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					Bonds Are Safe

They come with two promises:

   • The income stream they provide is usually
     fixed and relatively certain.

   • They will not mature at less than par
     or “face value.”

   • Therefore they are not risky.
Stocks Are Risky

  • They fluctuate in value substantially.

  • It’s hard to predict what they will be worth
    at any point in time.
                                                      Asset Allocation by Holding Period
                                                                S&P/LT Bonds
                        14%




                        12%


                                                                                                             Color     Description
                        10%                                                                                          100% Eq/0%   Bonds
Average Annual Return




                                                                                                                     90% Eq/10%   Bonds
                                                                                                                     80% Eq/20%   Bonds
                        8%                                                                                           70% Eq/30%   Bonds
                               Greater Return




                                                                                                                     60% Eq/40%   Bonds
                                                                                                                     50% Eq/50%   Bonds
                                                                                                                     40% Eq/60%   Bonds
                        6%                                                                                           30% Eq/70%   Bonds
                                                                                                                     20% Eq/80%   Bonds
                                                                                                                     10% Eq/90%   Bonds
                        4%                                                                                           0% Eq/100%   Bonds




                        2%

                                                                 Greater Risk

                        0%
                          0%                    2%   4%    6%      8%      10%       12%   14%   16%   18%

                                                                Standard Deviation
                                     Asset Allocation by Holding Period
                                               S&P/LT Bonds
                        14%
                                                                                    100% Equities




                        12%


                                                                                                     Color     Description
                        10%                                                                                  100% Eq/0%   Bonds
Average Annual Return




                                                                                                             90% Eq/10%   Bonds
                                                                                                             80% Eq/20%   Bonds
                        8%                                                                                   70% Eq/30%   Bonds
                                                                                                             60% Eq/40%   Bonds
                                                                                                             50% Eq/50%   Bonds
                                                                 100% Bonds
                                                                                                             40% Eq/60%   Bonds
                        6%                                                                                   30% Eq/70%   Bonds
                                                                1 Year
                                                                                                             20% Eq/80%   Bonds
                                                                                                             10% Eq/90%   Bonds
                        4%                                                                                   0% Eq/100%   Bonds




                        2%




                        0%
                          0%   2%   4%    6%      8%      10%       12%       14%    16%       18%

                                               Standard Deviation
                                     Asset Allocation by Holding Period
                                               S&P/LT Bonds
                        14%
                                                                                     100% Equities




                        12%


                                                                                                      Color     Description
                        10%                                                                                   100% Eq/0%   Bonds
Average Annual Return




                                                                                                              90% Eq/10%   Bonds
                                                                                                              80% Eq/20%   Bonds
                        8%                                                                                    70% Eq/30%   Bonds
                                                                                                              60% Eq/40%   Bonds
                                                                                                              50% Eq/50%   Bonds
                                                                  100% Bonds
                                                                                                              40% Eq/60%   Bonds
                        6%                                                                                    30% Eq/70%   Bonds
                                                                 1 Year
                                               3 Year                                                         20% Eq/80%   Bonds
                                                                                                              10% Eq/90%   Bonds
                        4%                                                                                    0% Eq/100%   Bonds




                        2%




                        0%
                          0%   2%   4%    6%        8%     10%       12%       14%    16%       18%

                                                Standard Deviation
                                     Asset Allocation by Holding Period
                                               S&P/LT Bonds
                        14%
                                                                                      100% Equities




                        12%


                                                                                                       Color     Description
                        10%                                                                                    100% Eq/0%   Bonds
Average Annual Return




                                                                                                               90% Eq/10%   Bonds
                                                                                                               80% Eq/20%   Bonds
                        8%                                                                                     70% Eq/30%   Bonds
                                                                                                               60% Eq/40%   Bonds
                                                                                                               50% Eq/50%   Bonds
                                                                   100% Bonds
                                                                                                               40% Eq/60%   Bonds
                        6%                                                                                     30% Eq/70%   Bonds
                                                                  1 Year
                                         5 Year 3 Year                                                         20% Eq/80%   Bonds
                                                                                                               10% Eq/90%   Bonds
                        4%                                                                                     0% Eq/100%   Bonds




                        2%




                        0%
                          0%   2%   4%     6%        8%     10%       12%       14%    16%       18%

                                                 Standard Deviation
                                     Asset Allocation by Holding Period
                                               S&P/LT Bonds
                        14%
                                                                                         100% Equities




                        12%

                                         X
                                        X                                                                 Color     Description
                        10%          X
                                                                                                                  100% Eq/0%   Bonds
Average Annual Return




                                    X
                                                                                                                  90% Eq/10%   Bonds
                                    X
                                                                                                                  80% Eq/20%   Bonds
                                    X
                        8%                                                                                        70% Eq/30%   Bonds
                                    X
                                                                                                                  60% Eq/40%   Bonds
                                    X
                                                                                                                  50% Eq/50%   Bonds
                                     X                                100% Bonds
                                                                                                                  40% Eq/60%   Bonds
                        6%              X
                                         X                           1 Year                                       30% Eq/70%   Bonds
                                                   3 Year                                                         20% Eq/80%   Bonds
                                    10 Year 5 Year
                                                                                                                  10% Eq/90%   Bonds
                        4%                                                                                        0% Eq/100%   Bonds




                        2%




                        0%
                          0%   2%   4%       6%         8%     10%       12%       14%    16%       18%

                                                    Standard Deviation
                                         Asset Allocation by Holding Period
                                                   S&P/LT Bonds
                        14%
                                                                                             100% Equities




                        12%

                                             X
                                          X                                                                   Color     Description
                        10%              X
                               X                                                                                      100% Eq/0%   Bonds
Average Annual Return




                               X         X
                                                                                                                      90% Eq/10%   Bonds
                               X         X
                                                                                                                      80% Eq/20%   Bonds
                               X         X
                        8%                                                                                            70% Eq/30%   Bonds
                               X         X
                               X                                                                                      60% Eq/40%   Bonds
                                         X
                                X                                                                                     50% Eq/50%   Bonds
                                          X                               100% Bonds
                                 X                                                                                    40% Eq/60%   Bonds
                        6%                 X
                                  X                                                                                   30% Eq/70%   Bonds
                                            X                            1 Year
                                   X                   3 Year
                                        10 Year 5 Year
                                                                                                                      20% Eq/80%   Bonds
                                    X
                                 20 Year                                                                              10% Eq/90%   Bonds
                        4%                                                                                            0% Eq/100%   Bonds




                        2%




                        0%
                          0%   2%      4%        6%         8%     10%       12%       14%    16%       18%

                                                        Standard Deviation
The Longer You Hold an
Asset Class, the More
Likely You Are to Receive
the Expected Return.
                                 Efficient Frontier—Combinations of S&P 500 with
                               Long Term Government Bonds and with Treasury Bills
                                             For 1-Year Holding Periods
                        14%




                        12%




                        10%
Average Annual Return




                        8%




                        6%
                                                                S&P / LT Bonds

                                S&P / T-Bills

                        4%




                        2%




                        0%
                          0%    2%        4%    6%      8%      10%       12%    14%   16%   18%

                                                     Standard Deviation
                                      Equal Risk/Return Portfolios for 1-Year Holding Periods
                                             Traditional 50/50 Stock & Bond Portfolios
                                                Vs. Stock & Treasury Bill Portfolios
                        11.10%
                                                                                   71% S&P, 29% T-Bills



                        10.90%



                        10.70%
Average Annual Return




                        10.50%


                                                                                     1950-95
                        10.30%



                        10.10%



                         9.90%


                                      57% S&P, 43% T-Bills                    50% S&P, 50% LT Govt Bonds
                         9.70%



                         9.50%
                             8.00%   8.50%    9.00%     9.50%   10.00%    10.50%     11.00%    11.50%     12.00%   12.50%

                                                                Standard Deviation
The Economics of Investing

Guiding Principle: The longer you hold an asset class
the more likely you are to receive the expected return
associated with that asset class.

      • The creation of a portfolio must be driven by the
        expectation of when the portfolio will be called upon
        to provide benefits (cash flow to meet specific needs).

      • A time line with quantifiable cash calls must be
        established before an optimal portfolio can be
        constructed. Out flows may be regular or irregular
        but they must be estimated.
Guiding Principle: The greater the proportion of the
highest rate of return asset class that you can hold, the
better your return is likely to be.

     • A portfolio will provide optimal results when asset
       characteristics are matched to the timing of
       expected cash outflows.

     • Risk is managed by choosing the number of years
       that the portfolio is protected against the need to
       sell an asset when it is down in value.

 Year 0                                                                                                               Year 20
   IooOOoIooOOoIooOOoIooOOoIooOOoIooOOoIooOOoIooOOoIooOOoIooOOoIooOOoIooOOoIooOOoIooOOoIooOOoIooOOoIooOOoIooOOoIooOOoIooOOoI




     Risk-Free or                                                             Highest Rate of Return
    Very Low Risk                                                        Asset Class (Highest Short-Term Risk)
Guiding Principle: Matching the investor’s
tolerance for risk with the number of years
for which little or no risk is taken, to meet
expected cash flows, provides the investor
with a rational asset allocation framework.
Asset Allocation is a Dynamic Process

  Risk-Free or Low Risk              High Rate of Return
                                         Asset Class




                               Time Line


 • Years in which the high rate of return assets equal or outperform the expected
   returns, cash outflows are replenished (and/or in periods of substantial excess
   returns, additional amounts may be harvested).

 • Years in which the high rate of return assets underperform their expected returns,
   cash outflows are not replenished automatically.

 • The result is that a portfolio is constructed so the probability of having to sell the
   more volatile, but high rate of return asset class is greatly reduced.

 • The decision to replenish or not to replenish the low risk portion of the portfolio is
   a dynamic process.

 • The process considers normalized return expectations for each asset class, and
   the probable forward rate of return for each class relative to the other.
                                  S&P 500 (Price Only) Channel Trends
                                       S&P 500 (price only) CHANNEL TRENDS


                 10000




                                                                                    S&P 500
 S&P 500 Index




                                                                                    CLOSE
S&P 500 INDEX




                                                                                    HISTORIC
                                                                                    LOWER
                  1000
                                                                                    HISTORIC
                                                                                    UPPER

                                                                                    NEW
                                                                                    LOWER

                                                                                    NEW
                                                                                    UPPER

                                                                                    HISTORIC
                                                                                    MEDIAN

                                                                                    NEW
                                                                                    MEDIAN ?
                   100
                         1985




                                1990




                                             1995




                                                           2000




                                                                      2005




                                                                             2010
                                                    YEAR
Bonds Are Safe

They come with two promises:

   • The income stream they provide is usually fixed and
     relatively certain. The promise is that the income stream
     will never increase.

   • They will not mature at less than par or “face value.” The
     promise is that they will never mature for more than par.

     Therefore, bonds are not risky. The reverse is that the
     value of a bond at any time is impacted by the level of
     current interest rates and the length of time you have to
     wait until the bond matures. To know what a bond will be
     worth at any point in time (other than the day it matures)
     an interest rate forecast must be made.
     I know of nothing more difficult, and as likely to be
     wrong.
Stocks Are Risky

  • Stocks fluctuate in value substantially. True, but this
    characteristic can be managed by proper portfolio
    management techniques.

  • It’s hard to predict what stocks will be worth at any
    point in time. However the stock market has a trend
    that is inextricably tied to the creation of wealth in
    this country. As a result, stock market value is likely
    to increase over time and the income stream has
    historically increased as companies secularly increase
    dividends from increased earnings.
Stocks Are Risky (cont.)



  • Unparalleled opportunity to manage tax consequences

        • Qualified dividends

        • When to take preferential long-term capital gains
Cash Equivalents as Percent of Portfolios
                                            S&P 500 with Barra Growth and Value
                                                    S&P 500 with Barra Growth and Value


50.00




40.00




30.00




20.00


                                                                                                                                                     S&P 500
10.00                                                                                                                                                S&P Growth
                                                                                                                                                     S&P Value


 0.00
         1984


                1985


                       1986


                              1987


                                     1988


                                            1989


                                                   1990


                                                          1991


                                                                 1992


                                                                        1993


                                                                               1994


                                                                                      1995


                                                                                             1996


                                                                                                    1997


                                                                                                           1998


                                                                                                                  1999


                                                                                                                         2000


                                                                                                                                2001


                                                                                                                                       2002


                                                                                                                                              2003
-10.00




-20.00




-30.00

				
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