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The New Rules of Investing for Retirement

Discover key mistakes individual investors make, traditional retirement strategies, and the rational approach to managing risk. Learn about micro investing mistakes, the Hedge Fund Phenomenon, and how mutual funds can provide a viable solution.

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The New Rules of Investing for Retirement

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  1. The New Rules of Investing for Retirement Bob Carlson Editor, Retirement Watch AAII February 2006 800-552-1152 www.RetirementWatch.com

  2. The Investment Battle The Windshield vs. The Bug

  3. The 7% Club • Individual investors earn lower • returns than they should. • Most losses are due to key • mistakes. • Mistakes are both macro and • micro.

  4. Micro Investing Mistakes • Asking the wrong question • Investing with a rearview • mirror • Following the ratings • Not building a portfolio

  5. Traditional Investment Strategies • Investing for Income (being • conservative) • Holding stocks for the long run • Using the “policy portfolio”

  6. The Policy Portfolio Determine return goal  Determine level of risk (volatility)  Pick diversified, efficient portfolio — index funds  Hold portfolio for the long term

  7. Problems with CAPM • Volatility is not risk • Real risk is goals are not achieved • Few investors can ignore the short and intermediate term • Bear markets can last 10 years or longer

  8. Problems with CAPM • Markets not always efficient • Past patterns don’t always continue — Remember LTCM • “Diversified” portfolios usually are correlated to stocks • “Utterly naïve” “utterly unrealistic” — Martin Whitman

  9. Problems with CAPM Source: T. Rowe Price

  10. Rational Investing: Risk Management • Markets are not always efficient and rational • Investors are rational but not necessarily right or in agreement • Results in valuation cycles for all assets

  11. Rational Investing: Risk Management • Optimists vs. pessimists determine the markets — expectations of returns • Consensus views tend to persist for a long time • Consensus at the extremes usually is wrong •  Cycles are the biggest risk to investors

  12. Rational Investing • The very long-term is not the way to manage money • Risk is uncertainty. It must be managed. • Managing the valuation cycle is key to managing risk •  A margin of safety is essential

  13. Rational Investing in Action • The Core Portfolio • Always have a fixed, diversified, balanced portfolio • Always in the markets. Avoids overtrading, trend following • Value-oriented funds in the Core Portfolio

  14. Rational Investing in Action • The Managed Portfolio • Manage the investment cycles and their risk • Not short-term trading; one- to three-year outlook • Primary goal is to reduce risk; eliminate high risk assets • Combine valuations with market and economic trends

  15. Micro Investing Mistakes • Using the economy and earnings • to adjust portfolios • Taking big risks to earn high • returns • Using automatic investment • signals; being fooled by • randomness • Confusing beta and alpha

  16. Meandering Markets

  17. Where Are We Now? Source: Ned Davis Research

  18. Falling Valuations 2/1/991/26/06Change S&P 500 1273 1273 0% S&P 500 EPS$44.49 $74.02 66% S&P 500 P/E28.4 17.2 -39%

  19. Where Are We Now?

  20. Where Are We Now?

  21. Where Are We Now?

  22. Where Are We Now?

  23. Where Are We Now? • Few values and opportunities worldwide • Likely in an era of below-average returns • U.S. stocks neither undervalued nor overvalued • Pockets of opportunity in U.S. stocks

  24. Where Are We Now? • International and emerging market stocks better values than U.S. stocks • U.S. real estate is fairly valued to modestly overvalued • Commodities probably still a good opportunity • Few opportunities in bond markets

  25. The Hedge Fund Phenomenon • Trillions of dollars of flowed into hedge funds since 2000 • Believed to be over 6,000 hedge funds • Investment talent flowing into hedge funds • Initially for wealthy, institutions

  26. The Hedge Fund Phenomenon • Investors seek:  Absolute returns, more • predictable returns •  Reduced risk, volatility •  Low correlation with major • market indexes

  27. Disadvantages of Hedge Funds • Difficult to evaluate • Little transparency, low regulation/accountability • Low liquidity •  High fees

  28. Disadvantages of Hedge Funds • Potential volatility • Low capacity, most of the best funds closed • Too many funds chasing the same strategies • Great variability; not a real asset class

  29. The Mutual Fund Solution • A number of mutual funds use “hedge fund” or alternative strategies • Open to all investors • Lower cost •  Daily liquidity

  30. The Mutual Fund Solution • Transparent investments, easier to evaluate • Low correlation with major markets • High long-term returns • Best funds have limited capacity, closed to new investors

  31. The “Hedge Fund” Portfolio • A portfolio of no-load, low expense mutual funds • Funds have low correlation to major market indexes • Funds have low correlation with each other • Use traditional “hedge fund” strategies

  32. The “Hedge Fund” Portfolio • Portfolio achieves long-term returns similar to stock indexes with less volatility • Buy-and-hold portfolio • Will lag in bull markets

  33. Mutual Fund “Hedge Funds” • Core “hedge funds”: • Hussman Strategic Growth • Pimco All Asset • Leuthold Core Investment • Long/Short Equity • Laudus Rosenberg Global • Long/Short Equity

  34. Mutual Fund “Hedge Funds” • Opportunity Funds • Third Avenue Value • Berwyn Income • FPA Crescent • Other funds: • High yield bonds • Cohen & Steers Realty Shares • American Century • International Bond • Oakmark Equity & Income

  35. Hedge Fund Portfolio Returns Back-Tested Results (Last 10 Years) Alpha 5.60 Beta 0.27 Std. Deviation 6.46 Worst Quarter -9.54% Best Quarter 10.84%

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