Market
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Celia and Henry:
Age: 57
Assets: $843,402
Annual Savings: $35,000
Planned Retirement: 30 Years
Plan Horizon: 40 Years
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DEFERRED INCOME PORTFOLIOEXTEND OUT THE YIELD CURVE
Purchase 10 to 15 years out on the
yield curve
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BUILDING TO RETIREMENT
25 Years of Uncertainty
5 Years of Future Income
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BUILDING TO RETIREMENT
24 Years of Uncertainty
6 Years of Future Income
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BUILDING TO RETIREMENT
23 Years of Uncertainty
7 Years of Future Income
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BUILDING TO RETIREMENT
23 Years of Uncertainty
7 Years of Future Income
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BUILDING TO RETIREMENT
22 Years of Uncertainty
8 Years of Future Income
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COMPARIN
G
INCOME S
TRAT
EGIES
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WHY NOT A BOND FUND?
1. Volatility around funding
2. Sensitivity to rising interest rates
3. Lack of control
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10 YEAR US TREASURY BOND YIELDS1800-2010
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BOND FUND VOLATILITY REVEALEDRISING INTEREST RATES 1950-1981
10-year Treasury Index is the proxy for high quality bond funds
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BOND FUND VOLATILITY REVEALEDRISING INTEREST RATES 1950-1981
10-year Treasury Index is the proxy for high quality bond funds
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BOND FUND INCOME VARIABILITY/SHORTFALL COMPARISON OVER 8-YEAR HORIZONS 1950-1981
Starting value = cost of 8-year Income Portfolio for each year. Target cash flows = $100,000/year plus 3% inflation. 10-year Treasury Index is the proxy for high quality bond funds
Bond funds run out of money
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WHY NOT A BOND LADDER?
1. Cash flows are not tied to actual needs
2. Income is more expensive
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WHY NOT A SIMPLE BOND LADDER?
YearBond Ladder
Income Portfolio
Target Cash Flows
2012 $133,636 $103,297 $100,0002013 $131,428 $108,750 $103,0002014 $130,452 $111,082 $106,0902015 $122,982 $113,612 $109,2732016 $121,468 $116,438 $112,5512017 $113,690 $119,099 $115,9272018 $106,378 $121,714 $119,4052019 $101,330 $124,691 $122,9872020 $104,576 $127,180 $126,6772021 $96,636 $130,502 $130,477Total Cash Flow $1,162,576 $1,176,366 Cost $1,052,363 $1,051,250
Quotes: 9/6/2011
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WHY NOT A BOND LADDER?
YearBond Ladder
Income Portfolio
Target Cash Flows
2012 $133,636 $103,297 $100,0002013 $131,428 $108,750 $103,0002014 $130,452 $111,082 $106,0902015 $122,982 $113,612 $109,2732016 $121,468 $116,438 $112,5512017 $113,690 $119,099 $115,9272018 $106,378 $121,714 $119,4052019 $101,330 $124,691 $122,9872020 $104,576 $127,180 $126,6772021 $96,636 $130,502 $130,477Total Cash Flow $1,162,576 $1,176,366 Cost $1,052,363 $1,051,250
$13,790 Greater Total Cash Flow From Income Portfolio
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WHY NOT A PERIOD CERTAIN ANNUITY?
1. Expensive
2. Inflexible
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WHY NOT A PERIOD CERTAIN ANNUITY?
Year Period Certain Income Portfolio
2012 $95,400 $98,235
2013 $98,262 $104,183
2014 $101,210 $105,590
2015 $104,246 $108,236
2016 $107,374 $110,222
2017 $110,595 $113,056
2018 $113,913 $115,887
2019 $117,330 $118,115
2020 $120,850 $120,837
2021 $124,475 $124,385
Total Cash Flow $1,093,654 $1,118,746
Cost $1,000,000 $999,808
Quotes: 9/6/2011 www.immediateannuity.com
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WHY NOT A PERIOD CERTAIN ANNUITY?
Year Period Certain Income Portfolio
2012 $95,400 $98,235
2013 $98,262 $104,183
2014 $101,210 $105,590
2015 $104,246 $108,236
2016 $107,374 $110,222
2017 $110,595 $113,056
2018 $113,913 $115,887
2019 $117,330 $118,115
2020 $120,850 $120,837
2021 $124,475 $124,385
Total Cash Flow $1,093,654 $1,118,746
Cost $1,000,000 $999,808
$25,092Greater Total Cash Flow
From Income Portfolio
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In 2008, AIG was the largest issuer of fixed annuities.
US Government capital infusion = $182 billion
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Which is safer?1. FDIC Insured CDs and
Government Agency bonds
OR2. Insurance companies
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DIVIDEND INCOME UNPREDICTABILITY
According to Standard and Poor’s, dividend payments from companies in the S&P 500 dropped by 23.5% from
January 2008 to January 2009
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REIT INCOME UNPREDICTABILITY
According to Cohen and Steer’s, publicly traded REITs cut their dividends by 26% in
2009
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QUESTIONS?
White Papers:The Cost of Waiting for Rates to
Rise
De-risking Retirement Income
The Safety of Investment Grade Bonds
Slides:Presentation
Financial Inspiration (Joke)
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