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Personal Risk Tolerance & Asset Allocation Joel Schumacher

Practice Question A: Your Age Under 30 31-40 41-50 51-60 Over 60

Investment Risk Review Systematic Risks Interest Rate Risk Inflation Risk Currency Risk (Exchange Rate Risk) Liquidity Risk Sociopolitical Risk

Investment Risk Review Non-Systematic Risks Management Risk Credit Risk Geographical Risk

Question B: Is risk a bad thing? Yes, it should be avoided at all times. Yes, but I can’t avoid it. Some risk is ok but too much is bad. No, risk helps me achieve my goals.

Risk vs. Reward We can’t avoid all investment risk. Higher levels of risks are generally associated with higher returns over the long run. Asset classes have different risk levels.

What is asset allocation? Securities and Exchange Commission says: “involves dividing an investment portfolio amount different asset categories”

Goal of Asset Allocation Risk Management

Asset Categories Main Categories Stocks Bonds Cash Equivalents Other Categories Real Estate Precious Metals

Sub-Categories Small Cap Stocks Mid Cap Stocks Large Cap Stocks Foreign Stocks Emerging Markets Stocks Sector Stocks Savings Bonds Government Bonds Corporate Bonds Municipal Bonds High Yield Bonds Commercial Real Estate Residential Real Estate

Risks are Correlated Asset Classes tend to be correlated Stock Prices tend to move together Bond Prices also tend to move together Stocks/Bonds of specific industries are correlated Banking, Automakers, Energy Companies, etc.

Question C: What is an investment portfolio? Your IRA Your employer retirement account All of your retirement savings All of your savings

Investment Portfolio Narrow Definition: My IRA with XZY company My emergency savings account Broader Definitions: All of my retirement savings My daughter’s college savings Savings Account & Savings Bonds

Risk and the Investment Goal Different investment goals have different levels of acceptable risk. Time until the goal is often a key factor. The alternative to poor performing investment is also a factor.

Investment Goals Common Goals: Retirement Home Purchase Car Purchase Vacation Tuition Emergency Account

Risk and the Individual We each have different levels of risk tolerance. Some of us are risk takers.

Question D: Do you consider yourself a risk taker? Always Sometimes Occasionally Rarely Never

Personal Risk Tolerance Quiz Differences: Number of questions they ask Type of results they provide Asset allocation recommendations vs. Risk Score Which is best? It depends. Solution: Try several.

Determining Your Asset Allocation

How do you decide what is best for your situation? Step 1: Determine Your Goal? Retirement Savings Home Purchase Car Purchase Vacation College Tuition Emergency Savings Account

How do you decide what is best for your situation? Step 2: When will this event take place? Short Term Goals Emergency Account might be needed on very short notice Car Purchase: month to years Longer Term Goals Retirement Planning: months to decades away

Risk Tolerance Step 3: Determine your risk tolerance. Personal Risk Assessment Quizzes may help Some of these tools provide “suggested allocations” Ask yourself “What are the consequences of poor investment returns?”

Determine Your Allocation Select an Allocation based on: Your Goal Your Time Frame Your Personal Risk Tolerance Available Options

Question E: Once you have selected an asset allocation mix, you don’t need to review it. True False

Question F: How often should you rebalance? Once a year More than once a year Only when your goals change Only if your situation changes It depends

Rebalancing You may want to rebalance when: Your goal or time frame changes. Your “alternative” to poor investment returns changes Periodically (Semi-Annually, Annually, etc.) to account for investment returns

Rebalancing Example Jen inherited $10,000 She is going to invest it for retirement She decided that her allocation should be: $5,000 in Large Cap Stocks $2,500 in Small Cap Stocks $2,000 in Bonds $ 500 in a Money Market Account

Rebalancing Why? Goals change Time frame changes Personal situation changes Investment returns change your allocation

Rebalancing Example Jen’s Initial Allocation was: 50% in Large Cap Stocks 25% in Small Cap Stocks 20% in Bonds 5% in a Money Market Account Here are 10 years of Investment Returns:

No Rebalancing: 2000 to 2009 Jen’s Ending Allocation was: 34% in Large Cap Stocks Range: 34% to 50% 27% in Small Cap Stocks Range: 24% to 32% 32% in Bonds Range: 23% to 32% 7% in Money Market Account Range: 4% to 7% Her account is worth: $11,128

Rebalancing Annually: 2000 to 2009 Jen’s Ending Allocation was: 50% in Large Cap Stocks Range: 36% to 51% 25.3% in Small Cap Stocks Range: 19% to 27% 20% in Bonds Range: 16% to 28% 4.7% in Money Market Account Range: 4% to 7% Her Account is worth: $13,631

Question G: When was the last time you rebalanced your investments? I never have More than 5 years ago 1 to 5 years ago In the last year I don’t have any investments

Key Points Asset Allocation Depends on Several Factors The Goal is Risk Management

Question H: Who is likely to take on more investment risk? 50 year old, investing for a future second home purchase 80 year old, investing his emergency savings account

Question I: Which combination has the lowest risk? Lowes & Home Depot stock Lowes & Microsoft stock Not Sure

Question J: Which combination has the lowest risk? Home Depot Bond & Microsoft Stock Home Depot Stock & Lowes Bond Not Sure

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