How does The Newport Group determine the expected returns?
The Newport Group determines the expected return for a model portfolio by analyzing historical returns for each asset class and
by factoring in assumptions about the future long-term performance of the economy. These assumptions are based
on both macroeconomic and microeconomic variables, including GDP, inflation, projected growth rates and earnings surprises.
While many practitioners use long-term historical averages as a proxy for expectations, The Newport Group believes
that a thoughtful approach to generating forward-looking inputs creates a much higher-quality result.
The Newport Group’s approach is to use unbiased expected returns on fixed income (equal to today’s yields), while
utilizing a premium build-up approach for expected equity returns. This method uses the current yield of the 10-year
Treasury as the base or "risk-free" return and then adds a premium to the bond yield to reflect the compensation for
equity risk.
What asset classes does Quicken use? 
| Quicken uses the following asset classes: |
|
| Large Cap Stocks |
Stocks of US companies that have a market capitalization (the current value of a company: total outstanding shares multiplied by price per share) of $4.0 billion or more. |
|
| Small Cap Stocks |
Stocks of U.S. companies that have a market capitalization (the current value of a company: total outstanding shares multiplied by price per share) of under $4.0 billion. |
|
| International Stocks |
Publicly traded stocks of companies based in countries other than the U.S. |
|
| Domestic Bonds |
Government or corporate bonds issued in the U.S. |
|
| Cash (Money Market) |
Stable, short-term investments that provide income that rises and falls with short-term interest rates. |
|
| Other |
Investments that cannot be classified as any of the above. |
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What are the expected returns for each asset class?
|
|
|
| Asset Class | Expected Return |
| Large Cap Stocks | 8.95% |
| Small Cap Stocks | 10.03% |
| International Stocks | 7.52% |
| Cash (money market) | 3.00% |
| Bonds (U.S.) | 4.30% |
|
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| These are the sources of data that The Newport Group uses when analyzing historical returns:
|
|
| Large Cap Stocks |
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| Small Cap Stocks |
- 1926-2002 DFA 6-10 Small Cap Index
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| International Stocks |
- 1969-2002 Morgan Stanley EAFE Index
|
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| Domestic Bonds |
- 1952-2002 DFA Intermediate Govt. Fixed Income
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| Money Market |
- 1926-2002 1-month U.S. Treasury Bill
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Model portfolios reduce risk
The model portfolios were designed to reduce risk. The measure of risk The Newport Group uses is the standard deviation.
Standard deviation is an indicator of how much the rate of return varies from year to year.
As an example, consider the following hypothetical returns for two different securities:
|
|
2000 |
|
2001 |
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2002 |
|
Return |
|
Standard Deviation |
|
|
| Security 1 |
+ 5% |
+ 15% |
+ 10% |
+ 10% |
5 % |
| Security 2 |
– 10% |
+ 25% |
+ 15% |
+ 10% |
13 % |
The return for the two securities is the same, but because the return varied more for Security 2, its standard deviation is higher.
How does The Newport Group use the standard deviation to reduce risk?
Suppose two asset classes have high standard deviations, but one tends to perform well when the other tends to perform poorly.
That is, their performance is not highly correlated.
If these two classes are combined to form a portfolio, the standard deviation of the resulting portfolio will be less than the weighted average of the two individual standard deviations.
What are the historical standard deviations?
| Here are the standard deviations (from 1926 to 1999) for the asset classes Quicken uses:
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| Asset Class | Standard Deviation |
| Large Cap Stocks | 15.92% |
| Small Cap Stocks | 21.17% |
| International Stocks | 16.98% |
| Cash (money market) | 0.89% |
| Bonds (U.S.) | 6.02% |
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