Fundamentals For Investors - Morningstar, Inc.

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2016Fundamentals forInvestors

Morningstar Investment Services2Table of ContentsUnderstanding Diversification3Staying the Course11Retirement Challenges19Benefits of Diversification4Understanding Risk Tolerance and Risk Capacity12Bittersweet20A Diversified Portfolio: Sum of the Parts5The Importance of Staying Invested13Retirees Face Numerous Risks21The Asset Allocation Puzzle6U.S. Market Recovery After Financial Crises14Quick Facts: Retirement22Asset-Class Winners and Losers7The Cost of Market Timing15Retirement Income Sources23Stock and Bond Snapshots8Risk of Stock Market Loss Over Time16Potential Shortfall: The Risk of HighWithdrawal Rates24Ibbotson SBBI (1926–2015)9Market-Timing Risk17Concerned about Longevity25Ibbotson SBBI (1996–2015)10Tune Out the Noise18Enhancing Diversification Using Real Assets26So, You’re Ready for Retirement.Or Are You?27Disclosure28The images in this book have been individually reviewed by FINRA. For a copy of the applicable FINRA review letters visit: www.global.morningstar.com/finrareview. Please note that this presentation booklet as a whole has not been reviewed by FINRA. 2016 Morningstar. All Rights Reserved.

Morningstar Investment ServicesA Diversified Portfolio:UnderstandingDiversificationSum of the PartsRisk and return characteristics 2016 Morningstar. All Rights Reserved.3

Morningstar Investment Services4Benefits of Diversification“Don’t put all your eggs in one basket” is a commonexpression that most people have heard in theirlifetime. It means don’t risk losing everything by puttingall your hard work or money into any one place.To practice this in the context of investing meansdiversification—the strategy of holding more than onetype of investment, such as stocks, bonds, or cash,in a portfolio to reduce the risk. In addition, an investorcan diversify among their stock holdings by buyinga combination of large, small, or international stocks, andamong their bond holdings by buying short-termand long-term bonds, government bonds, or high-andlow-quality bonds. 2016 Morningstar. All Rights Reserved.A diversification strategy reduces risk because stocks,bonds, and cash generally do not react identicallyin changing economic or market conditions. Diversification does not eliminate the risk of experiencinginvestment losses; however, by investing in a mix of theseinvestments, investors may be able to insulate theirportfolios from major downswings in any one investment.Over the long run, it is common for a more riskyinvestment (such as stocks) to outperform a less riskydiversified portfolio of stocks, bonds, and cash.However, one of the main advantages of diversificationis reducing risk, not necessarily increasing return.The benefits of diversification become more apparent overa shorter time period, such as the 2007–2009 bankingand credit crisis. Investors who had portfolios composedonly of stocks suffered large losses, while thosewho had bonds or cash in their portfolios experiencedless severe fluctuations in value.

Morningstar Investment Services5A Diversified Portfolio: Sum of the PartsRisk and return characteristicsPast 10 rn: 8.8%Risk: 22.0%Large stocksReturn: 10.3%Risk: 17.3%CashReturn: 4.9%Risk: 3.4%Small stocksReturn: 12.3%Risk: 22.9%BondsReturn: 8.5%Risk: 12.2%Total portfolioReturn: 9.8%Risk: 10.8%InternationalstocksReturn: 3.0%Risk: 22.2%Past 5 years2011–2015Large stocksReturn: 7.3%Risk: 19.0%CashReturn: 1.1%Risk: 2.0%Small stocksReturn: 6.8%Risk: 23.4%InternationalstocksReturn: 3.6%Risk: 14.9%CashReturn: 0.0%Risk: 0.0%Small stocksReturn: 10.5%Risk: 20.6%BondsReturn: 6.4%Risk: 15.2%Total portfolioReturn: 6.0%Risk: 10.3%Large stocksReturn: 12.6%Risk: 12.6%BondsReturn: 7.3%Risk: 17.1%Total portfolioReturn: 7.4%Risk:7.1%IU17Past 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. Diversification does noteliminate the risk of experiencing investment losses. 2016 Morningstar. All rights reserved.

Morningstar Investment Services6The Asset Allocation PuzzlePossessing a considerable amount of knowledgeabout stocks, bonds, and cash is only a small part of theinvestment planning process. Many investors areunder the false notion that the greatest determinant ofportfolio performance is the specific investmentchoices they make. Actually, the biggest decision youwill make is how much to allocate to differentinvestment categories.3 GoalsDetermining what asset allocation is appropriatedepends largely on the goals you seek to achieve. Areyou saving for retirement, college education foryour children, or a vacation home? Each goal must beconsidered in creating the appropriate asset mix.3 Time HorizonTime horizon is the length of time a portfolio willAsset allocation is all about finding the mix of investments remain invested before withdrawals are made. If yourthat is right for your situation. Goals, time horizon,investment horizon is fairly short, you’d likelyand risk tolerance are some of the key factors that shouldwant a more conservative portfolio—one with returnsbe considered when allocating assets.that do not fluctuate much. If your investmenthorizon is longer, you could invest more aggressively.3 Risk ToleranceEveryone has a different emotional reaction to suddenchanges in their portfolio value. Some people havetrouble sleeping at night, while others are unfazed byfluctuations in the market and can endure 2016 Morningstar. All Rights Reserved.

Morningstar Investment Services7Asset-Class Winners and 7.9 ��0.6–13.3 26.210.95.713.05.3–36.7 1.9 –15.7 1.48.54.94.84.7–37.0 �14.0 –21.2 –22.1 1.01.23.01.2–5.2–43.1 –14.9 0.1–11.7 0.1–12.8 –4.5–3.6Lowestreturn Small stocks Large stocks International stocks Long-term government bonds Treasury bills Diversified portfolioPRIYL09Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. Diversification does not eliminate the risk of experiencing investment loss. Aninvestment cannot be made directly in an index. The diversified portfolio is equally weighted between small stocks, large stocks, long-term government bonds, Treasury bills, and international stocks (20% each). 2016 Morningstar. All rights reserved.

Morningstar Investment Services8Stock and Bond SnapshotsReturns over various time periods as of December 20151-yearLong-termgovt ks1.4SmallstocksInternationalstocksEmergingmarket ��6.4104.212.615.1–3.6–100% ast 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. Returns are calculated asannualized total returns for the time periods indicated. 2016 Morningstar. All rights reserved.

Morningstar Investment Services9Ibbotson SBBI Stocks, Bonds, Bills, and Inflation 1926–2015 100k 26,433Compound annual return Small stocks Large stocks Government bonds Treasury bills Inflation10k1k12.0%10.05.63.42.9 5,390 132100 21 RIYL01Past 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 illustrativepurposes only and not indicative of any investment. An investment cannot be made directly in an index. 2016 Morningstar. All rights reserved.

Morningstar Investment Services10Ibbotson SBBI Stocks, Bonds, Bills, and Inflation 1996–2015 10Compound annual return Small stocks Large stocks Government bonds Treasury bills Inflation10.2%8.27.02.42.2 6.92 4.82 3.88 1.60 1.5410.6019962001200620112016PRIYL02Past performance is no guarantee of future results. Hypothetical value of 1 invested at the beginning of 1995. Assumes reinvestment of income and no transaction costs or taxes. This is for illustrativepurposes only and not indicative of any investment. An investment cannot be made directly in an index. 2016 Morningstar. All rights reserved.

Morningstar Investment ServicesA DiversifiedStayingthe CoursePortfolio: Sum of the PartsRisk and return characteristics 2016 Morningstar. All Rights Reserved.11

Morningstar Investment Services12Understanding Risk Tolerance and Risk CapacityRisk Strategy MatrixWhen determining an appropriate asset allocationmix, it is important to consider not only one’s risktolerance, but also one’s risk capacity.Risk CapacityLowHighNo Action RequiredConsider reallocatingmore conservativelyLowConsider reallocatingmore aggressivelyNo Action RequiredRisk ToleranceHighAn investor’s risk tolerance refers to his or heraversion to risk, while an investor’s risk capacity relatesto his or her ability to assume risk. Sometimes, aninvestor’s risk capacity and risk tolerance do not matchup. If an investor’s capacity to take risk is low butthe risk tolerance is high, then the portfolio should bereallocated more conservatively to prevent takingunnecessary risk. On the other hand, if an investor’srisk capacity is high but the risk tolerance is low,reallocating the portfolio more aggressively may benecessary to meet future return goals. In eithercase, speaking with a financial advisor may help todetermine if your risk tolerance and risk capacityare in sync.There is no guarantee that diversification or asset allocation will protect against market risk. These investment strategies do not ensure a profit or protect against loss in a declining market. Holding a portfolio of securities for thelong term does not ensure a profitable outcome and investing in securities always involves risk of loss. It is highly recommended that you consult with a financial professional for advice specific to your situation. 2016 Morningstar. All Rights Reserved.

Morningstar Investment Services13The Importance of Staying InvestedEnding wealth values after a market decline 190k Stay invested in stock market Exit market and reinvest after 1 year Exit market and invest in cash Recession (Dec 2007–June 2009)170 174,812150130 113,8951109070 54,58050Jan 07Jan 08Jan 09Jan 10Jan 11Jan 12Jan 13Jan 14Jan 15Jan 16IU04Past 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. 2016 Morningstar. All rights reserved.

Morningstar Investment Services14U.S. Market Recovery After Financial CrisesCumulative return of all-stock portfolio after various events100% Return90.1%Portfolio After 1 month After 6 months After 1 year After 3 years After 5 ober 1987:Stock market crashAugust 1989:U.S. savings andloan crisisSeptember 1998:Long-Term CapitalManagement’s bailoutMarch 2000:The dot-com crashSeptember 2001:Terrorist attackPast performance is no guarantee of future results. Returns reflect the percentage change in the index level from the end of the month in which the event occurred to one month, six months, one year, threeyears and five years after. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. 2016 Morningstar. All rights reserved.October 2008:Banking and creditcrisisA300

Morningstar Investment Services15The Cost of Market TimingRisk of missing the best days in the market �2–4–3.7%Invested for all5,040 trading days10 best days missed20 best days missed30 best days missed40 best days missed50 best days missedDaily returns for all 5,040 trading 2015PRIYL20Past 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. 2016 Morningstar. All rights reserved.

Morningstar Investment Services16Risk of Stock Market Loss Over Time1926–2015 Periods with gain Periods with lossOne-year returns50%27%073%5-year annualized returns50%14%0Each bar represents the average return for the preceding 5-year time period.86%15-year annualized returns50%0100%Each bar represents the average return for the preceding 15-year time 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. 2016 Morningstar. All rights reserved.

Morningstar Investment Services17Market-Timing RiskThe effects of missing the best month of annual returns 1970–201540% Return Annual return Annual return minus best month3020100–10–20Return if investedfor the whole yearReturn if the bestmonth is 102015PRIYL19Past 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. 2016 Morningstar. All rights reserved.

Morningstar Investment Services18Tune Out the NoiseThere’s a reason that investors tend to only hear about3 Look, but don’t stare.“looming” market doom or “imminent” market growth.While it’s important for investors to know theWhile many news outlets have incentive to drawperformance of their accounts, short-term market fluctuviewer attention with wildly bullish or bearish predictions, ations can be quite volatile. While the probability ofthese sensationalized views may be a distraction torealizing a loss within any given day is high, thea sound investment approach. When tempted to make alikelihood of realizing a loss historically has decreasedradical change to your investment portfolio basedover longer holding periods. Periodic review of anon these headlines, it is important to recall some basicinvestment portfolio is necessary, but investors shouldn’tfundamentals to keep your plan on track.let short-term swings affect their view of the future.3 Drown out the noise.Market movements are notoriously difficult topredict. The media outlets that scream the loudest arenot always the most accurate. The fallout fromattempting to time the market in response to one ofthese predictions can be dangerous to your portfolio.Holding a portfolio of securities for the long term does not ensure a profitable outcome, and investing in securities always involves risk of loss. 2016 Morningstar. All Rights Reserved.3 Stay focused on the long term.Investors who have taken the time to determinea sound investment plan based on specific goals andrisk tolerances are best advised to stick to that plan.While it may not always grab headlines, a sensible,tailored investment plan may be the best solution tomeeting long-term goals.

Retirement Challenges

Morningstar Investment Services20BittersweetProbability of a 65–Year-Old Living to Various Ages100%probabilityThe Merriam-Webster Dictionary defines bittersweet assomething that is pleasant alloyed with pain. This couldalso be associated with retirement. The sweet part is thatpeople are living longer thanks to innovations inhealthcare. The bitter reality is that when people livelonger they risk outliving their assets.MaleFemaleAt least one spouse788186758588Longevity risk is the possibility of outliving one’sretirement savings. While longevity is generally a goodthing, the risks associated with it are becoming a majorconcern for individuals entering retirement.9150Luckily, longevity risk can be managed through properplanning and products. To plan properly, consider whenyou would like to retire, the number of years youanticipate in retirement, and your desired income level.91939625065 age70758085Source: Annuity 2000 Mortality Tables—Transactions, Society of Actuaries, 1995–1996 Reports. 2016 Morningstar. All Rights Reserved.9095100

Morningstar Investment Services21Retirees Face Numerous RisksRetirees Face Numerous RisksLongevityLong retirement horizons—acouple aged 65 has 25% chanceof a survivor living to age 96WithdrawalsWhat rate is sustainable?Sequencing by tax bracketManaging RMDsRetiree spendingReplacement ratioEssential versus lifestyle expensesMedical expensesSolvencyPension plans and retireebenefits—a thing of the pastSocial Security and MedicareRetirement incomeMarket volatilityUncertain returns and incomeImpact of point in timeAsset allocation and locationSavingsUnder-funded definedcontribution accountsMost Americans have anenormous savings gapInflationErodes the value of savingsand reduces returnsHealth-care inflation 3.7% 2016 Morningstar. All Rights Reserved. 2014 Morningstar. All Rights Reserved.

Morningstar Investment Services22Quick Facts: Retirement3 According to Aon Hewitt’s “The Real Deal” 2012 study,an average full-career contributing employee needs 11.0times pay at age 65, after Social Security, to expectto have sufficient assets to last through retirement. Forexample, if your salary is 80,000, you will need tohave accumulated 880,000 by the time you’re 65 andready to retire.3 In reality, the same employee is expected to haveonly 8.8 times pay in resources at retirement, whichtranslates into a 2.2 times pay shortfall. To reuse theexample above, this means you’d be 176,000 short.3 Wells Fargo conducted a survey of 1,000 middle-classAmericans. The study shows that across middleclass members of all generations, only 24% are confidentin the stock market as a place to invest for retirement.The apprehension about the market is stronger for thoseage 25 to 29, with 56% expressing fear of losingtheir nest egg. When asked if given 5,000 for retirementwhere they would invest, 58% of those age 25to 29 said they would invest in a savings account/CD.3 Only 18% of workers are very confident they will haveenough money to live comfortably in retirement (according to the EBRI 2014 Retirement Confidence Survey).3 The 2013 Transamerica Retirement Survey found thatthe percentage of participants who have taken a loanfrom their 401(k) plan has increased from 16% in2008/2009 to 21% in 2012, then slightly decreasedto 17% in 2013.Sources: Aon Hewitt’s “The Real Deal: 2012 Retirement Income Adequacy at Large Companies.” “14th Annual Transamerica Retirement Survey of American Workers,” Transamerica Center for Retirement Studies, July 2013. Wells Fargonews release, “Middle Class Americans Face a Retirement Shutdown,” October 2013. 2016 Morningstar. All Rights Reserved.

Morningstar Investment Services23Retirement Income SourcesTimes are Changing: Sources of Retirement Income are ShiftingWorkers (expected)100%Retirees (actual)Concerns about shortfalls in traditional retirement incomesources like Social Security and pension plans havecaused people to expect to rely more heavily on personalsavings to fund their retirement.80The graph illustrates that while only 50% of currentretirees utilize their personal savings forretirement income, 65% of current workers anticipatepersonal savings to play a role during retirement.Further, 73% of workers expect to receive retirementincome from an employer-sponsored retirementsavin

1-year 3-year 5-year 10-year Municipal bonds High-yield bonds International bonds Aggregate bonds Large stocks Small stocks International stocks Emerging-market stocks % Return –10 00 10 –10 10 –100 01 0 –10 10 –0.7 3.3 –4.5 –5.0 0.8 1.4 –3.6 –0.4 –14.6 2.6 3.2 1.7 –2.6 1.0 15.1 12.9 5.5 –6.4 7.3 5.3 5.0 0.5 2.9 12.6 10 .

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