$
NINE THINGS
Harold Evensky, CFP
WHATME WORRY?
SQUARING THE CURVE
1
Probability of a 65-year-old living to various ages
0%
25%
50%
75%
100%
65 70 75 80 85 90 95 100 105
MaleFemaleAt least one spouse
Age
78 81 86
85 88 91
91 93 96
Prob
abili
ty
86
91
Squaring The Curve
0
2
4
6
8
10
0 10 20 30 40 50 60 70 80 90 100AGE
Perfect
Death
Health StatusSquared
Traditional
RETURNS (NO CONTROL)
2
This Time There is Something
DifferentEquity Premium
12% <6%
THE NEW REALITY?
7.6%
Retail Efficient Frontier is 3-Dimensional
EXPENSES&TAXES
RISK
RETURN
Viable efficient frontier analysis does not exist on an after tax basis
EXPENSE & TAX DRAGCURRENT FUTURE RETURN* RETURN
GROSS 14.0% 7.8%Less Expenses (1%) 1.0 1.0Less Taxes (20%) 2.6 1.4 NET GROSS RETURN 10.4 5.4
After InflationWhat Do You Have to Spend?
Past Future7.2% 2.4%
* 40% Fixed / 60% Equity – 20 Years
The key to a successful investment model will
be one focused onAn optimal strategy
instead of an optimal portfolio
CORE & SATELLITE
β
CORE & SATELLITE
COREβ +
CORE & SATELLITE (TACTICAL)
EXP &TAX EFFICIENT
CORE
SC & VALUE BIAS
EMERGING MARKET
TACTICAL/SECTOR
U.S.SMALL CAP
GROWTH
ALTERNATIVE HEDGE/V.C.
REAL ESTATE
COMMODITIES
Pascal’s WagerDoes God Exist?
The consequences of a choice are as important, or even more important, as the odds of something happening.
Pascal’s Retirement Wager
Consider not only the likelihood of living well past normal life expectancy or experiencing high inflation or a market downturn but also the consequences of each.
VOLATILITY RISK & LUCK
3
~ 20% Reduction
THE E&K CASH FLOW STRATEGY
THE TOTAL
PORTFOLIO
CASH FLOW RESERVE
THE INVESTMENT PORTFOLIO
CASH FLOW RESERVE
THE INVESTMENT PORTFOLIO
1 YEARS CASH FLOW
5 YEARS LUMP SUM
BALANCE OF PORTFOLIO
REINVESTMENT OF ALL INTEREST & DIVIDENDS
ADJUSTED AS NECESSARY FOR OPPORTUNITY COSTS
CASH FLOW RESERVE
THE INVESTMENT PORTFOLIO
PERSONAL CHECKING ACCOUNT
Rebalance
RefillRegular Monthly
Payments
the “PAY CHECK”
BEHAVIORAL FINANCE
4
Daniel Kahneman2002 Nobel Prize in economics for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty
IN CLASSICAL FINANCE PEOPLE ARE
RATIONALIN BEHAVIORAL FINANCE
PEOPLE ARE NORMAL
ARE THE HORIZONTAL LINES PARALLEL OR DO THE SLOPE?
HEURISTICSHEURISTICS
MENTAL SHORTCUTS
OVERCONFIDENCEOVERCONFIDENCECOMPARED TO OTHERS IN
THIS ROOM, ARE YOUR CHILDERN &
GRANDCHILDREN ABOVE AVERAGE?
OVERCONFIDENCEOVERCONFIDENCE
“I CAN TIME THE MARKET”
OVERCONFIDENCEOVERCONFIDENCE
“MY ADVISOR CAN PICK STOCKS BETTER
THAN MOST”
Terry Odean’s research
When an investor sells a stock and immediately buys another
The stock that is sold does better by 3.5% in the following year
THE COST OF A GOOD IDEA
REPRESENTATIVENESSREPRESENTATIVENESS
IF IT LOOKS LIKE A………………...
REPRESENTATIVENESSREPRESENTATIVENESS
HHTHTTTHTH
TTTTTTTTTT
REPRESENTATIVENESSREPRESENTATIVENESSMORNINGSTAR GAVE THIS FUND...
IT MUST BE GOOD
MENTAL MATHMATICSMENTAL MATHMATICSHOT TECH STOCK - IF
GOVT. SAYS GO 90% PROTOTYPE GOOD 90% REGIONAL TEST OK 90% NATIONAL ROLLOUT 90%
DO YOU INVEST?66%
MENTAL MATHMATICSMENTAL MATHMATICSLAST YEAR, I MADE 80%
AHEAD 20%
BEHIND 28%
THIS YEAR, I LOST 60%
THEREFORE I’MMENTAL MATH
REALITY
THE WAY A QUESTION IS FRAMED,
DETERMINES THE OUTCOME
FRAMINGFRAMING
Which would you rather have?‘10% fat’ or ‘90% fat-free’
FRAMINGFRAMING
FRAMINGFRAMINGNAME THE TOP 10
BASEBALL PLAYERSPAINTERSMOVIE ACTORS
MONEY MANAGERSDRESS DESIGNERS
BEWARE OF OVERCONFIDENT
ANALYSIS4
Good software can make it easier to do complex things, but it can’t magically transform the complex into the simple
FALSE CONFIDENCE
COMPLEMENTART ANALYITICS
Sensitivity analysis - a range of possibilities that go beyond what the individual might have considered
What-if scenarios - a walk through possible futures
Sensitivity Analysis
Year 1 – 2 STD
Year 2 – 1 STD
What-If Scenario Planning
PLAYING IT SAFE
5
Dividends and Interest The paycheck
syndrome
MYTH I’m Retired so I need...
MRS BOONE NEEDS 5% CASH FLOW
Bond Cash Flow Stock Cash Flow TotalAllocation from Bonds Allocation from Stock Cash Flow
100% 7% 0% 0% 7%90% 6.3% 10 0.3 6.8%80% 5.6% 20 0.6 6.2%70% 4.9% 30 0.9 5.8%60% 4.2% 40 1.2 5.4%50% 3.5% 50 1.5 5.0%40% 2.8% 60 1.8 4.6%
-$4,000.00-$3,000.00-$2,000.00-$1,000.00
$0.00$1,000.00$2,000.00$3,000.00$4,000.00$5,000.00$6,000.00
1 2 3 4 5 6 7 8 9 10
“INCOME PORTFOLIO”
Fidelity Intermediate
Bond
Fidelity Intermediate & Vanguard S&P
“TOTAL RETURN”
“EXCESS”ANNUAL CASH FLOW
I’m poor!
I’m rich!
$100,000.00
$110,000.00
$120,000.00
$130,000.00
$140,000.00
$150,000.00
$160,000.00
$170,000.00
1 2 3 4 5 6 7 8 9 10 11
TOTAL RETURN
INCOME
ACTIVE MANAGEMENT
6
MPT ISN’T DEAD
7
The process of selecting a portfolio may be divided into
two stages.
PORTFOLIO SELECTION
Journal of Finance 1952
Harry Markowitz
The first stage starts wit observations and
experience and ends with beliefs about the future
performances of available securities.
“One suggestion as to tentative µi, ij is to use observed µi, ij for some
period of the past. I believe that better methods, which
take into account more information, can be found.”
NOT MAXIMIZING
SOCIAL SECURITY
8
ANNUITIES & REVERSE
MORTGAGE9
71
Age 92 Success Wealth
CFR Only 56% $825
Standby 99% $900
Tenure 85% $1,050
Age 100 Success Wealth
CFR Only 41% $805
Standby 95% $440
Tenure 71% $1,100
*Wealth in $1,000’s
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