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Legal Considerations in the Investment of Assets

Kevin C. Kaufhold

Copyright 2005 Kaufhold & Associates, P.C.Copyright 2005 Kaufhold & Associates, P.C.

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• Educational in Nature

• Qualifications

• Disclosures

I. Introduction

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II. Legal Considerations • Common Law Obligations

• Illinois Trusts – Prudent Investor Rule

• Foundations / Endowments

• Corporate Investment of Assets

• Investment of Public Assets

• Pension & Health Trust Funds

• Investment Managers & Advisors

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III. Financial Considerations• Applicable Investment Concepts What must you do to satisfy fiduciary?

What should you do to invest wisely?• Get out of Debt

Credit Cards Manage RE mortgage

• Develop a Pattern of Saving & Investing Investor Education Keep it Simple Live Below Your Means The Power of Compound Returns Invest Regularly Dividend & Dividend Reinvestment

Reduce Other Loans

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Dollar Cost Averaging

Keep Costs, Expenses, Taxes Low.

Can Active Mutuals Outperform?

Invest in the Long Run

How Much to Save?

Tax Issues & Turnover

Insurance Issues & Coverage

Investment Policies and Practices

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IV. Risk and Return Concepts• Definitions of Risk & Return

• The Risk – Return Trade-Off

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The Risk - Return Trade-Off - 1926-2002 Data

y = 0.4455x + 0.0249R2 = 0.9888

0.00

0.05

0.10

0.15

0.20

0.00 0.05 0.10 0.15 0.20 0.25 0.30 0.35

Standard Deviation

Ann

l Ave

Ret

urns

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IV. Risk and Return Concepts• Definitions of Risk & Return

• The Risk – Return Trade-Off

• Balancing of Risk & Return Through Optimization

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Risk and Return - One Year Hold

0.00

0.02

0.04

0.06

0.08

0.10

0.12

0.14

0.16

0.00 0.02 0.04 0.06 0.08 0.10 0.12 0.14 0.16 0.18 0.20 0.22 0.24 0.26

Std Dev. Of Ave Annl Rtn

Ave

Ann

l Rtn

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IV. Risk and Return Concepts• Definitions of Risk & Return

• The Risk – Return Trade-Off

• Balancing of Risk and Return through Optimization

• Reduction of Risk through Diversification

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IV. Risk and Return Concepts• Definitions of Risk & Return

• The Risk – Return Trade-Off

• Balancing of Risk and Return through Optimization

• Reduction of Risk through Diversification

• Reduction of Risk through International

Diversification

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IV. Risk and Return Concepts• Definitions of Risk & Return

• The Risk – Return Trade-Off

• Balancing of Risk and Return through Optimization

• Reduction of Risk through Diversification

• Reduction of Risk through International

Diversification

• Reduction of Risk through Time

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Risk and Return Across Time

0.00

0.02

0.04

0.06

0.08

0.10

0.12

0.14

0.16

0.00 0.02 0.04 0.06 0.08 0.10 0.12 0.14 0.16 0.18 0.20 0.22 0.24 0.26

Std Dev. Of Ave Annl Rtn

Ave

Ann

l Rtn

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IV. Risk and Return Concepts• Definitions of Risk & Return

• The Risk – Return Trade-Off

• Balancing of Risk and Return through Optimization

• Reduction of Risk through Diversification

• Reduction of Risk through International

Diversification

• Reduction of Risk through Time

• Reduction of Risk over Time for all Asset Classes

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Return Probabilities, by Holding Period - 1926-2002

-0.10

-0.05

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0 5 10 15 20 25 30

Holding Period

Com

poun

d R

etur

n

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IV. Risk and Return Concepts• Definitions of Risk & Return

• The Risk – Return Trade-Off

• Balancing of Risk and Return through Optimization

• Reduction of Risk through Diversification

• Reduction of Risk through International

Diversification

• Reduction of Risk through Time

• Reduction of Risk over Time for all Asset Classes

• Other Forms of Risk Increasing Across Time

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Projected Cumulative Wealth

0

5

10

15

20

25

30

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Future Years

Wea

lth In

dex

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IV. Risk and Return Concepts• Definitions of Risk & Return

• The Risk – Return Trade-Off

• Balancing of Risk and Return through Optimization

• Reduction of Risk through Diversification

• Reduction of Risk through International

Diversification

• Reduction of Risk over Time for All Asset Classes

• Reduction of Risk through Time

• Other Forms of Risk Increasing Across Time

• Very-Long Term Risk and Return

• Risk and Return Across Holding Periods

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ST LT VLT

Risk Std Dev Shortfall Risk

Underperf. Risk

Intergen. Risk

Policy Drift, etc.

Return Pricing Return Rtn to Net Worth Intergen. Transfers

Bus Model CAPM/MPT

MVO

Asset/Liability

Low P/V Indicators

Utility Analysis

Complex Behavior

Estate Planning

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V. On the Allocation of Assets• Allocation vs. Specific Asset Selection

• Historical Rates of Return

• Cultural Differences

• Age Considerations

• Alternative Asset Classes

• Risk Tolerances & Holding Periods

• Asset Liability Modeling

• Three Factor Modeling

• Macro vs. Micro Styles

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VI. Practical Allocation Models• Lifestyle Funds

• Target Retirement Funds

• A Simple Approach from S&P

• A Holding Period Approach

• Investment Objective/Risk Tolerance Models• Complex, Professional Level Models

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VII. Conclusion

• As to the Law: “Fiduciaries must act solely in the interest of plan participants … for the exclusive purpose of providing plan benefits…”

• As to Finances: “Investment is most intelligent when it is most businesslike”.

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VIII. Questions / Notes