2. From last week 3. Markets are People 5. Diversify 8. Costs Kill
Stocks have prices;
businesses have value

3. Chapter 3 Lessons A mix of stocks and bonds is needed
To manage risk
Provide adequate returns of portfolio growth and income generation.
Save your entire life, even after retirement

4. 5. Diversify → 2. Investment Plan
Example: At age 60, say…
40% stocks % bonds
chart on page 77 assumes moderate risk tolerance

5. Foreign stock ownership risk
Risk to currency exposure
Foreign stocks are riskier and more expensive to own.
Fund fees are higher.
Large cap value index fund - does it
S.E.C’s oversight not equaled
Companies not as well managed

6. 50/50 Stocks and Reits
$2000 invested $1000 and $1000 (50/50) in stocks and REITs at the beginning of 1995
End of 1995:
Stocks: $ 1,000 X 37% gain = $ 1,370
REITs: $ 1,000 X 12% gain = $ 1,120
Total: $ 2,490

7. 50/50 Stocks and Reits To rebalance to a 50/50 mix we need
Stocks: $ 1,000 X 37% gain = $ 1,370
REITs: $ 1,000 X 12% gain = $ 1,120
Total: $ 2,490
To rebalance to a 50/50 mix we need
$ 1,245 (1/2 of 2,490) in each of stocks and REITs. 
To do this we sell $1,370 - $ 1,245 = $ 125 of stocks buy $125 of REITs.

8. 50/50 Stocks and Reits
Now at the start of 1996 we have $ 1,245 in each of stocks and REITs. At the end of 1996 we have: Stocks: $ 1,245 X 22% gain = $ 1,519 REITs: $ 1,245 X 33% gain = $ 1,655 Total: $ 3,174

9. 50/50 Stocks and Reits To rebalance to a 50/50 mix we need to have
Stocks: $ 1,245 X 22% gain = $ 1,519
REITs: $ 1,245 X 33% gain = $ 1,655
Total: $ 3,174
To rebalance to a 50/50 mix we need to have
$ 1,587 (1/2 of 3,174) in each of stocks and REITs.
To do this we buy $1,587 - $ 1,519 = $ 68 of stocks and sell $68 of REITs.

10. Rebalance We buy low and sell high when we rebalance!
Portfolio volatility is reduced
Done on a periodic schedule

11. Buy – Hold – Rebalance
Investors who trade the most underperform those who trade the least by 7.1% per year.
Trading is Hazardous to Your Wealth, Journal of Finance, vol. 55, no. 2 April 2000
5 Diversification

12. Author’s page 89 example…
For moderate 70 year old:
70% bonds 30% stocks
80/20 domestic to foreign mix
24% domestic stocks
6% foreign stocks
70% bonds

13. Risk tolerance
113 business students filled out risk-tolerance quizzes from six major financial companies
The average similarity among the results was only 56%
May depend less on who you are than on whose quiz you take

14. Risk tolerance is an emotional judgment and can and does change with conditions.

15. Determine the level of return we require
Construct one with a reasonable number of asset classes to mitigate risk
Compare our result with the author’s chart on page 77 for our age

16. Next Week’s Key Points Chapter 4 pages 95-125
Avoid investing emotionally
Learn to distrust simple narrative explanations of complex economic or financial events
Don’t invest for entertainment; dare to be dull.
We feel bad about investing because of “risk aversion myopia”.

17. Next Week’s Key Points
Nations with the fastest growing economies often have the lowest stock returns.
We are overconfident pattern seeking primates.
Plan, don’t panic. Avoid analogies. Remember: life is random.
Most of all: Page 98: Anticipation is better than pleasure