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©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management 2003-2008 All rights reserved P r o v i d i n g W E A L T H C A R E W E A L T H C A R.

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Presentation on theme: "©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management 2003-2008 All rights reserved P r o v i d i n g W E A L T H C A R E W E A L T H C A R."— Presentation transcript:

1 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E W E A L T H C A R E Managing Portfolio Uncertainty Presented by: David B. Loeper, CIMA ®, CIMC ®

2 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 2 Let’s Start With A Simple Test…Write Down Your Answers… Question #1: Would a Wealthcare Plan with 20% Confidence Be Sufficient? a) Nob) Yes Why? Question #2: Would you INTENTIONALLY mislead a client/prospect about their confidence level? a) Nob) Yes Question #3: If you were UNINTENTIONALLY MISLEADING THEM, would you want to correct it? a) Nob) Yes

3 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 3 Let’s Start With A Simple Test…Write Down Your Answers… Question #4: Would you consider it misleading if an advisor told a client they had 80% confidence, but in reality they had only 63%-71% confidence? a) Nob) Yes Why? Question #5: Have you ever had a fund/manager that significantly underperformed the market? a) Nob) Yes Question #6: When you picked them, were you seeking an investment that would perform poorly? a)Nob) Yes If No, then why did you pick them and what went wrong?

4 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 4 Answer Key #1 – Is 20% Confidence Enough? a) No Why? – Because the stakes are too high, the client only has ONE LIFE

5 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 5 Answer Key #1 – Is 20% Confidence Enough? a) No Why? – Because the stakes are too high, the client only has ONE LIFE #2 – Would you INTENTIONALLY mislead a client? a) No – If you answered “Yes” you may be excused

6 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 6 Answer Key #1 – Is 20% Confidence Enough? a) No Why? – Because the stakes are too high, the client only has ONE LIFE #2 – Would you INTENTIONALLY mislead a client? a) No – If you answered “Yes” you may be excused #3 – If you were UNINTENTIONALLY misleading clients, would you correct it? b) Yes – If you answered “No” you may be excused

7 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 7 Answer Key #1 – Is 20% Confidence Enough? a) No Why? – Because the stakes are too high, the client only has ONE LIFE #2 – Would you INTENTIONALLY mislead a client? a) No – If you answered “Yes” you may be excused #3 – If you were UNINTENTIONALLY misleading clients, would you correct it? b) Yes – If you answered “No” you may be excused #4 – Is it misleading to tell a client they are in the comfort zone when they really are well below the comfort zone? b) Yes – If you answered “No”, you may be excused

8 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 8 Answer Key #1 – Is 20% Confidence Enough? a) No Why? – Because the stakes are too high, the client only has ONE LIFE #2 – Would you INTENTIONALLY mislead a client? a) No – If you answered “Yes” you may be excused #3 – If you were UNINTENTIONALLY misleading clients, would you correct it? b) Yes – If you answered “No” you may be excused #4 – Is it misleading to tell a client they are in the comfort zone when they really are well below the comfort zone? b) Yes – If you answered “No”, you may be excused #5 – Have you ever had a fund/manager that significantly underperformed the market? b) Yes – If you answered “No”, you are either: Lucky, Inexperienced, Kidding Yourself, a Liar… or…..Brilliant

9 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 9 Answer Key #1 – Is 20% Confidence Enough? a) No Why? – Because the stakes are too high, the client only has ONE LIFE #2 – Would you INTENTIONALLY mislead a client? a) No – If you answered “Yes” you may be excused #3 – If you were UNINTENTIONALLY misleading clients, would you correct it? b) Yes – If you answered “No” you may be excused #4 – Is it misleading to tell a client they are in the comfort zone when they really are well below the comfort zone? b) Yes – If you answered “No”, you may be excused #5 – Have you ever had a fund/manager that significantly underperformed the market? b) Yes – If you answered “No”, you are either: Lucky, Inexperienced, Kidding Yourself, a Liar… or…..Brilliant #6 – Were you seeking an investment that would perform poorly? b) Yes – you may be excused No…Then What Went Wrong? SOMETHING

10 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 10 BOTH sides use the same “evidence” as support for their position: For Example: Universe Rank – Market at 40th%-tile: “Passive…therefore” passive will outperform 60% (or so) of active managers “Active…therefore” some managers have skill and we can pick them Who is right? Is the evidence PROOF or just data? What is the CAUSE? BOTH perspectives on the “evidence” require accepting other UNPROVEN premises if they are to be valid EVIDENCE: Passive:Requires that past performance is indication of future results This has not be proven…therefore the “passive therefore” is invalid Active:Requires that the CAUSE of out-performing to be skill and not luck Equivalent of saying that someone that flipped heads six out of ten coin flips is better than average at flipping heads!? In money management we do not know whether the cause was skill or luck…(in coin flips we know it is luck) therefore unless we can PROVE skill the “active therefore” is invalid The Active versus Passive Debate (click here for white paper)click here

11 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 11 The Active versus Passive Debate (click here for white paper)click here BOTH sides use the same “evidence” as support for their position: Efficient Market Theory: Passive: Markets are efficient and any “incorrect pricing” is quickly corrected, therefore one cannot consistently find inefficiently priced securities. Active: Most money is actively invested, and people wouldn’t do that if markets were efficient, and “some” securities are not as efficiently priced (i.e. small cap, foreign). Sharpe’s Mathematics of Active ManagementSharpe’s Mathematics of Active Management: Passive: In the end, the market must equal itself! The average dollar invested must equal the market less expenses. Active: That’s why we don’t pick average managers…we pick above average! If you have a debate and both sides use the same “evidence” to prove their contradicting conclusions, either the conclusion or the evidence should be dismissed

12 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 12 Do you understand timing Risk? Year Projected Portfolio Values 12.15% »Investor with $2 million in an Aggressive taxable portfolio »$118k retirement income »30 year plan »Do not dip into principal in real terms »Assuming 12.15% return EVERY year »Default tax & inflation assumptions: »Ending Value: $2,062,442

13 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 13 That represented the 50 th -percentile result…an average…one of many potential outcomes…Timing risk is exposed by including UNCERTAINTY: »Investor with $2 million in an Aggressive taxable portfolio »$118k retirement income »30 year plan »Do not dip into principal in real terms »Assuming 12.15% return EVERY year »Default tax & inflation assumptions: »Ending Value: Broke in year 8 to more than $29mil Year

14 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 14 That represented the 50 th -percentile result…an average…one of many potential outcomes…Timing risk is exposed by including UNCERTAINTY: »Investor with $2 million in an Aggressive taxable portfolio »$118k retirement income »30 year plan »Do not dip into principal in real terms »Assuming 12.15% return EVERY year »Default tax & inflation assumptions: »Ending Value: Broke in year 8 to more than $29mil Year Simplified to their confidence… comfort (or lack thereof)

15 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 15 Do you understand the difference between Average Return (arithmetic mean), Compound Return (geometric mean) and how uncertainty affects them? EXAMPLE 1: Average Return: 20% with no variance % Return$ ReturnEnding Value Start$100 Year 1:20%$20.00$120 Year 2:20%$24.00$144Compound = 20.00%

16 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 16 Do you understand the difference between Average Return (arithmetic mean), Compound Return (geometric mean) and how uncertainty affects them? EXAMPLE 1: Average Return: 20% with no variance % Return$ ReturnEnding Value Start$100 Year 1:20%$20.00$120 Year 2:20%$24.00$144Compound = 20.00% EXAMPLE 2: Average Return: 20% with SOME variance % Return$ ReturnEnding Value Start$100 Year 1:39%$39.00$139 Year 2:1%$1.39$140.39Compound = 18.48%

17 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 17 Do you understand the difference between Average Return (arithmetic mean), Compound Return (geometric mean) and how uncertainty affects them? EXAMPLE 1: Average Return: 20% with no variance % Return$ ReturnEnding Value Start$100 Year 1:20%$20.00$120 Year 2:20%$24.00$144Compound = 20.00% EXAMPLE 2: Average Return: 20% with SOME variance % Return$ ReturnEnding Value Start$100 Year 1:39%$39.00$139 Year 2:1%$1.39$140.39Compound = 18.48% EXAMPLE 3 Average Return: 20% with WIDE variance % Return$ ReturnEnding Value Start$100 Year 1:60%$60.00$160 Year 2:-20%-$32.00$128Compound = 13.14%

18 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 18 Compound Return: 12.15% Based on Modeling a CERTAIN AVERAGE (arithmetic mean) of 13.8% And Standard Deviation (extent returns will vary from their average) of 19.6% Let’s Examine the confidence level of our example client… But make an assumption that we are CERTAIN that we will AVERAGE a 2% Alpha (market out-performance) For our example client, the variance in the aggressive portfolio made the 50 th -percentile COMPOUND (geometric mean) return…

19 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 19 This extra performance dramatically improves the investor’s confidence and comfort of producing: $118,000 a year in inflation adjusted income Net after tax (default assumptions – 100% turnover, 50% of gains long term) $2 Million Ending Value in spending power Confidence (comfort) equaling the market:

20 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 20 This extra performance dramatically improves the investor’s confidence and comfort of producing: $118,000 a year in inflation adjusted income Net after tax (default assumptions – 100% turnover, 50% of gains long term) $2 Million Ending Value in spending power Confidence (comfort) equaling the market: Confidence WITH 2% Alpha EACH YEAR Thus why you select investments that outperform by 2% every year

21 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 21 You may even improve on this by selecting Tax Efficient investments that outperform by 2% every year: $118,000 a year in inflation adjusted income Net after tax (default assumptions – 100% turnover, 50% of gains long term) $2 Million Ending Value in spending power Confidence WITH 2% Alpha EACH YEAR

22 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 22 You may even improve on this by selecting Tax Efficient investments that outperform by 2% every year: $118,000 a year in inflation adjusted income Net after tax (default assumptions – 100% turnover, 50% of gains long term) $2 Million Ending Value in spending power Confidence WITH 2% Alpha EACH YEAR Tax Efficient (15% turnover and 100% of gains long term) with 2% Alpha each year: Your advice puts them in the comfort zone!!!

23 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 23 Active Management is a VERY GOOD THING and CLEARLY we should do it when:

24 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 24 Active Management is a VERY GOOD THING and CLEARLY we should do it when: We are CERTAIN we will AVERAGE 2% more than the market And we do exactly that each & every year… Equal Market: Tax Efficient (15% turnover and 100% of gains long term) with 2% Alpha each year:

25 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 25 Active Management is a VERY GOOD THING and CLEARLY we should do it when: We are CERTAIN we will AVERAGE 2% more than the market And we do exactly that each & every year… Equal Market: Tax Efficient (15% turnover and 100% of gains long term) with 2% Alpha each year: Does Anyone See Any Problems In This?

26 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 26 Active Management is a VERY GOOD THING and CLEARLY we should do it when: We are CERTAIN we will AVERAGE 2% more than the market And we do exactly that each & every year… Two Obvious PROBLEMS: »First, we are not 100% certain we will AVERAGE 2% More than the market (we will ignore this for now and assume you all will average 2% more than the market anyway) »Second, there is TIMING RISK uncertainty in our active management (sometimes we out-perform by a lot, sometimes a little, and every once in a while…we might even under perform by a little) What happens when we ignore TIMING RISK?

27 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 27 Measuring the UNCERTAINTY of Active Management Timing RISK For an aggressive portfolio, how far might returns vary from the market in one year? Sample Universe 8.0% Spread from average (1SD) With 2% Alpha Implies: In FavorOut of FavorNormal Relative Performance+10.36%-5.01%+1.46 Average of all markets: +2%

28 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 28 Measuring the UNCERTAINTY of Active Management Timing RISK For an aggressive portfolio, how far might returns vary from the market in one year? Sample Universe 8.0% Spread from average (1SD) With 2% Alpha Implies: In FavorOut of FavorNormal Relative Performance+10.36%-5.01%+1.46 Average of all markets: +2% Is this reasonable to you? Which is a more realistic model? A)Assume we beat the market by the exact same amount each year? B)Assume we will beat the market by 2% on average, but our market relative performance will vary from year to year?

29 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 29 Measuring the UNCERTAINTY of Active Management Timing RISK Effect of Timing Risk for Market Relative Performance: 2% Average Alpha & 8% Standard Deviation Percentile Market Relative Return Market Relative Performance INCLUDING TIMING RISK – 30 Years: Despite AVERAGING 2% above market The compounding effect of that uncertainty leaves us a 50% chance of only beating the market by 1.61%: AND exposes us to the Timing Risk we previously ignored A 10% Chance of Underperforming even though on average we outperformed

30 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 30 Just as Considering TIMING RISK in plans exposes uncertainty… We can blend the market relative performance variance and measure confidence WITHOUT IGNORING Active Management Timing RISK Our Sample Client – Tax Efficient Results with CERTAIN 2% Alpha: Without Timing Risk (Assume 2% Alpha EACH YEAR)

31 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 31 Just as Considering TIMING RISK in plans exposes uncertainty… We can blend the market relative performance variance and measure confidence WITHOUT IGNORING Active Management Timing RISK Our Sample Client – Tax Efficient Results with CERTAIN 2% Alpha: Without Timing Risk (Assume 2% Alpha EACH YEAR) WITH Timing Risk (Assume 2% Alpha but there is some variance)

32 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 32 WITH Timing Risk (Assume 2% Alpha but there is some variance) With CERTAINTY of Averaging a 2% Alpha, INCLUDING Active Timing Risk, We Still Add Value on AVERAGE Our Sample Client – Tax Efficient Results with CERTAIN 2% Alpha: Equal Market: Just not as much as we thought!

33 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 33 WITH Timing Risk (Assume 2% Alpha but there is some variance) With CERTAINTY of Averaging a 2% Alpha, INCLUDING Active Timing Risk, We Still Add Value on AVERAGE Our Sample Client – Tax Efficient Results with CERTAIN 2% Alpha: Equal Market: Just not as much as we thought! Oops…forgot one thing… In the market portfolio we assumed 100% turnover and 50% of the gains taxed as short term

34 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 34 WITH Timing Risk (Assume 2% Alpha but there is some variance) Our Sample Client – Tax Efficient Results with CERTAIN 2% Alpha: Funny thing about UNCERTAINTY…DESPITE Averaging a 2% Alpha, If We INCLUDE Active Timing Risk, Our VALUE ADD EVAPORATES! Equal Market, Same Tax Assumptions as Active: (15% turnover, 100% of gains as long term)

35 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 35 WITH Timing Risk (Assume 2% Alpha but there is some variance) Our Sample Client – Tax Efficient Results with CERTAIN 2% Alpha: Passive Management: 0.49% NEGATIVE ALPHA (certain underperformance), 30 bps variance from market & tax efficient Of course, we can’t invest in the market for free and even index funds vary from the market a little…

36 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 36 Our Sample Client – Tax Efficient Results with CERTAIN 2% Alpha: Passive Management: 0.49% NEGATIVE ALPHA (certain underperformance), 30 bps variance from market & tax efficient Of course, we can’t invest in the market for free and even index funds vary from the market a little… WHEN WE INCLUDE TIMING RISK… A CERTAIN 2% Alpha adds 3 points of confidence relative to our passively managed portfolio

37 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 37 That ALPHA provides hope of a higher income… CERTAIN 2% Active Alpha (with timing risk) Vs. OUR Portfolio… Confidence of supporting $168,000 Inflation Adjusted Income:

38 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 38 That ALPHA provides hope of a higher income… CERTAIN 2% Active Alpha (with timing risk) Vs. OUR Portfolio… Confidence of supporting $168,000 Inflation Adjusted Income: OUR Passive Management with CERTAIN negative alpha… Only a 29% Chance! ACTIVE INCLUDE TIMING RISK, CERTAIN 2% Alpha, 39% Chance of $168k Income!

39 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 39 But we do not plan on coin flip odds or worse THAT CONTRADICTS comfort & confidence… Confidence of supporting $60,000 Inflation Adjusted Income: Result With Market Results – Tax Efficient No Cost No Variance From Market ACTIVE INCLUDE TIMING RISK, CERTAIN 2% Alpha, 84% Chance of $60,000 Income!

40 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 40 But we do not plan on coin flip odds or worse THAT CONTRADICTS comfort & confidence… Confidence of supporting $60,000 Inflation Adjusted Income: ACTIVE INCLUDE TIMING RISK, CERTAIN 2% Alpha, 84% Chance of $60,000 Income! Price to OUR Passive Management with CERTAIN negative alpha & some variance…86% Chance

41 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 41 Didn’t most of us have some investments that under performed? Do you think you can really pick 10 out of 10 that will AVERAGE 2% more than the market? All the analysis so far made that assumption Out of 10 Picks, How Many Will Be Winners? 9? 8? 7? 6? 5? 4? This is another UNCERTAINTY…and we can model the risk your confidence (or lack thereof) has on the client’s overall confidence Has Anyone Been Bothered By This CERTAINTY of Averaging a 2% Alpha?

42 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 42 Has Anyone Been Bothered By This CERTAINTY of Averaging a 2% Alpha? $60,000 income Tax Efficient Passive Certain negative alpha Some additional timing risk relative to the market: 86% Confidence Active $60,000 income Tax Efficient, 2% Alpha PICK 10 OUT OF 10 84% Confidence

43 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 43 Has Anyone Been Bothered By This CERTAINTY of Averaging a 2% Alpha? $60,000 income Tax Efficient Passive Certain negative alpha Some additional timing risk relative to the market: 86% Confidence Active $60,000 income Tax Efficient, 2% Alpha PICK 9 OUT OF 10 81% Confidence

44 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 44 Has Anyone Been Bothered By This CERTAINTY of Averaging a 2% Alpha? $60,000 income Tax Efficient Passive Certain negative alpha Some additional timing risk relative to the market: 86% Confidence Active $60,000 income Tax Efficient, 2% Alpha PICK 8 OUT OF 10 78% Confidence

45 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 45 Has Anyone Been Bothered By This CERTAINTY of Averaging a 2% Alpha? $60,000 income Tax Efficient Passive Certain negative alpha Some additional timing risk relative to the market: 86% Confidence Active $60,000 income Tax Efficient, 2% Alpha PICK 7 OUT OF 10 75% Confidence

46 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 46 Has Anyone Been Bothered By This CERTAINTY of Averaging a 2% Alpha? $60,000 income Tax Efficient Passive Certain negative alpha Some additional timing risk relative to the market: 86% Confidence Active $60,000 income Tax Efficient, 2% Alpha PICK 6 OUT OF 10 72% Confidence

47 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 47 Has Anyone Been Bothered By This CERTAINTY of Averaging a 2% Alpha? $60,000 income Tax Efficient Passive Certain negative alpha Some additional timing risk relative to the market: 86% Confidence Active $60,000 income Tax Efficient, 2% Alpha PICK 5 OUT OF 10 69% Confidence

48 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 48 Has Anyone Been Bothered By This CERTAINTY of Averaging a 2% Alpha? $60,000 income Tax Efficient Passive Certain negative alpha Some additional timing risk relative to the market: 86% Confidence Active $60,000 income Tax Efficient, 2% Alpha HEAVEN FORBID! PICK 4 OUT OF 10 65% Confidence

49 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 49 THIS is WHY WE JOINED THE ENEMY! NOT BECAUSE OF: Fees, Taxes, Or Where Indices Fall in Universes… But Because of the PRICE to our clients ONLY life! Confidence of $60,000 Income- Tax Efficient Passive: 86% Active, Tax Efficient 2% Alpha: 10 for 10: 84% 9 for 10: 81% 8 for 10: 78% 7 for 10: 75% 6 for 10: 72% 5 for 10:69% 4 for 10:65%

50 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 50 The PRICE TO OUR CLIENT’S LIFE IS HUGE! The Price to Active Uncertainty INCOME TO HAVE SAME CONFIDENCE AS TAX EFFICIENT PASSIVE: $60,000 Confidence of $60,000 Income- Tax Efficient Passive: 86% Active, Tax Efficient 2% Alpha: 10 for 10: 84% 9 for 10: 81% 8 for 10: 78% 7 for 10: 75% 6 for 10: 72% 5 for 10:69% 4 for 10:65% $52,000 $47,000 $40,000 $34,000 $31,000 $30,000 $23,000 NOT A TYPO!!! ARE YOU DISCLOSING THIS RISK!!!???

51 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 51 “But I’m Not Attempting to Out Perform – I’m About Risk Control!” I’m not looking for this: I’m Controlling Risk! Then What’s This??? 80 Year Efficient Frontier

52 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 52 The Bottom Line to Your Clients… If you are implementing with active management: 1. The confidence level represented by MARKET returns is a MATERIAL misrepresentation of the client’s true confidence level » 89% confidence for market – 84% Active, 2% Alpha, Pick 10 of 10 » 75% confidence for Active if you pick 7 of 10 (ARE YOU DISCLOSING THIS?)

53 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 53 The Bottom Line to Your Clients… If you are implementing with active management: 1. The confidence level represented by MARKET returns is a MATERIAL misrepresentation of the client’s true confidence level » 89% confidence for market – 84% Active, 2% Alpha, Pick 10 of 10 » 75% confidence for Active if you pick 7 of 10 (ARE YOU DISCLOSING THIS?) 2. At coin-flip confidence (near 50%-tile), Picking 10 of 10 add 3 pts of confidence versus passive at the same level of income

54 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 54 The Bottom Line to Your Clients… If you are implementing with active management: 1. The confidence level represented by MARKET returns is a MATERIAL misrepresentation of the client’s true confidence level » 89% confidence for market – 84% Active, 2% Alpha, Pick 10 of 10 » 75% confidence for Active if you pick 7 of 10 (ARE YOU DISCLOSING THIS?) 2. At coin-flip confidence (near 50%-tile), Picking 10 of 10 add 3 pts of confidence versus passive at the same level of income 3. The active bet versus our passive portfolios equates to this… » ASSUMING YOU CAN PICK WINNERS 7 of 10 TIMES IGNORING FEES: » 20% chance of having 9.2% more income » 50% chance of having 5.5% LESS INCOME » 20% chance of having 29% LESS INCOME WOULD YOU MAKE THIS BET? ARE YOU DISCLOSING THIS RISK? ARE YOU AND YOUR CLIENT CONCIOUSLY ACCEPTING THIS RISK? OR, ARE YOU ASSUMING THERE IS NO RISK? (like we used to do in financial plans)

55 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 55 The Bottom Line to Your Clients… If you are implementing with active management: 1. The confidence level represented by MARKET returns is a MATERIAL misrepresentation of the client’s true confidence level » 89% confidence for market – 84% Active, 2% Alpha, Pick 10 of 10 » 75% confidence for Active if you pick 7 of 10 (ARE YOU DISCLOSING THIS?) 2. At coin-flip confidence (near 50%-tile), Picking 10 of 10 add 3 pts of confidence versus passive at the same level of income 3. The active bet versus our passive portfolios equates to this… » ASSUMING YOU CAN PICK WINNERS 7 of 10 TIMES IGNORING FEES: » 20% chance of having 9.2% more income » 50% chance of having 5.5% LESS INCOME » 20% chance of having 29% LESS INCOME WOULD YOU MAKE THIS BET? ARE YOU DISCLOSING THIS RISK? ARE YOU AND YOUR CLIENT CONCIOUSLY ACCEPTING THIS RISK? OR, ARE YOU ASSUMING THERE IS NO RISK? (like we used to do in financial plans)

56 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 56 In Summary, The Choice is Yours… You Can: »Implement in manner that reduces confidence except for the remote probabilities of a relatively small improvement (20% chance of 9% more income, but 50% chance of less) »Intentionally mislead your clients about their confidence »Evade correcting previous unintentionally misleading representations »Continue to represent they are in the comfort zone when you know the way you implement is putting them below it »Seek investments that out-perform »Despite the price to your client’s life of doing so IS THIS HOW YOU ANSWERED THE QUESTIONS IN THE QUIZ?

57 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 57 You Can: »Implement in manner that reduces confidence except for the remote probabilities of a relatively small improvement (20% chance of 9% more income, but 50% chance of less) »Intentionally mislead your clients about their confidence »Evade correcting previous unintentionally misleading representations »Continue to represent they are in the comfort zone when you know the way you implement is putting them below it »Seek investments that out-perform »Despite the price to your client’s life of doing so Isn’t there a way of making the most of the only life your client has WITHOUT NEEDLESSLY ACCEPTING THESE RISKS? DON’T ALL OF THESE ACTIONS (OR INACTIONS) CONTRADICT: Comfort? Confidence? And… AVOIDING: UNDUE SACRIFICE?

58 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 58 You can gamble your client’s future, and your career… »By representing your value as picking investments (despite the price to the client’s life)

59 ©Copyright Financeware, Inc., d/b/a Wealthcare Capital Management All rights reserved P r o v i d i n g W E A L T H C A R E PAGE 59 You can gamble your client’s future, and your career… »By representing your value as picking investments (despite the price to the client’s life) Or, you can deliver the Wealthcare Value Proposition of making the most of the one life each client has… Providing confidence & comfort in achieving that which the client uniquely values… Without accepting undue sacrifices to their lifestyle And avoiding ANY investment risks (including the bet on active) that DO NOT BUY the client something they value Questions?


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