PRESENTATION FOR HARVEY MUDD ALUMNI

BEST PRACTICES FROM INSIDE A PROFESSIONAL FINANCIAL ADVISORY FIRM

March 23, 2012
Proud Bird Restaurant
Potpourri of Topics
Estate planning
Umbrella liability
Education planning
Mortgage payo"
Charitable Giving
Advisory landscape
Tax loss harvesting
Retirement
spending
Investing
Your questions
Estate Planning
This is rst because its important
Under current federal law couples can pass
on $10M without paying estate tax
So why do you need to worry about this?
Its about control of assets, not tax savings
Probate is time consuming and expensive
California probate is running 18 months
Statutory fee on $1M assets is $23,000
Estate Planning (cont.)
Standard package includes
Revocable living trust
Pour-over wills
Healthcare powers of attorney
Financial powers of attorney
Guardians for children are listed in wills
Selecting trustees/executors and ultimate
beneciaries often proves di#cult
Cost: $1,500 to $3,500 (non-blended
family)
Umbrella Liability Insurance
A question about umbrella liability
insurance appears on the Certied Financial
Planner
TM
certication test every year
Is in addition to your homeowners and auto
policies (i.e., an umbrella over)
Provides additional coverage against large
claims and lawsuits
Very a"ordable $1M coverage about $200
Education Planning
529 college savings
plans recommended
Contributions grow tax-
free if used for college
Opportunity to front-
load with ve year
contribution
Each state runs a plan
Shop based on
investment choices
Be careful with
custodial (UTMA)
accounts
Mortgage Payo"
Should I pay o" my home mortgage loan?
The portfolio leverage answer:
Assume taxable (i.e., accessible) investment
portfolio earning 8% per year
Assume interest rate 4.5%; tax bracket 37%
combined (28% fed + 9% CA)
After-tax cost of loan = (4.5%)(1-.37) = 2.8%
Return di"erence: 8% - 2.8% = 5.2%
Limited by income available for debt service
Charitable Giving
Donor-advised funds
can be a good option
Income tax deduction
in year of contribution
Make donations from
the fund any time
Assets leave your
estate but you retain
control
Used to reduce tax in
high income years
Advisory Landscape
Proliferation of credentials
CFP, CFA, CIMA, CPA, EA, ChFC, CLU, CMFC, PFS,
RIA, AAMS, CDFA, etc.
Growth in client-centered, advice-driven
model versus traditional product sales
model
Independent rms vs. Wall Street rms
Fiduciary standards debate
Advisors are
employees
Products and services
limited, often
proprietary
Sales culture,
product-centric
business model
Advisors/reps are
NASD Series 7
licensed to sell
nancial products
Paid by commission
and fees which can
create conicts of
interest
Advisors not
duciaries (not
obligated to act in
clients best interest)
Fully A!liated Supervised Independent Fully Independent
Brokerage Firm:
(e.g. Smith Barney, Merrill
Lynch, UBS, Morgan Stanley)
Independent Broker/
Dealer (IBD):
(e.g. LPL, Royal Alliance)
Advisors are
independent
contractors
Products and services
limited to IBD
o"erings
Mixed culture,
products and advice
Advisors/reps are
NASD Series 7
licensed to sell
nancial products
Paid by commission
and fees which can
create conicts of
interest
Advisors not
duciaries (not
obligated to act in
clients best interest)
Advisors are self-
employed/partners
Broadest product
access and most
sophisticated service
o"erings
Client-centered,
advice driven business
model
Advisors are NASD
Series 65/66 licensed
to provide investment
advice
Advice for fee
compensation reduces
conicts of interest
Fiduciaries by law,
required to act in
clients best interest
Registered Investment
Advisor (RIA):
(e.g. Parkworth Wealth Mgmt., Inc.)
NAPFA
About 600,000 people are called nancial advisor in the U.S.
Includes brokerage reps, broker/dealer reps, bank reps and insurance
reps
Most are sales people; conicts abound
Of those, about 65,000 are CFP

practitioners
Certied Financial Planner
TM
certicants have completed 6+ graduate
level courses and practicum, passed a two-day exam, have minimum 3
years experience and complete 30 hours of continuing education every 2
years
Considered the most highly qualied nancial advisors
Of those, about 1,300 are NAPFA registered
The National Association of Personal Financial Advisors
(www.napfa.org) is known for advocacy of fee-only compensation
structures to reduce conicts of interest, and tough membership
requirements stressing ethics and competence
NAPFA registered advisors must be CFP practitioners, submit work
samples (e.g., nancial plan) to peer review, sign a duciary oath and
complete 60 hours continuing education across 7 subject areas every 2
years
High transparency
Low fees
ERISA 3(38) duciary advisors
Independent registered investment
advisory rm managed plans
Plan sponsor/participant driven
Non-duciary consultants
Insurance company and large
brokerage rm managed plans
Lack of transparency
Unnecessarily high fees
Conicts of interest
Changing 401(k) Marketplace
Tax Loss Harvesting
Technique to reduce and defer capital gains taxes
generated by taxable portfolios
Involves selling an investment at a loss, buying
back a similar investment and holding for 30 days,
then selling that investment and buying back the
original investment
Result is a capital loss that can be used to o"set
capital gains in that year or carried forward to use
in future years
Retirement Spending
For the rst time in human
history, mass population is
scheduled to be retired
nearly as long as they worked
Retirement portfolios will
need to keep working hard
Sustainable withdrawal rates
while maintaining principal
are in 3%-5% range
A glimpse at the future:
Stanford and Yale
endowments are pioneering
spending rules using a low-
pass lter to smooth
spending
Stanford Spending Rule:
[w
1
* (s * (1+i))] + [w
2
* (r *
m)]
w
1
= 60%
w
2
= 40%
s = last years spending
i = ination
r = policy spending rate
m = last years market value
Randomness of Returns
Highest Return
Lowest Return
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
36.94 28.58 66.41 31.04 40.59 7.62 74.48 35.14 34.54 35.97 39.78 8.83 79.02 34.59 9.37
33.75 23.11 33.01 8.96 18.04 5.11 69.18 33.16 24.13 32.99 8.16 6.60 70.19 29.53 3.38
33.36 11.95 30.16 8.28 12.35 3.82 66.79 32.11 22.63 32.59 8.04 4.75 51.48 28.07 2.31
25.79 10.24 28.41 7.33 8.44 3.58 60.25 30.58 15.10 27.54 6.35 -37.00 47.81 20.79 2.11
19.66 9.69 21.51 4.01 7.28 3.39 57.81 27.33 13.82 26.32 6.31 -38.64 47.02 20.17 0.57
7.27 8.41 21.04 -2.01 6.44 -2.85 56.28 25.95 9.70 21.87 6.24 -39.20 44.83 19.30 -5.38
7.12 7.75 6.99 -3.08 -2.37 -6.00 36.43 19.15 5.61 21.70 5.95 -42.54 37.51 19.20 -10.78
5.93 5.91 4.37 -6.40 -2.71 -11.72 36.18 17.74 4.91 17.08 5.49 -44.49 28.46 15.06 -15.12
0.39 -2.33 4.04 -9.10 -6.48 -13.84 28.69 10.88 4.45 15.80 -2.61 -45.12 26.46 13.32 -15.59
-11.59 -10.04 3.55 -12.26 -11.89 -19.87 2.04 2.65 3.08 4.32 -12.24 -47.11 2.29 3.73 -17.05
-14.55 -17.01 1.90 -12.26 -15.41 -22.10 1.95 1.35 2.36 4.09 -17.55 -53.14 0.80 1.99 -18.17
-15.12 -25.34 -2.58 -30.61 -16.75 -30.28 1.47 0.83 1.34 3.75 -18.38 -53.18 0.19 0.83 -19.90
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
US Large Cap
33.36 28.58 21.04 -9.10 -11.89 -22.10 28.69 10.88 4.91 15.80 5.49 -37.00 26.46 15.06 2.11
US Large Cap Value
33.75 11.95 6.99 -6.40 -2.71 -30.28 36.43 17.74 9.70 21.87 -12.24 -53.14 37.51 20.17 -19.90
US Small Cap
25.79 -2.33 28.41 -12.26 18.04 -19.87 57.81 19.15 5.61 17.08 -2.61 -38.64 47.02 29.53 -5.38
US Small Cap Value
36.94 -10.04 4.37 -3.08 40.59 -11.72 74.48 27.33 4.45 21.70 -18.38 -44.49 70.19 34.59 -10.78
US Real Estate
19.66 -17.01 -2.58 31.04 12.35 3.58 36.18 33.16 13.82 35.97 -17.55 -39.20 28.46 28.07 9.37
International Large Cap Value
0.39 23.11 33.01 4.01 -15.41 -13.84 69.18 30.58 15.10 32.99 6.35 -45.12 51.48 13.32 -17.05
International Small Cap
-14.55 10.24 30.16 -12.26 -16.75 -2.85 60.25 32.11 22.63 26.32 8.04 -47.11 44.83 20.79 -15.59
International Small Cap Value
-15.12 9.69 21.51 -2.01 -6.48 3.82 66.79 35.14 24.13 27.54 6.24 -42.54 47.81 19.30 -15.12
Emerging Markets
-11.59 -25.34 66.41 -30.61 -2.37 -6.00 56.28 25.95 34.54 32.59 39.78 -53.18 79.02 19.20 -18.17
One-Year US Fixed
5.93 5.91 4.04 7.33 7.28 3.39 1.47 0.83 2.36 4.32 5.95 4.75 0.80 0.83 0.57
Five-Year US Government
Fixed
7.12 7.75 1.90 8.96 8.44 7.62 2.04 1.35 1.34 3.75 8.16 8.83 0.19 3.73 3.38
Five-Year Global Fixed
7.27 8.41 3.55 8.28 6.44 5.11 1.95 2.65 3.08 4.09 6.31 6.60 2.29 1.99 2.31
The vast majority of the variation in
returns is due to risk factor exposure
After fees, traditional management
typically reduces returns
sensitivity
to market
[market
return minus
T-bills]
sensitivity
to size
[small stocks
minus big
stocks]
sensitivity
to BtM
[value
stocks
minus
growth]
random
error
e(t)
+ + + + =
average
expected
return
[minus T-
bills]
average
excess
return
THE MODEL TELLS THE DIFFERENCE BETWEEN INVESTING AND SPECULATING
Priced Risk
Positive expected return
Systematic
Economic
Long-term
Investing
Unpriced Risk
Noise
Random
Short-term
Speculating.
Structured
Exposure to
Factors
Unexplained Variation
Market
Size
Value/Growth
Structure Determines Performance
Equity Market
(complete value-weighted universe of
stocks) Stocks tend to have higher
expected returns than xed income over
time.
Company Size
(measured by market capitalization)
Small company stocks tend to have higher
expected returns than large company
stocks over time.
Company Price
(measured by ratio of company book value
to market equity) Lower-priced value
stocks tend to have higher expected
returns than higher-priced growth stocks
over time.
Value
Large
Small
Growth
Increased Risk
Exposure and
Expected Return
Total
Stock
Market
Decreased Risk
Exposure and
Expected Return
Three Dimensions of Stock
Returns around the World
Risk and Return are Related
US
Large
Value
S&P
500
US
Large
Growth
US
Small
Value
CRSP
6-10
US
Small
Growth
Intl.
Value
Intl.
Small
MSCI
EAFE
Intl.
Growth
Emg.
Markets
Value
Emg.
Markets
Small
Emg.
Markets
Market
Emg.
Markets
Growth
US Large
Capitalization Stocks
19272011
US Small
Capitalization Stocks
19272011
Non-US Developed
Markets Stocks
19752011
Emerging
Markets Stocks
19892011
13.63 11.77 11.29 18.82 15.72 13.74 17.44 18.23 12.98 10.74 22.86 20.00 17.77 15.63
27.10 20.41 21.81 35.07 30.84 33.90 24.81 28.32 22.37 22.07 42.31 40.86 36.47 34.77
Average Return (%)
Standard Deviation (%)
Annualized
Compound
Returns (%)
Size and Value E"ects Worldwide
The Failure of Active Management
Percentage of Active Public Equity Funds That Failed to Beat the
Index
Five Years as of June 2011
US Large
Cap
US Mid
Cap
US Small
Cap
Global Internationa
l
International
Small
Emerging
Markets
%

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f

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t
i
v
e

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d
s

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h
a
t

F
a
i
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e
d

t
o

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u
t
p
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f
o
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Equity Fund Category
Investing
Asset allocation is the primary determinant of a broadly
diversied portfolio's performance
Market timing and individual security selection are far less
important in determining performance
Portfolio return is related to risk. Generally, the more risk the
greater the return.
Diversication is essential. Investors are not compensated for
the additional risk of concentrated investments.
Passive, not active management, is preferred in most markets
Reducing expenses and minimizing taxes increases net return
Rebalancing maintains portfolio structure and risk level
Asset location is powerful in reducing taxes
Alternative investments can increase return while reducing
risk
Bull and Bear Markets
S&P 500 Index (USD)
Daily Returns: January 1, 1926December 31, 2011
220%
-13%
-85%
20%
-16%
-39%
119%
87%
27%
-15%
-10%
-13%
100%
44%
-53%
25%
40%
-13%
-14%
26%
-25%
22%
-11%
23%
-33%
83%
-11%
99%
-26%
19%
-11%
-16%
26%
53%
91%
-13%
121%
-11%
26%
-13%
18%
69%
-21%
-11%
44%
-27%
15%
96%
-11%
59%
-27%
-10%
-21%
-32%
56%
-12%
38%
-45%
22%
-13%
50%
-13%
38%
-15%
27%
-13%
26%
-10%
21%
-16%
48%
-20%
78%
-11%
156%
-33%
73%
-10%
16%
-19%
303%
-12%
37%
50%
-19%
-12%
23%
-11%
13%
-47%
21%
-14%
113%
03/09/2009
-55%
12/31/201
1
-11%
1%
Average Duration
Bull Market: 413 Days
Bear Market: 220 Days
Average Return
Bull Market: 58%
Bear Market: -21%
Your Questions
Bruce R. Barton, CFP

CFA
[email protected]
(408) 436-9800