Investing and Planning with Inflation Ahead
•Download as PPTX, PDF•
2 likes•723 views
Aurum Wealth Management Chief Investment Officer Michael McKeown, CFA, CPA, and Financial Planning Manager Alynne Zielinski, MBA, CFP, discuss how to invest and plan your financial future with inflation on the horizon.
Recommended
Recommended
More Related Content
What's hot
What's hot (19)
Similar to Investing and Planning with Inflation Ahead
Similar to Investing and Planning with Inflation Ahead (20)
More from Skoda Minotti
More from Skoda Minotti (20)
Recently uploaded
Recently uploaded (20)
Investing and Planning with Inflation Ahead
- 1. Investing & Planning with Inflation Ahead June 27, 2018
- 2. HEADLINE (Calibri Bold 32)What I will cover today • The retirement landscape • Longevity and Inflation • Healthcare costs • Savings strategies • Planning with inflation in mind 2
- 3. HEADLINE (Calibri Bold 32)The Retirement Landscape Market Returns Policies Income Longevity Spending vs. Saving Asset Allocation Asset Location No Control •Fed policies/rates •Taxes and inflation •Policies on savings and Health benefits •Market returns Some Control •Longevity •Employment earnings •Employment duration •Social Security Total Control •Asset location •Asset allocation •Saving •Spending 3
- 4. HEADLINE (Calibri Bold 32) We are living longer and must plan for longevity Chart: Social Security Administration, Period Life Table, 2014 (published in 2017), J.P. Morgan Asset Management. Table: Social Security Administration 2017 OASDI Trustees Report. Probability at least one member of a same-sex female couple lives to age 90 is 56% and a same-sex male couple is 40%. PLAN FOR LONGEVITY Average life expectancy continues to increase and is a mid-point not an end-point. You may need to plan on the probability of living much longer – perhaps 30+ years in retirement – and invest a portion of your portfolio for growth to maintain your purchasing power over time. 4
- 5. HEADLINE (Calibri Bold 32) As we age our spending shifts to higher inflation categories *There are no individual inflation measures for these specific subcategories. Source (top chart): BLS, 2016 Consumer Expenditure Survey for households where at least one member has a bachelor’s degree. Charitable contributions include gifts to religious, educational and political organizations, and other cash gifts. Spending percentages may not equal 100% due to rounding. Source (bottom chart): BLS, Consumer Price Index, J.P. Morgan Asset Management. Data represent annual percentage increase from December 1981 through December 2017 with the exception of entertainment and education, which date back to 1993. The inflation rate for the Other category is derived from personal care products and tobacco. Tobacco has experienced 7% inflation since 1986 but each age group only spends 0.4%-0.7% on tobacco (21%-37% of combined personal care products and tobacco), which is a lower proportion than represented in the Other inflation rate. LOSING GROUND Inflation can disproportionately affect older Americans due to differences in spending habits and price increases in those categories. 5
- 6. HEADLINE (Calibri Bold 32)Medicare projected inflation is 4.2% per year Note: Excludes government costs. National weighted average by state population used to estimate Medigap age-related premium increases; these will vary by geography. Medigap premiums usually increase due to age, in addition to annual inflation, except for most policies in the following states, which are community rated (all ages experience the same rates): AR, CT, MA, ME, MN, NY, VT, WA, and the states that are mostly issue-age rated (rates are the same for all who first purchased at a particular age): AZ, FL, GA, ID, MO and NH. Analysis includes the most comprehensive Medigap plan available in each state. Source: Employee Benefit Research Institute (EBRI) data as of December 31, 2017; SelectQuote data as of January 18, 2018; Centers for Medicare and Medicaid Services website, January 22, 2018; CMS Annual Release of Part D National Average Bid Amount, July 31, 2017; 2017 Medicare Trustees Report, July 13, 2017; Consumer Expenditure Survey data as of December 31, 2017; J.P. Morgan analysis. MODEL MEDICARE INFLATION CORRECTLY When planning for Medicare costs in retirement, consider using: • 4.2% until you start Medicare at age 65 to account for annual cost increases • 6.5% at age 65 and older to also adjust for increases related to age and uncertainties 6
- 7. HEADLINE (Calibri Bold 32) Total Health Care projected inflation rate is 6.5% • Notes: Age 85 estimated total median cost in 2018 is $7,097. Medigap premiums usually increase due to age, in addition to annual inflation, except for most policies in the following states: AR, CT, MA, ME, MN, NY, VT WA, AZ, FL, ID and MO. Analysis includes the most comprehensive and expensive plan available in each state. • Parts B and D additional premiums are calculated from federal tax returns two years prior; individuals may file for an exception on form SSA-44 if they reduce or stop work. For the definition of MAGI, please see slide 41. • Source: Employee Benefit Research Institute (EBRI) data as of December 31, 2017; SelectQuote data as of January 18, 2018; Centers for Medicare and Medicaid Services website, January 22, 2018; CMS Annual Release of Part D National Average Bid Amount, July 31, 2017; 2017 Medicare Trustees Report, July 13, 2017; Consumer Expenditure Survey data as of December 31, 2017; J.P. Morgan analysis. A GROWING CONCERN Given variation in health care cost inflation from year to year, it may be prudent to assume an annual health care inflation rate of 6.5%, which may require growth as well as current income from your portfolio in retirement. 7
- 8. HEADLINE (Calibri Bold 32)Pensions are a thing of the past 8
- 9. HEADLINE (Calibri Bold 32) Have a consistent strategy for saving and investing The above example is for illustrative purposes only and not indicative of any investment. Account value in this example assumes a 6.0% annual return and cash assumes a 2.0% annual return. Source: J.P. Morgan Asset Management, Long-Term Capital Market Assumptions. Compounding refers to the process of earning return on principal plus the return that was earned earlier. SAVING FUNDAMENTALS Saving early and often, and investing what you save, are some of the keys to a successful retirement due to the power of compounding over the long term. 9
- 10. HEADLINE (Calibri Bold 32)How much savings do I need? Example: Age: 50 Income: $300,000 Savings Multiple 8.0 $300k x 8.0= $2,400,000 MODEL ASSUMPTIONS Assumed annual gross savings rate: 10%* Pre-retirement investment return: 6.0% Post-retirement investment return: 5.0% Inflation rate: 2.25% Retirement age – • Primary earner: 65 • Spouse: 62 Years in retirement: 30 *10% is approximately twice the U.S. average annual savings rate 10
- 11. HEADLINE (Calibri Bold 32) Personal financial planning helps alleviate some concerns and challenges Can I maintain my lifestyle? Will I run out of money? When do I take social security? Financial market volatility Inflation Personal Financial Planning ChallengesConcerns 11
- 12. HEADLINE (Calibri Bold 32)Planning builds the foundation for retirement Long term financial planning: • Is a collaborative process • Projects inflation, income and expenses over a set period of time • Uses forecasting to determine investment returns over time • Stress tests your current savings & investment strategies against your future retirement goals. A sound financial plan will help you determine how much you need to save, how much you can spend and how you should be invested to meet your goals. 12
- 13. HEADLINE (Calibri Bold 32)Assumptions for sample plan • Current ages: 56 & 54 • Husband retires at 63, wife at 61 in 2025. • Planning to ages 91 & 93 • Current Net Worth: $1,430,000 • Combined savings of $33,100/year to 401k plans • Spending goals: • Living Expenses: $68,000/year from 2025 - 2057 • Travel: $ 10,000 / year from 2025 - 2045 • Health Care: • Private Insurance: $20,994 for 1 year • Both Medicare: $12,588/ year 2029-2053 • Social Security - Both claim at their Full Retirement age of 67 • Inflation: • Healthcare 6.5% • General 2.5% • Social Security 1.8% 13
- 14. HEADLINE (Calibri Bold 32)Will your money last through retirement? 14
- 15. HEADLINE (Calibri Bold 32)When should I take my benefit? For illustrative purposes only. For those born in 1956 or earlier, there is a 7.3% compound growth rate for each year of waiting to take benefits; 7.4% for those born in 1957 or after. The Social Security Amendments Act of 1983 increased FRA from 65 to 67 over a 40-year period. The first phase of transition increased FRA from 65 to 66 for individuals turning 62 between 2000 and 2005. After an 11-year hiatus, the transition from 66 to 67 (2017-2022) will complete the move. Source: Social Security Administration, J.P. Morgan Asset Management UNDERSTAND THE TRADEOFFS Deciding when to claim benefits will have a permanent impact on the benefit you receive. Claiming before your full retirement age can significantly reduce your benefit, while delaying increases it. In 2017, full retirement age began transitioning from 66 to 67 by adding two months each year for six years. This makes claiming early even more of a benefit reduction. 15
- 16. HEADLINE (Calibri Bold 32)Impact of longevity and return on when to claim Social Security Source (chart): Social Security Administration, J.P. Morgan Asset Management. Source (longevity at age 62): Social Security Administration, Period Life Table, 2014 (published in 2017), J.P. Morgan Asset Management. Source (expected returns): J.P. Morgan Asset Management Long-Term Capital Market Assumptions. Assumes the same individual, born in 1956, retires at the end of age 61 and claims at 62 & 1 month, 66 & 4 months and 70, respectively. Benefits are assumed to increase each year based on the Social Security Administration 2017 Trustee’s Report “intermediate” estimates (annual benefit increase of 3.1% in 2019 and 2.6% thereafter). Expected rate of return is deterministic, in nominal terms, and net of fees. CONSIDER PORTFOLIO RETURNS AND YOUR LIFE EXPECTANCY The lower your expected long-term investment return and the longer your life expectancy – the more it pays to wait to take your benefit. 16
- 17. HEADLINE (Calibri Bold 32) How involved will you be in executing your plan? Where are we in the current market cycle? What are the technical indicators suggesting? Where are interest rates & inflation headed? How do I invest for the return I need? How much risk should I take? What should I be overweight or underweight in? As I make changes what impact will it have on taxes? How am I peforming according to my financial plan? What are the corresponding benchmark returns? Rebalance Monitor Research Investment Strategy Do you have the time, energy and skill? 17
- 18. HEADLINE (Calibri Bold 32)Follow a consistent process REVIEW Do I want to spend all my money, leave it to the kids, donate it to charity or give to Uncle Sam? Review your needs, wants and wishes. Adjust your financial plan as necessary. Prepare and plan for investment and lifestyle choices PLAN Find an advisor who is knowledgeable, experienced and you can trust. Define your needs, wants and wishes in retirement. Build a formal financial plan. INVEST How involved do I want to be in the management of my money? What is the right allocation to achieve my desired standard of living? 18
- 19. HEADLINE (Calibri Bold 32)Key Takeaways • Control what you can control • Saving • Spending • Investing – Asset allocation and asset location • We are living longer and must plan accordingly • Accurately modeling & projecting healthcare costs is imperative to a successful retirement plan • Building a plan is the first step. Executing and sticking to a plan is a lifelong process. 19
- 20. HEADLINE (Calibri Bold 32) Ibbotson® SBBI® Stocks, bonds, bills, and inflation 1926–2017 •Past performance is no guarantee of future results. Hypothetical value of $1 invested at the beginning of 1926. Assumes reinvestment of income and no transaction costs or taxes. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © Morningstar. All Rights Reserved. 20
- 21. HEADLINE (Calibri Bold 32) Ibbotson® SBBI® After Taxes 1926–2017 •Past performance is no guarantee of future results. Hypothetical value of $1 invested at the beginning of 1926, with taxes paid monthly. No capital gains taxes are assumed for municipal bonds. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. Assumes reinvestment of income and no transaction costs. © Morningstar. All Rights Reserved. 21
- 22. HEADLINE (Calibri Bold 32) Ibbotson® SBBI® After Taxes and Inflation 1926–2017 •Past performance is no guarantee of future results. Hypothetical value of $1 invested at the beginning of 1926, with taxes paid monthly. No capital gains taxes are assumed for municipal bonds. Assumes reinvestment of income and no transaction costs. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © Morningstar. All Rights Reserved. 22
- 23. HEADLINE (Calibri Bold 32) Inflation and Taxes Reduce Returns Compound annual returns 1926–2017 23
- 24. HEADLINE (Calibri Bold 32) Reduction of Risk Over Time 1926–2017 •Past performance is no guarantee of future results. Each bar shows the range of compound annual returns for each asset class over the period 1926–2017. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © Morningstar. All Rights Reserved. 24
- 25. HEADLINE (Calibri Bold 32)Consistent Long-Term Performance Compound annual returns 1972–2017 •Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © Morningstar. All Rights Reserved. 25
- 26. HEADLINE (Calibri Bold 32)Reliable Income Returns Equity REIT annual returns, past 20 years •Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © Morningstar. All Rights Reserved. 26
- 27. HEADLINE (Calibri Bold 32) Real Estate Has Experienced a Narrower Range of Returns Range of annual returns: 1985–2017 •Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © Morningstar. All Rights Reserved. 27
- 28. HEADLINE (Calibri Bold 32)Potential to Reduce Risk and Increase Return Stock and bond investors 1972–2017 •Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © Morningstar. All Rights Reserved. 28
- 29. HEADLINE (Calibri Bold 32)Asset Class Correlation with Inflation Correlation of rolling 12-month returns to 12-month changes in 10-year Breakeven inflation, March 1997 to May 2016. Source: Research Affiliates 29
- 30. HEADLINE (Calibri Bold 32)Returns of First, Second, & Third Pillar 0 2 4 6 8 10 12 14 Annual Returns: 1997 to 2018 30
- 31. HEADLINE (Calibri Bold 32)Risk Diversification of Third Pillar A B C D E F G H I J A US Equity 1.00 B International Equity 0.85 1.00 C Core Fixed Income -0.05 0.00 1.00 D Short-Term Bonds -0.27 -0.22 0.74 1.00 E Emerging Markets Equity 0.76 0.82 -0.02 -0.23 1.00 F REITs 0.57 0.54 0.19 -0.06 0.47 1.00 G Commodities / CTA -0.04 0.06 0.26 0.31 0.07 0.05 1.00 H TIPS 0.02 0.10 0.76 0.50 0.14 0.24 0.25 1.00 I Emerging Markets Bonds 0.56 0.56 -0.02 -0.23 0.67 0.44 -0.04 0.37 1.00 J High Yield 0.65 0.66 0.18 -0.02 -0.23 0.47 0.05 0.14 0.57 1.00 31
- 32. HEADLINE (Calibri Bold 32)Portfolio with Third Pillar Assets 1st Pillar Assets Traditional - Growth 2nd Pillar Assets Traditional - Defense 3rd Pillar Assets Inflation Fighters - Diversifier US Equity International Equity Emerging Markets Equity Core Fixed Income TRADITIONAL FRAMEWORK US Equity International EquityEmerging Markets Equity REITs Commodities TIPS Emerging Markets Bonds High Yield / Bank Loans Core Fixed Income Short-Term Bonds AURUM FRAMEWORK 3% vs. 30% 32
- 33. HEADLINE (Calibri Bold 32)Inflation: How the Government Measures • Inflation is a general increase in prices and fall in the purchasing power of money. • The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. • Core Consumer Price Index (CPI) is equal to CPI minus energy and food prices and is used to measure core inflation. 33
- 34. HEADLINE (Calibri Bold 32)Consumers See 2% Inflation Ahead 34
- 35. HEADLINE (Calibri Bold 32)Many Drivers of Inflation Over Time 35
- 36. HEADLINE (Calibri Bold 32)Later Cycle if Wage Inflation is here 36
- 37. HEADLINE (Calibri Bold 32)Investment Dashboard Attractive / Overweight Emerging Markets Equity Global Fixed Income Treasury Inflation Protected Securities Ultra Short Fixed Income Neutral / Equalweight US Large Cap International Equity REITs *upgraded 1st Quarter Unattractive / Underweight US Small Cap Core Fixed Income High Yield Corporates / Credit Alternative Strategies 37
- 38. HEADLINE (Calibri Bold 32)Key Takeaways 1. Planning Starts Early 2. Implement with portfolio to defend against risks, including inflation and longevity 3. Inflation Risks Rising Today 38
- 39. HEADLINE (Calibri Bold 32)Information Disclosure 39 IMPORTANT DISCLOSURE INFORMATION Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended and/or undertaken by Aurum Wealth Management Group, LLC (“Aurum”), or any non-investment related content, will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Aurum is neither a law firm nor accounting firm, and no portion of its services should be construed as legal or accounting advice. Moreover, you should not assume that any discussion or information contained in this presentation serves as the receipt of, or as a substitute for, personalized investment advice from Aurum. Please remember that it remains your responsibility to advise Aurum, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. A copy of our current written disclosure Brochure discussing our advisory services and fees is available upon request. The scope of the services to be provided depends upon the needs of the client and the terms of the engagement.
Editor's Notes
- Ibbotson® SBBI® 1926–2017 An 92-year examination of past capital market returns provides historical insight into the performance characteristics of various asset classes. This graph illustrates the hypothetical growth of inflation and a $1 investment in four traditional asset classes over the time period January 1, 1926, through December 31, 2017. Small and Large stocks have provided the highest returns and largest increase in wealth over the past 92 years. As illustrated in the image, fixed-income investments provided only a fraction of the growth provided by stocks. However, the higher returns achieved by stocks are associated with much greater risk, which can be identified by the volatility or fluctuation of the graph lines. Government bonds and Treasury bills are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than the other asset classes. Furthermore, small stocks are more volatile than large stocks, are subject to significant price fluctuations and business risks, and are thinly traded. About the data Small stocks in this example are represented by the Ibbotson® Small Company Stock Index. Large stocks are represented by the Ibbotson® Large Company Stock Index. Government bonds are represented by the 20-year U.S. government bond, Treasury bills by the 30-day U.S. Treasury bill, and inflation by the Consumer Price Index. Underlying data is from the Stocks, Bonds, Bills, and Inflation® (SBBI®) Yearbook, by Roger G. Ibbotson and Rex Sinquefield, updated annually. An investment cannot be made directly in an index.
- Ibbotson® SBBI® After Taxes 1926–2017 Taxes can have a dramatic effect on an investment portfolio. Stocks are one of the few asset classes that have provided significant after-tax growth over time. This image illustrates the hypothetical growth of inflation and a $1 investment in stocks, municipal bonds, government bonds, and Treasury bills after taxes over the time period January 1, 1926, through December 31, 2017. Over the long run, the adverse effect of taxes on investment returns becomes especially pronounced. Stocks are the only asset class depicted that provided any significant long-term growth. After considering taxes, government bonds barely outperformed inflation over this time period. Municipal bonds (for which income is exempt from federal income taxes) outperformed government bonds but significantly underperformed stocks. In a world with taxes, focusing on fixed-income assets alone has not provided investors with a substantial increase in wealth. If you desire substantial after-tax growth, you may want to consider a larger allocation to stocks. Another alternative, if you are able, is to consider tax-deferred investment vehicles. Government bonds and Treasury bills are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest, while stocks and municipal bonds are not guaranteed. Stocks have been more volatile than the other asset classes. Municipal bonds may be subject to the alternative minimum tax (AMT) and state or local taxes, and federal taxes would apply to any capital gains distributions. About the data Federal income tax is calculated using the historical marginal and capital gains tax rates for a single taxpayer earning $120,000 in 2015 dollars every year. This annual income is adjusted using the Consumer Price Index in order to obtain the corresponding income level for each year. Income is taxed at the appropriate federal income tax rate as it occurs. When realized, capital gains are calculated assuming the appropriate capital gains rates. The holding period for capital gains tax calculation is assumed to be five years for stocks, while government bonds are held until replaced in the index. No capital gains taxes on municipal bonds are assumed. No state income taxes are included. Stocks are represented by the Ibbotson® Large Company Stock Index. Municipal bonds are represented by 20-year prime issues from Salomon Brothers’ Analytical Record of Yields and Yield Spreads for 1926–1985 and Mergent’s Bond Record thereafter. Government bonds are represented by the 20-year U.S. government bond, inflation by the Consumer Price Index, and Treasury bills by the 30-day U.S. Treasury bill. An investment cannot be made directly in an index.
- Ibbotson® SBBI® After Taxes and Inflation 1926–2017 The adverse effects of inflation and taxes on investment returns become especially pronounced over the long run. This image illustrates the hypothetical growth of a $1 investment after considering the effects of both taxes and inflation on each asset class over the past 92 years. Of the asset classes considered, stocks are the only asset class that provided significant growth. Municipal bonds, for which income is exempt from federal income taxes, barely provided enough total return to offset inflation. Government bonds closely kept pace with inflation. Treasury bills, however, fared the worst. After considering both taxes and inflation, the initial $1 was reduced to approximately $0.48. If you wish to overcome the effects of taxes and inflation, you may want to consider a larger allocation to stocks. Another alternative, if you are able, is to consider tax-deferred investment vehicles. Government bonds and Treasury bills are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest, while stocks and municipal bonds are not guaranteed. Stocks have been more volatile than the other asset classes. Municipal bonds may be subject to the alternative minimum tax (AMT) and state or local taxes, and federal taxes would apply to any capital gains distributions. About the data Federal income tax is calculated using the historical marginal and capital gains tax rates for a single taxpayer earning $120,000 in 2015 dollars every year. This annual income is adjusted using the Consumer Price Index in order to obtain the corresponding income level for each year. Income is taxed at the appropriate federal income tax rate as it occurs. When realized, capital gains are calculated assuming the appropriate capital gains rates. The holding period for capital gains tax calculation is assumed to be five years for stocks, while government bonds are held until replaced in the index. No capital gains taxes on municipal bonds are assumed. No state income taxes are included. Stocks are represented by the Ibbotson® Large Company Stock Index. Municipal bonds are represented by 20-year prime issues from Salomon Brothers’ Analytical Record of Yields and Yield Spreads for 1926–1985 and Mergent’s Bond Record thereafter. Government bonds are represented by the 20-year U.S. government bond, inflation by the Consumer Price Index, and Treasury bills by the 30-day U.S. Treasury bill. An investment cannot be made directly in an index.
- Inflation and Taxes Reduce Returns The adverse effects of inflation and taxes on investment returns become especially pronounced over the long run. Comparing the returns of different asset classes both before and after inflation and taxes is helpful in understanding why it is so important to consider inflation and taxes when making long-term investment decisions. This image illustrates the compound annual returns of three asset classes before and after considering the effects of inflation and taxes. Since 1926, inflation and taxes have dramatically reduced the returns of stocks, bonds, and cash. Of the asset classes considered, stocks are the only asset class that provided significant growth. Government bonds, after factoring in both inflation and taxes, barely provided a positive return. Treasury bills, however, fared the worst—a return of –0.8% was produced. If you wish to overcome the effects of inflation and taxes, you may want to consider a larger allocation to stocks. Another alternative, if you are able, is to consider tax-deferred investment vehicles. Diversification does not eliminate the risk of experiencing investment losses. Stocks are not guaranteed and have been more volatile than other asset classes. Government bonds and Treasury bills are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than the other asset classes. About the data Federal income tax is calculated using the historical marginal and capital gains tax rates for a single taxpayer earning $120,000 in 2015 dollars every year. This annual income is adjusted using the Consumer Price Index in order to obtain the corresponding income level for each year. Income is taxed at the appropriate federal income tax rate as it occurs. When realized, capital gains are calculated assuming the appropriate capital gains rates. The holding period for capital gains tax calculation is assumed to be five years for stocks, while government bonds are held until replaced in the index. No state income taxes are included. Stocks are represented by the Ibbotson® Large Company Stock Index. Government bonds are represented by the 20-year U.S. government bond, cash by the 30-day U.S. Treasury bill, and inflation by the Consumer Price Index. An investment cannot be made directly in an index. The data assumes reinvestment of income and does not account for transaction costs.
- Reduction of Risk Over Time One of the main factors you should consider when investing is the amount of risk, or volatility, you are prepared to assume. However, recognize that the range of returns appears less volatile with longer holding periods. Over the long term, periods of high returns tend to offset periods of low returns. With the passage of time, these offsetting periods result in the dispersion of returns gravitating or converging toward the average. In other words, while returns may fluctuate widely from year to year, holding the asset for longer periods of time results in apparent decreased volatility. This graph illustrates the range of compound annual returns for stocks, bonds, and cash over one-, five-, and 20-year holding periods. On an annual basis since 1926, the returns of large-company stocks have ranged from a high of 54% to a low of –43.3%. For longer holding periods of five or 20 years, however, the picture changes. The average returns range from 28.6% to –12.5% over five-year periods, and between 17.9% and 3.1% over 20-year periods. During the worst 20-year holding period for stocks since 1926, stocks still posted a positive 20-year compound annual return. However, keep in mind that holding stocks for the long term does not ensure a profitable outcome and that investing in stocks always involves risk, including the possibility of losing the entire investment. Although stockholders can expect more short-term volatility, the risk of holding stocks appears to lessen with time. Government bonds and Treasury bills are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than the other asset classes. Furthermore, small-company stocks are more volatile than large-company stocks and are subject to significant price fluctuations, business risks, and are thinly traded. About the data Small stocks are represented by the Ibbotson® Small Company Stock Index. Large stocks are represented by the Ibbotson® Large Company Stock Index. Long-term government bonds are represented by the 20-year U.S. government bond, and Treasury bills by the 30-day U.S. Treasury bill. An investment cannot be made directly in an index. The data assumes reinvestment of all income and does not account for taxes or transaction costs.
- Consistent Long-Term Performance REIT return characteristics make REITs an attractive choice for a diversified portfolio. From a pure return perspective, REITs have had an attractive compound annual return of 11.9% since 1972, placing between large and small stocks. The performance depicted assumes reinvestment of all income and does not account for taxes or transaction costs. As the REIT industry has grown, REITs have exhibited performance behavior that is unique. While they offer the income earning potential of bonds and the price appreciation of stocks, REIT returns have had a low correlation to bonds and a moderate correlation to stocks. Their unique trading characteristics and their potential for good income and price return may make them a viable investment for some investors looking for further diversification and income. Diversification does not eliminate the risk of experiencing investment losses. Government bonds are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while returns and principal invested in stocks and REITs are not guaranteed. Furthermore, small stocks are more volatile than large stocks and are subject to significant price fluctuations, business risks, and are thinly traded. About the data Bonds in this example are represented by the 20-year U.S. government bond and large stocks by the Ibbotson® Large Company Stock Index. REITs are represented by the FTSE NAREIT All Equity REIT Index® and small stocks by the Ibbotson® Small Company Stock Index. An investment cannot be made directly in an index.
- Reliable Income Returns The income generated from REITs has proven to be relatively consistent over time. The image illustrates the income return and price appreciation of REITs on an annual basis since 1998. While REITs can offer the potential for good price appreciation, they are not guaranteed and the price return can fluctuate widely from year to year. However, the income generated from REITs has been relatively stable and consistent. The average annual income return of the FTSE NAREIT All Equity REIT Index® from 1998 to 2017 was 5.3%. REITs can serve as part of a growth investor’s strategy, while also helping to seek the income return requirement for income-oriented investors. Some portion of a portfolio may be appropriately allocated to REITs for a broad range of investor types. Returns and principal invested in REITs are not guaranteed. REITs typically provide high dividends plus the potential for moderate, long-term capital appreciation. A REIT must distribute at least 90% of its taxable income to shareholders annually. Real estate investment options are subject to certain risks, such as risks associated with general and local economic conditions, interest rate fluctuation, credit risks, liquidity risks and corporate structure. About the data REITs are represented by the FTSE NAREIT All Equity REIT Index®. An investment cannot be made directly in an index. The data assumes reinvestment of income and does not account for taxes or transaction costs.
- Real Estate Has Experienced a Narrower Range of Returns The range of annual returns for direct real estate investments differs from the range of annual returns for REITs and large stocks. Returns from both REITs and investments in direct real estate are generated from the cash flows of properties. A combination of dividend yield and share value appreciation has made REIT returns competitive with equity investments. The image compares the range in annual returns of direct real estate, REITs, and large stocks since 1985. The compound annual returns and the ranges of returns for large stocks and REITs were similar. The compound annual return of direct real estate over the same time period has been lower than that of both large stocks and REITs. Direct real estate, however, experienced significantly lower downside risk when compared with REITs and large stocks. The lowest return for direct real estate since 1985 was –18.1%, compared with –37.0% and –37.7% for large stocks and REITs, respectively. On account of higher barriers to entry and greater liquidity risk, investing in direct real estate may not be suitable for all investors. If deemed appropriate, direct real estate may potentially provide additional insulation in tough market conditions due to lower downside risk. Returns and principal invested in stocks and REITs are not guaranteed. Stocks have been more volatile than other asset classes. REIT performance depicted in this presentation represents that of publicly-traded REITs only. REITs typically provide high dividends plus the potential for moderate, long-term capital appreciation. A REIT must distribute at least 90% of its taxable income to shareholders annually. Real estate investment options are subject to certain risks, such as risks associated with general and local economic conditions, interest rate fluctuation, credit risks, liquidity risks and corporate structure. Direct real estate trades in a private asset market, which is different in structure and function compared to the publicly-traded REIT market. The performance of direct real estate represented by the MTBI is based on research from the MIT Center for Real Estate, which draws from the NCREIF property transaction database. The performance of direct real estate represented by the NTBI is based on properties that were in the NCREIF Property Index (NPI) and were sold that quarter. The NTBI methodology is a simpler, average price based version of the MTBI that does not require regression modeling. This measure of direct real estate differs from non-public REITs in many ways, such as it does not incorporate brokerage fees or take into account market valuation in the event of public offering. About the data Large stocks are represented by the Ibbotson® Large Company Stock Index. REITs are represented by the FTSE NAREIT All Equity REIT Index®. Direct real estate is represented by the Transactions-Based Index of Institutional Commercial Property Investment Performance (TBI) from the MIT Center for Real Estate from 1985 to 2010 and the NCREIF Transaction Based Index (NTBI) thereafter. An investment cannot be made directly in an index. The data assumes reinvestment of all income and does not account for taxes or transaction costs. The average return represents a compound annual return.
- Potential to Reduce Risk and Increase Return: Stock and Bond Investors Adding REITs to a portfolio of stocks, bonds, and cash can potentially improve portfolio performance. This image illustrates the risk-and-return profiles of three hypothetical investment portfolios. Adding a 10% allocation to REITs in a stock, bond, and cash portfolio increased return from 10.0% to 10.2% and decreased risk from 10.0% to 9.5%. Including 20% REITs in the portfolio further improved return to 10.3% and lowered risk to 9.3%. Sharpe ratio is a statistic that measures the reward-to-variability ratio. It is particularly useful in comparing investment options to see how much return you could get for the level of risk incurred (return per unit of risk). As illustrated, the Sharpe ratio increases as REIT allocations increase in this example. Sharpe ratio was calculated by subtracting the average annual 1972–2017 return on T-bills from the portfolio return, then dividing by portfolio risk. Because stocks, bonds, cash, and REITs generally do not react identically to the same economic or market stimuli, combining these assets can often produce a more appealing risk-and-return trade-off. Keep in mind, however, that diversification does not eliminate the risk of experiencing investment losses. Government bonds and Treasury bills are guaranteed by the full faith and credit of the United States government as to the timely payment of principal and interest, while returns and principal invested in stocks are not guaranteed. Stocks have been more volatile than other asset classes. Returns and principal invested in REITs are not guaranteed. REITs typically provide high dividends plus the potential for moderate, long-term capital appreciation. A REIT must distribute at least 90% of its taxable income to shareholders annually. Real estate investment options are subject to certain risks, such as risks associated with general and local economic conditions, interest rate fluctuation, credit risks, liquidity risks and corporate structure. About the data Stocks are represented by the Ibbotson® Large Company Stock. Bonds are represented by the 20-year U.S. government bond, Treasury bills by the 30-day U.S. Treasury bill, and REITs by the FTSE NAREIT All Equity REIT Index®. An investment cannot be made directly in an index. The average return and risk are represented by the arithmetic annual return and annual standard deviation, respectively. Standard deviation measures the fluctuation of returns around the arithmetic average return of the investment. The higher the standard deviation, the greater the variability (and thus risk) of the investment returns. Portfolios are rebalanced annually. The data assumes reinvestment of income and does not account for taxes or transaction costs.