personal finance: another perspective investments 3: 12 important lessons

Personal Finance:

Another Perspective

Investments 3:

12 Important Lessons

Objectives for this Session

A. Understand the investment hourglass

B. Understand the priority of money

C. Understand the principles of successful investing

D. Understand historical asset class performance

Another Perspective on Wealth

The Lord has told us:• Lay not up for yourselves treasures upon earth,

where moth and rust doth corrupt, and where thieves break through and steal: But lay up for yourselves treasures in heaven, where neither moth nor rust doth corrupt, and where thieves do not break through nor steal. (Matthew 6: 19-20)

Another Perspective (continued)

The American prophet Jacob counseled:• But before ye seek for riches, seek ye for the

kingdom of God. And after ye have obtained a hope in Christ ye shall obtain riches, if ye seek them; and ye will seek them for the intent to do good—to clothe the naked, and to feed the hungry, and to liberate the captive, and administer relief to the sick and the afflicted. (Jacob 2: 18-19)

Another Perspective (continued)

President Spencer W. Kimball said:• Many people spend most of their time working in

the service of a self-image that includes sufficient money, stocks, bonds, investment portfolios, property, credit cards, furnishings, automobiles, and the like to guarantee carnal security throughout, it is hoped, a long and happy life. Forgotten is the fact that our assignment is to use these many resources in our families and quorums to build up the kingdom of God.” (Ensign, June 1976, p.

4.)

A. Understand the Investment Hourglass

• What should you do before you start investing?• Is there a priority to paying bills?• Are there certain things you should never do

without?• Are there other bills more important than

investing?• Is there a purpose to investing?

Before You Invest: The Hourglass Top

4. Know your personal goals, budget, and have an investment plan

If you can answer these affirmatively, you are ready to invest!

3. Be out of major credit card and short-term consumer debt

2. Have adequate life and health insurance

1. Have your priorities in order and are “square” with the Lord

The Hourglass (continued)

• What does the hourglass top do?• It puts your priorities in order

• And what should those priorities be?

• God

• Family

• Personal responsibility

Taxable Assets Retirement Assets

1. Basics: Emergency Fund and Food Storage1. Basics: Emergency Fund and Food Storage

Investing: The Hourglass Bottom

2. Core: Broad Market Index or Core Mutual Funds2. Core: Broad Market Index or Core Mutual Funds

3. Diversify: Broaden and Diversify your Asset Classes3. Diversify: Broaden and Diversify your Asset Classes

4. Opportunistic (optional): Individual Stocks and Sector Funds4. Opportunistic (optional): Individual Stocks and Sector Funds

The Hourglass (continued)

• The hourglass bottom teaches 3 important lessons:• 1. It helps keep risk in perspective• 2. It teaches the “how to” about investing?• 3. It separates out taxable and retirement assets

Things Learned

• 1. There is a framework for helping us understand investing

• 2. Since life is priorities based, our investing should follow our priorities as well.

• 3. There is an order to what we should do before investing

• 4. There is an order to building our portfolio as well

B. Understand the Priority of Money (for investing and retirement)

• What is the priority of money?• The priority of money is a process of

understanding which types of investment vehicles will help you achieve your goals the fastest

• Why should we learn it?

• Because it can help you achieve your financial goals faster

Priority of Money (continued)

• What is the difference between investment vehicles and financial assets?• The investment vehicle is the tax-law defined

framework that has specific tax advantages, i.e., 401k, 403b, Individual Retirement Account (IRA), SEP IRA, cash value insurance, etc.

• The financial assets are the securities that are invested in by the vehicles, i.e., stocks, bonds, mutual funds, REITs, MMMFs, CDs, etc.

Priority of Money (continued)Current Investment Vehicles for 2006:

Plan Tax-def. Tax-elim. Max Amount For Employees of:401-k Y $15,000* Businesses w/plans403-b Y 15,000* Non-profit, tax-exempt457 Y 15,000* State/municipalitiesSEP IRA Y 44,000 Small businessesSIMPLE IRA Y 10,000* Small businessesIRA Y 4,000* IndividualsRoth IRA Y 4,000* IndividualsEducation IRA Y 2,000 Individual Education529 Plans Y 315,000 p.c. Individual Education * There are additional “catch up” amounts for those over age 50.


• What is the priority of money?

1. Free money• Money made available by your company, generally on

a matching basis, to encourage greater participation in company sponsored retirement plans, i.e., 401k, Keogh and other matching plans

Why is this the first priority?

• It’s free What are the risks?

• You must be fully vested to have ownership of the funds and 59 ½ to take distributions


2. Tax-advantaged money

2.a. Tax Eliminated moneyThis money allows the elimination of all future taxes

• This money can be used at retirement (or education) without penalty or taxes (i.e., Roth IRA for retirement and the Education IRA, 529 Funds, and Series EE/I (where bonds are used for education)

What are the risks?

• You must be 59½ to take distributions

• Money from 529 Funds and bonds must be used for qualified educational expenses to be tax-free


2.b. Tax-deferred moneyThis money defers taxes until retirement

• This is money that has specific tax advantages, particularly the ability to be invested before-tax, with principle and earnings taxed only at retirement (IRA, SEP IRA, 401k, 403b, etc.)

What are the risks?

• You must be 59½ to take distributions

• Distributions before retirement require a 10% penalty and the funds are taxed at ordinary income tax rates

• This money changes capital gains to ordinary income


3. Tax-efficient and wise investments This is wisely invested money

• This is money that is invested tax-efficiently and wisely, consistent with the principles of successful investment

What are the risks?

• You pay taxes on earnings each year

• You need to compare the returns, after-taxes and transaction costs to the appropriate benchmark


How do you invest tax efficiently?• a. Know the impact of taxes on your returns

• After-tax return = Before-Tax Return * (1 – Marginal Tax Rate). Know your marginal federal and state tax rate!

• b. Replace ordinary income with capital gains• Capital gains are taxed at a much lower rate

• c. Defer earnings to the future. • Pay taxes on the earnings as late as possible

• d. Minimize taxable distributions


• How do you prioritize your vehicle choices?• While some investment vehicles are higher on

the priority of money than others, they also have lower contribution amounts (i.e., $4,000 for the Roth in 2006). What should you do?• Use the highest priority money first, and

then next highest, etc. until you have utilized all your available funds

Implications for Portfolios

• Where should you put different types of financial assets?• Retirement Accounts: 401k, IRA’s, 529 Funds, etc.

• Actively traded financial assets• Taxable bonds and high turnover mutual funds

• Remember you do not pay taxes until you retire• Taxable Accounts

• Financial assets with a buy and hold strategy• Tax-free bonds and tax-efficient mutual and index

funds• Remember you pay taxes on these fund’s

distributions each year

Things Learned

• 5. Different investment vehicles have different tax advantages

• 6. Utilize the investment vehicles that give you the highest after-tax return and that helps you achieve your goals the fastest

• 7. Taxable and retirement assets should be managed differently due to tax effects

C. Understand the 10 Principles of Successful Investing

• Is there one right way to invest?

• Is there one right way to teach investing?

Principles for Successful Investing (continued)

• How important are correct principles when investing?• The Prophet Joseph Smith said: “I teach them

correct principles and they govern themselves.” (Messages of the First Presidency, comp. James R. Clark, 6 vols., Salt Lake City: Bookcraft, 1965-75, 3:54.)

• Are the principles behind successful investing important?


Elder Dallin H. Oaks commented:• We live in a complex society, where even the simplest

principle can be exquisitely difficult to apply. I admire investors who are determined not to obtain income or investment profits from transactions that add to the sum total of sin and misery in the world. But they will have difficulty finding investments that meet this high standard. Such complexities make it difficult to prescribe firm rules. We must rely on teaching correct principles, which each member should personally apply to govern his or her own circumstances. (Dallin H. Oaks, “Brother’s Keeper,” Ensign, Nov. 1986, 20 )


• Whatever you invest in, and at whatever phase of your investment you are in, these principles are critical. • While there may be discussion as to the number of

principles, the importance of the principles are not disputed!

• If you build your portfolio in line with these principles, you will have a successful portfolio


1. Know yourself• Know your goals

• Have well-written and thought-out goals• Know your budget

• Live within your means, and save and invest• Know your ability to tolerate risk

• Know what kind of investor you are


• Watch overconfidence• Men trade 45% more than women

• Their annualized returns were 2.7% less

• Single men trade 67% more than single women

• Their annualized returns were 1.4% less

• Watch on-line trading

• Before on-line, investors beat the market by 1.9%

• Afterwards, they underperformed by 3.6%Carla Fried, “The Problem with your Investment Approach,” Business 2.0, November 2003, p. 146


2. Understand Risk• Risk is inherent in all investing activities

• There are lots of different types of risk

• Among these include inflation, business, interest rate, financial, market, political, regulatory, exchange rate, call, and liquidity risk

• Invest at a risk level you are comfortable with

• Find that risk level

• Taking a risk tolerance test may help


3. Stay diversified• Always invest in many different asset classes and

assets

• Diversification is your key defense against risk

• Make sure you understand the risks of each and every asset class you invest in

• It’s a risky (and an uncertain) place out there. Be prepared!

• Remember that the numbers you see for specific asset class performance are from diversified portfolios


4. Keep your costs low

• Watch all your costs very carefully: taxes, transaction costs, management fees, etc.

• A $1 saved is more than a $1 earned because:

• You must pay taxes on every new dollar earned

• The dollar saved can earn income and income on income (compound interest)

• Know that frequent trading incurs significant costs

Source: Jason Karceski, Miles Livingston, Edward O’Neal, “Mutual Fund Brokerage Commissions, January 2004, p. 12.


5. Invest long-term• Avoid short-term trading

• Its expensive and generates transactions costs and taxes

• Invest wisely

• There are no get-rich-quick schemes that work.

• Stay at least partly in the market

• Taking money out of the market or not continuing to save and invest stops your progress

Trading Costs and Returns


6. Invest tax-efficiently• Defer or eliminate taxes as much as possible

• Remember, mutual funds distribute 90% of all capital gains and dividends each year that you must pay taxes on

• Invest tax-efficiently so you don’t have to pay more taxes each April

• It’s not what you make, but what you keep after taxes and inflation that makes you wealthy


7. Monitor portfolio performance• President Thomas S. Monson stated:

"Where performance is measured, performance improves. Where performance is measured and reported, the rate of improvement accelerates."

• How can you know how you are doing if you don’t monitor your portfolio performance?

• Set portfolio benchmarks and then monitor performance at least quarterly and annually


8. Don’t waste too much time and energy trying to beat the market• It is very difficult, expensive, and time consuming to try

and beat the market

• If you must trade, trade tax-efficiently and in tax-deferred accounts

• If your actively managed funds under-perform, look to index funds as inexpensive, tax efficient and very viable alternatives


9. Invest only with high quality and reputable people and institutions• When help is needed, don’t be afraid to get help.

• But get good help from good people consistent with the principles discussed

• Use the best resources available

• Know how those resources are compensated

• Work only with licensed and registered advisors

• Get references for any resources


10. Develop a good investment plan consistent with your goals and these principles, and follow it closely• Think it through and write it wisely

• It’s your roadmap to success

• If you write it wisely and invest accordingly, it will save you much heartache in the future

• And you will likely achieve your personal goals

Things Learned

• 8. Correct principles lead to better lives and better portfolios

9. Understand and use correct principles and you have a much better chance of building successful portfolios and reaching your goals

D. Understand Historical Asset Class Performance

• Different asset classes have performed differently over the past 80 years• Why study the past?

• President Gordon B. Hinckley stated:• All of us need to be reminded of the past.

It is from history that we gain knowledge which can save us from repeating mistakes and on which we can build for the future. (“Reach with a Rescuing Hand,” New Era, July 1997, p. 4.)

Asset Class Returns from 1925 to 2005

$2,662

$13,703

$71

$18

$11

$0

$1

$10

$100

$1,000

$10,000

$100,000

1925

1929

1933

1937

1941

1945

1949

1953

1957

1961

1965

1969

1973

1977

1981

1985

1989

1993

1997

2001

2005

S&P500 SmallCap T-bond T-bill CPI

Historical Risk and Return RelationshipThere is a positive relationship between risk and return

Annual Risk versus Return from 1925-2005

S&P500

SmallCap

T-bondT-billCPI

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0%

Standard Deviation

An

nu

al

Ret

urn

s

S&P500 SmallCap T-bond T-bill CPI

S&P500 Annual Returns since 1926 S&P500 1-Year Returns from 1926 - 2005

-60.0%

-40.0%

-20.0%

0.0%

20.0%

40.0%

60.0%

1926 1936 1946 1956 1966 1976 1986 1996

S&P500 5 Year Annual ReturnsS&P 500 5 Year Annual Returns from 1930 - 2005

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

1930 1940 1950 1960 1970 1980 1990 2000

S&P500 10 Year Annual ReturnsS&P 500 10 Year Annual Returns from 1935 - 2005

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

1935 1945 1955 1965 1975 1985 1995 2005

Major Asset Class Returns and Risk (through 2005)

Asset Class 1 5 10 25 50 75 80

Year Years Years Years Years YearsYears

Large Capitalization Stocks (S&P)

• Mean 4.9% 0.5% 9.1% 12.5% 10.4% 10.5% 14.6%

• Std. dev.7.9% 14.9% 15.6% 15.0% 14.5% 19.1% 29.5%

Small Capitalization

• Mean 5.7% 16.4% 13.6% 13.9% 14.3% 14.6% 5.5%

• Std. dev. 15.1% 20.1% 22.4% 19.2% 20.4% 29.5%8.1%

Fixed Income Return and Risk

Asset Class 1 5 10 25 50 75 80

Year Years Years Years Years YeaYears

Treasury-bonds • Mean 7.8% 7.7% 7.6% 11.1% 6.6% 5.5% 3.7%• Std. Dev. 9.0% 10.4% 9.2% 10.6% 9.5% 8.1% 0.9%Treasury-bill • Mean 3.0% 2.1% 3.6% 5.7% 5.3% 3.7% 3.4%• Std. Dev. 0.2% 0.4% 0.5% 0.9% 0.8% 0.9% 1.8%Inflation • Mean 3.5% 2.5% 2.6% 3.4% 4.1% 3.4% 0.0%• Std. Dev. 1.9% 1.3% 1.0% 1.0% 1.1% 1.8% 0.0%

Other Asset Classes Return and Risk

Asset Class 1 5 10 25 50 75 80 Year Year Years Years Years Years Years

YearsInternational (MSCI EAFE)• Mean 9.8% 4.4% 4.0% 5.1% n.a. n.a. n.a. • Std. Dev. 10.0% 15.4% 14.9% 16.9% n.a. n.a. n.a.

Emerging Markets (MSCI EM Global)• Mean 34.5% 19.4% 7.0% n.a. n.a. n.a. n.a.• Std. Dev. 19.6% 21.1% 23.8% n.a. n.a. n.a. n.a.

REIT (MSCI REIT Index)• Mean 9.8% 12.6% 25.3% n.a. n.a. n.a. n.a.• Std. Dev. 16.0% 14.3% 14.0% n.a. n.a. n.a. n.a.

Things Learned

• 10. There is a positive relationship between risk and return

• 11. While equities are volatile on an annual basis, over longer periods of time the bad periods are offset by good periods

• 12. The longer the time period, the more likely you will have positive returns

12 Lessons Learned

• 1. There is an investing framework • 2. Since life is priorities based, our investing

should follow our priorities as well. • 3. There is an order to what we should do before

investing • 4. There is an order to building our portfolio• 5. Different investment vehicles have different tax

advantages• 6. Utilize the vehicles that give you the highest

after-tax return and that helps you achieve your goals the fastest

12 Lessons Learned (continued)

• 7. Taxable and retirement assets should be managed differently

• 8. Correct principles lead to better lives and portfolios

9. Use correct principles and you have a much better chance of building successful portfolios

• 10. There is a positive relationship between risk and return

• 11. While equities are volatile on a short-term basis, over longer periods the bad periods are offset by good periods

• 12. The longer the time period, the more likely you will have positive returns

Review of Objectives

Do you:

A. Understand the investment hourglass

B. Understand the priority of money

C. Understand the principles of successful investing

D. Understand the historical performance of the major asset classes

Tools Available for Personal Finance

• The Marriott School is very concerned about the need for solid information on personal finance from a correct perspective

• We have put together a website to help members and non-members alike get their financial houses in order

• While not yet approved by the Marriott School, there is still much that is useful that can be shared

• Visit the website at http://personalfinance.byu.edu

Introduction to the Website

Thank You

Opt Out for Credit Card Applications

• Getting too many credit card applications? There is a national credit opt-out number to take you off the mailing lists of all four major credit reporting agencies:

• It is easy and painless

• Call 1-888-567-8688 or 1-888-5 OPT OUT

• Answer the questions on the phone. It only asks your home phone number, your name, and your social security number. Then they send a form to fill out and mail in.

• It is worth it (unless you like junk mail).

Opt Out for Telemarketers

• The do not call registry can be accessed by signing on to:

• Donotcall.gov

• From here, you will put in up to 3 phone numbers and your email address.

• You will then receive confirming emails. When you receive them, click on the hyperlink to confirm them, and you are all set up for 5 years.

https://www.donotcall.gov/Register/Reg.aspx

personal finance: another perspective investments 3: 12 important lessons

Documents

lord slide

retirement assets slide

investment hourglass

sector funds slide

food storage investing

christ ye

perspective investments

priority of money