1. Investment and Financial Planning
Vision Investment Services, Inc.
Module 5
Welcome to the program.
This is a module of approximately two and a half hours on investment and financial planning.
As we learn, we will be focusing on the Tom and Linda Adams case.
Copyright 2003, The Selbst Group Inc.

2. Our Program Styles of investing
An introduction to portfolio management
Financial Planning Tools and Techniques— Retirement Planning
Financial Planning Tools and Techniques— College Funding
These are the topics we will cover in this module.
Copyright 2003, The Selbst Group Inc.

3. Styles of Investing Growth investing Value investing
Top-down vs. bottom up
Active vs. passive
Quant investing
Momentum investing
Contrarian investing
Asset allocation
Dividend strategies
Cyclical and sector rotation strategies
The impact of technology
Theme or sector investing
In this first section, we will cover several popular styles of investing.
These are really just different ways of evaluating and selecting investments.
Just as people prefer different styles of clothing, they prefer different styles of investing.
Some of these styles offer more risk and return potential than others.
Almost all of them focus mainly on stocks.
Copyright 2003, The Selbst Group Inc.

4. Growth Investing $1.60 $1.20 $0.80 $0.40 Microsoft (MSFT)
Styles of Investing
Growth Investing
1.71
Microsoft (MSFT)
Diluted Earnings Per Share
$1.60
1.42
1.41
1.38
$1.20
.84
One of the most popular styles has been growth investing. The simple definition of this style might be participating in stocks of companies that are growing their customers, operations, products, and sales. But the serious growth investor looks at other data, too.
Probably the most important data to a growth investor is the company’s earnings per share. Earnings are bottom-line profits the company earns, after all expenses and taxes. When earnings are divided by the number of shares, you get earnings per share.
The growth investor wants to see a steady upward pattern in earnings per share.
Probably the greatest growth company of modern times has been Microsoft.
Microsoft stocks was first sold to the public in 1985, and in that year it had just a penny of earnings per share. But by 1989, earnings had increased four times, to four cents a share. From then on, Microsoft earnings went on a steady climb, reaching $1.71 per share in What happened then? A recession combined with a technology sector collapse caused the era of straight-up growth to end. Is Microsoft still considered a growth stock? Yes, by most it is. The stock market still values Microsoft based on an expectation that growth will resume, although not at the pace of the company’s early years.
Most growth companies pay little or no dividends. Until recently, Microsoft paid none. So, earnings measure the money the company can reinvest back into its own growth. Earnings per share are reported quarterly, and they are the best measure of success for growth investors. A steady pattern of quarter-to-quarter earnings growth should create strong upward movement in share prices over time. But the opposite is also true. When a growth company slows its earnings growth rate, the share price can take a big tumble because investors lose faith in future growth.
Growth stocks tend to be more volatile than the market as a whole, because they are in high demand when earnings keep growing and can fall out of favor when earnings falter. The sectors that are most widely followed by growth investors include technology, pharmaceutical and retailing.
$0.80
.66
.43
$0.40
.29
.23
.20
.15
.10
.06
.01
.01
.02
.03
.04
1985
1987
1989
1991
1993
1995
1997
1999
2001
Copyright 2003, The Selbst Group Inc.

5. Eastman Kodak Vs. Industry
Styles of Investing
Value Investing
Out-of-favor companies
Attractive values as defined by:
Below average price/earnings ratio
Below average price/book ratio
14.1
Eastman Kodak Vs. Industry
Photo
Industry
11.3
Value investing is the other side of the stock market coin. Value investors believe almost the opposite of growth investors.
Instead of looking for growing companies that are the stock market’s darlings, they look for out-of-favor companies selling at attractive values.
These values are most often defined by below average price/earnings ratio and below average price/book ratio.
The slide shows both types of data for Eastman Kodak, a company that is widely known and followed. But for various reasons, Eastman Kodak has fallen out of favor with investors. Why do you think that might be so? (VOLUNTEERS)
Price/earnings ratio is calculated by dividing the current stock price by a year’s worth of earnings. It measures how much investors are willing to pay for each dollar of earnings. Recently, Kodak had a price/earnings ratio of 11.3, compared to an average of 14.1 for its industry group. The photo industry, as a whole, has a P/E well below the U.S. stock market average.
Price/book ratio is calculated by dividing the current price by the company’s book value, the sum of its assets minus its liabilities. Once again, Kodak falls below the industry average. When you find companies with these two ratios well below the industry average, you may have a value stock. What do value investors want? They look for “catalysts” that can move companies like Kodak closer to the industry group average. These are events that will make the market like the company again, like a hot product or new management team.
Eastman Kodak
2.79
2.63
Photo Industry
Eastman Kodak
Price/Earnings Ratio
Price/Book Ratio
Copyright 2003, The Selbst Group Inc.

6. Top Down Vs. Bottom Up Top Down Macro economy Sectors Industries
Styles of Investing
Top Down Vs. Bottom Up
Top Down
Macro economy
Sectors
Industries
Stock screening criteria
Manager themes
Individual stock ideas
Two styles you may hear mentioned quite a lot are top down and bottom up. These are really stock selection disciplines. An investor or money manager could select either growth or value stocks using a top down or bottom up approach.
The top down approach begins with “big picture” data and works down to a micro level of detail. The first question for a top down investor may involve the macro economy. Is the economy good enough that I should be investing in stocks at all? If so, how much? Next, which sectors and industry groups in the stock market offer the best current opportunity. Then, stock screening criteria might be employed, such as selecting growth stocks with the most consistent pattern of earnings growth. Then, manager themes might be applied. For example, a manager is looking for stocks capable of participating in the aging of America, or new electronic media. Finally, the top down manager selects individual stocks. The performance of a top down portfolio is driven mainly by macro decisions about the economy, sectors and industries.
Bottom up is a way of saying—I look at the quality of the company more than anything else, and I pick companies I like. The manager’s current theme and individual stock selection ideas are the keys to performance.
Bottom Up
Individual stock selection
Manager themes
Copyright 2003, The Selbst Group Inc.

7. Active Vs. Passive Active Passive Managers seek to beat benchmarks
Styles of Investing
Active Vs. Passive
Active
Managers seek to beat benchmarks
Total return
Risk-adjusted return
All bottom-up strategies are active
Top-down strategies overweight or underweight sectors vs. benchmark
Passive
Managers seek to mirror benchmarks
Index funds
Sector weightings and characteristics match benchmark
Low cost, low turnover
Another divide between styles of investing, similar to growth vs. value or top down vs. bottom up, is active vs. passive. Ten to 15 years ago, almost all investment strategies were active. In recent years, passive strategies have become more popular for reasons we’ll discuss later, relating to Modern Portfolio Theory.
Active managers seek to beat market averages or benchmarks through superior research and investment selection. They believe they can do it better than most other people. In some cases, they may seek to beat benchmarks on a straight total return basis. In other cases, they aim for a superior risk-adjusted return. In other words, they say: “I will aim for a lower or higher risk level than the benchmark. But I’ll try to add value in proportion to the risk undertaken.” You’ll learn later about tools for measuring risk-adjusted performance.
All bottom-up strategies are actively managed. The manager believes his/her ability to pick stocks and themes can add value.
Active top-down strategies seek to add value by overweighting or underweighting sectors vs. a benchmark. Also, they can add value through superior stock or theme selection.
Passive managers seek to mirror benchmarks by holding the same portfolio of stocks. Index funds are the most visible and accessible type of passively managed portfolios available to most individual investors. In a passive strategy, portfolio sector weightings and characteristics match the benchmark, even if the individual holdings may differ somewhat. For example, you can “index” the S&P 500 Index without buying all 500 component stocks, provided you make sure the portfolio has the same sector weightings and characteristics. The main advantage of passive strategies is their low cost to manage and their low turnover. That means they don’t buy or sell investments very often. And that, in turn, can mean tax advantages compared to active strategies.
Answer Case Quiz Question #1 in your workbook. (VOLUNTEERS) The late 90s were a time when few actively managed growth funds beat the S&P 500 Index funds. That may or may not continue. If Linda wants average market performance, the index fund is likely to give it to her consistently along with low management fees. But if she wants to pursue above-average performance, she should stick with her growth fund. The S&P 500 index fund is not necessarily less risky than the growth fund, and it is definitely not low risk.
Copyright 2003, The Selbst Group Inc.

8. Quant Investing Benchmark: S&P 500 Index Expected tracking error: 3-4%
Styles of Investing
Quant Investing
Benchmark: S&P 500 Index
Expected tracking error: 3-4%
Sector
% of Stocks  Rel. to S&P 500
Basic Materials
Energy
Consumer Non-Cyclicals
Consumer Cyclicals
Consumer Services
Industrials
Utilities
Transportation
Health Care
Technology
Telecommunications
Commercial Services
Financial Services
There is a middle ground between active and passive styles, and it is called “quant investing.” This is a style that is heavily numbers oriented, often managed in large part by sophisticated computer programs. A quant fund seeks to mirror a benchmark index for the most part. But it “tweaks” the index in an attempt to add a measured component of value. For example, the slide shows a quant portfolio that uses the S&P 500 Index as benchmark, and has an “expected tracking error” of 3-4%. In all but the most extreme situations, this portfolio should not vary more than 3-4% per year away from the benchmark’s return, on either the upside or downside. Over time, the manager will try to add value by varying more often on the upside than the downside.
Look at the portfolio composition by sector relative to the S&P 500 Index. This benchmark is traditionally divided among 13 basic sectors of the economy, shown on the slide. The first column shows the percent of stocks held in each sector, and the second shows how that compares to the benchmark means the weightings match means 10% more and .90 means 10% less.
This portfolio stays very close to the benchmark in many sectors. The largest overweights relative to the benchmark are in basic materials and utilities. The manager believes these sectors represent more attractive current opportunities than average. On the other hand, the greatest underweight is in transportation. The manager believes that sector represents less attractive current opportunities. Those judgment calls on overweights and underweights represent most of the active management value added to this strategy. Otherwise, it’s virtually an index fund. Since quant funds don’t seek to add much active value, their management cost can be low, too, although not generally as low as a pure index fund.
Copyright 2003, The Selbst Group Inc.

9. Momentum Investing The Herd Hot stocks, industries and sectors
Styles of Investing
Momentum Investing
The Herd
Hot stocks, industries and sectors
High revenue growth
Positive earnings stories
Steady dividend growth
In recent years, momentum investing has gained popularity as a style. In a nutshell, momentum means following the herd as it rushes headlong into various sectors or stocks. Momentum investors tend to sit on the sidelines, looking for clearly established trends, stocks, industries or sectors. They often favor the high revenue growth and positive earnings stories that cause investors to stampede into hot situations.
A more conservative approach to momentum investing looks for companies that have steady growth in dividends. However, since there are few companies like that anymore, dividend momentum investing has lost favor.
In short, momentum investors identify trends in progress and participate in them. They are rarely the first investors into a situation. They don’t buy at the bottom. They believe that once a trend is clearly established, it generally will continue for some time. Some momentum investors follow the stock market as a whole more than individual stocks. They move money into the market when a clear uptrend is established, and pull it out when a clear downtrend is established.
Identify trends in progress and participate
Copyright 2003, The Selbst Group Inc.

10. Contrarian Investing The Herd Contrarian
Styles of Investing
Contrarian Investing
The Herd
Contrarian
The opposite of momentum investing is contrarian investing. During the huge bull market of the late 1990s, the hottest growth stocks just kept climbing in value with unrelenting momentum. That made momentum investing popular, and it pushed contrarian investing into the closet. But invariably, the pendulum swings back, and contrarian investing could come back in favor again.
Contrarian investors believe that markets are generally efficient. We’ll learn more about what efficient markets mean. In essence, it means that stock prices reflect the value of the investment, at any given time.
However, contrarians think the herd over-reacts to hot trends and to sell-offs. So when the herd is buying, contrarians are selling, and vice versa.
Contrarians think the herd is filled with small investors who are driven by emotions more than reasons, and usually are wrong anyway.
The herd mentality creates inefficiencies in market prices and opportunities for those smart enough to go contrary to the prevailing wisdom.
Contrarians can be value investors who look for out-of-favor stocks and hold them awhile. Or they can be reverse momentum players, looking for short-term herd stampedes to exploit.
Markets are generally efficient
The herd is over-reacting
The herd is filled with small investors, who are usually wrong
The herd creates inefficiencies and opportunities
Copyright 2003, The Selbst Group Inc.

11. Asset Allocation Conservative Model Aggressive Model Cash 10%
Styles of Investing
Asset Allocation
Conservative Model
Aggressive Model
Cash 10%
Other 15%
Cash 20%
Other 15%
Bonds 25%
Stocks 30%
One style that’s become quite popular for helping investors deal with market ups and downs is asset allocation. The idea is that investors can participate in bull markets with tolerable exposure to bear markets by diversifying their money into several asset classes.
The slide shows how an asset allocation style works. It contains two pie charts side-by-side. One represents a conservative asset allocation model, and the other a more aggressive model.
The conservative model divides a portfolio as follows: 20% to cash, 35% to bonds, 30% to stocks and 15% to other assets such as real estate, art, coins or precious metals. Cash, bonds, stocks and other are called “asset classes.” Since only 30% of the portfolio is exposed to stocks, the other 70% will not be totally exposed to a bear market. But the stock portion can participate in a bull market.
The aggressive model divides assets as follows: 10% to cash, 25% to bonds, 50% to stocks and 15% to other. Since the stock portion is greater, the participation in bull markets and exposure to bear markets also will be greater.
The idea behind an asset allocation style is that you don’t try to guess bull and bear markets. The mix of assets is set and held for the long-term. Occasionally, the mix can be revised or “rebalanced” to correct for changes created by changing market prices.
Bonds 35%
Stocks 50%
Copyright 2003, The Selbst Group Inc.

12. Dividend Strategies Div. Yield 12/31/01 Div. Yield 12/31/02
Styles of Investing
Dividend Strategies
Div. Yield 12/31/01
Div. Yield 12/31/02
Dogs of 2002
Dogs of 2003
Eastman Kodak 6.12%
Philip Morris 5.06%
General Motors 4.12%
JP Morgan Chase 3.74%
DuPont 3.29%
Caterpillar 2.68%
SBC Comm. 2.61%
International Paper 2.48%
Merck 2.38%
ExxonMobile 2.34%
Philip Morris 6.32%
JP Morgan Chase 5.67%
General Motors 5.43%
Eastman Kodak 5.14%
SBC Comm. 3.98%
DuPont 3.30%
Honeywell 3.13%
General Electric 3.12%
Caterpillar 3.06%
AT&% 2.87%
Stock dividend strategies are not as popular as they once were, because dividends are not as high as they once were. Some major companies like Microsoft have attracted huge investor followings without ever paying a dividend. But there are a few investment programs built around dividend disciplines. One of the most popular among them is called “dogs of the Dow.” The slide explains how it works.
There are 30 component stocks in the Dow Jones Industrial Average of blue-chips. Each year, on 12/31, the 10 with the highest dividend yields are selected and dubbed “Dogs of the Dow.” In some circles, dividends are thought to be stodgy and old-fashioned. Stocks that pay high-dividend were called dogs, laggards. Then, some investors noticed that high dividend stocks did have periods of pretty good performance. So, the dogs became somewhat fashionable.
Dividend yield is calculated by dividing the annual dividend by the stock price, on 12/31 in this case. On 12/31/01, Eastman Kodak had the highest dividend yield among Dow 30 stocks. We said Kodak was a value stock, and it’s not uncommon to see the value stock components of the Dow Index on this list.
Every year, the dogs change. A year later, on 12/31/02, Philip Morris had the highest dividend yield among Dow stocks. Today, investors can actually buy into funds that offer the 10 Dogs of the Dow stocks, revised annually. In general, high-dividend stocks are a way to participate in the stock market with below average risk. The dividends provide some cushion of return that can buffer declines and supplement gains. Have the Dogs outperformed the whole Dow index or market as a whole? In some periods they do and in others they don’t. During the big bull market of the late 90s, they didn’t. But in the stock market downturn of 2001 and 2002, they did outperform the whole U.S. stock market.
Copyright 2003, The Selbst Group Inc.

13. Cyclical and Sector Rotation Strategies
Styles of Investing
Cyclical and Sector Rotation Strategies
Health Care
Retailing
Recession
Expansion
Among the more sophisticated of investment styles are cyclical and sector rotation strategies. Economists, investment professionals and experienced individual investors have known for a long time that the market, like the economy, is divided into numerous industry sectors.
They also know from experience that the economic activity and stock prices of these sectors move independently of other sectors and often independently of the market itself. A sector rotation strategy seeks to take advantage of shifts in the economic cycle by rolling money into those sectors which offer the best risk/reward ratios during each phase.
The slide depicts this by showing a movement into energy as the economic cycle begins an expansion. As the expansion continues, money is shifted into retailing stocks and then as a recession begins into health care. Financial stocks are chosen as the recession deepens and real estate as it bottoms.
Sector rotation is a complex strategy for several reasons. First, economic cycles don’t always rotate as neatly in reality as shown on the slide. It’s not always apparent when expansions and recessions begin, until they are well underway. Second, no two sector rotation managers can quite agree on which sectors work best at which points in the economy. So some managers might arrange the sectors on the slide differently than shown. Third, sector rotation can either be pursued very aggressively, by timing large movements of money across cycle phases, or more passively, by tweaking an asset allocations among sectors by a few percentage points periodically.
Financial
Energy
Real Estate
Copyright 2003, The Selbst Group Inc.

14. The Impact of Technology
Styles of Investing
The Impact of Technology
More information faster
Use of computer models
Programmed trading strategies
Internet trading and lower transaction costs
Day traders and high turnover strategies
Across all styles of investing, the impact of technology is being felt as a huge force. There is no question that technology favors and facilitates some styles, while perhaps outdating others. On the other hand, as the “tech bust” of 2001 and 2002 showed, the technology sector and its stocks can be very cyclical and prone to downturns.
Technology delivers more market information faster than has ever been possible before, and this enables investment styles based on speed to market. Technology also allows investors and managers to benefit from sophisticated computer models. Many quant styles and passive indexing strategies are driven almost totally by computer. A step beyond selecting stocks by computer is actually executing trades by computer, which is called programmed trading strategies. These strategies follow pre-programmed rules to enter buy and sell orders when the computer detects market opportunities or inefficiencies.
Internet trading and lower transaction costs have enabled many individual investors to engage in sophisticated investment styles that were cost-prohibitive before. The most visible among them have been the so-called “day traders” who engage in high turnover strategies. In some cases, they may buy and sell the same security several times during the same day, in hopes of earning tiny profits on each trade. Of course, many of these investors lost large amounts during the tech bust.
Copyright 2003, The Selbst Group Inc.

15. Sector, Theme and Regional Investing
Styles of Investing
Sector, Theme and Regional Investing
Sector
Banking
Communications
Energy
Gold
Technology
Theme
Defense against terrorism
Biotech breakthrough
Aging of America
Socially responsible
Region
Asia
Emerging economies
Europe
Latin America
Pacific Rim
That leads to the last styles we will discuss, which are sector, theme and regional investing. These styles have in common a focus on specific types of investment, to the exclusion of all others. Examples of sector-based styles include banking, communications, energy, gold and technology stocks and portfolios.
Theme investing pursues a concept or idea and stocks participating in it. Examples are defense against terrorism, biotech breakthroughs, the Aging of America, and socially responsible strategies.
Regional styles focus on specific areas of the world, such as Asia, emerging economies, Europe, Latin America and the Pacific Rim.
What to you think sector, theme and regional investing have in common? (VOLUNTEER). They are focused. They can perform very well when the particular sector, theme or region is in favor. Conversely, they can do poorly when the focus area falls out of favor. Another way to say that is—they lack broad diversification. For that reason, it may not be a good idea to put too much money into any one sector, theme or region. Instead, participate in several.
Copyright 2003, The Selbst Group Inc.