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Investment Counseling Investment Analysis Together, we will complete a thorough review of your existing portfolio, evaluating its diversification, risk level — compared to appropriate benchmarks — and related expense factors. We will evaluate your current position in light of your stated goals, risk tolerance and time horizon. Asset Allocation/Portfolio Design and Portfolio Management Using proven portfolio management concepts, we will generate an investment plan tailored to your specific needs. A formal Investment Policy Statement defines all aspects of your portfolio design. Portfolios are based on historic market returns and risk measurements and are constructed for your particular situation. This process seeks to reduce taxes and investment expenses and to lower portfolio risk making it more likely that you will achieve financial success. Access to No-Load, Low Cost Institutional Class Mutual Funds As fee-only investment advisors, we can provide access to tax-efficient, low cost institutional class funds that are unavailable to the general public. Because these funds are designed for large institutional investors, they charge low fees and involve no commissions or loads. The Market and You Time Horizon The primary factor affecting your investment decision is your time horizon — the amount of time that you reasonably expect to have your funds invested. Time impacts cash/cash equivalents, bonds (fixed income), and stocks (equities) in different ways. Cash equivalents (e.g., money market accounts or Certificates of Deposit) pose little risk to principal, but may suffer tremendous erosion from the effects of inflation. Bonds react inversely to changes in interest rates, losing value as rates rise. Equities must be considered as long-term investments. Because of their short-term volatility, investing in stocks for periods of less than five years carries a significant risk of loss of principal. Determining a reasonable time horizon for your portfolio will provide a starting point for the division of assets among these major classes of investments. Asset Allocation A number of academic studies have concluded that the bulk of a portfolio’s return is determined by simple asset allocation — dividing the portfolio into a selected percentage of stocks, bonds, and cash. Over longer periods of time, stocks behave like stocks, bonds like bonds, and cash like cash. Actively managing a portfolio through security selection and market timing increases related expenses but adds little to the total long-term return. In many if not most instances, security selection and market timing become detractors from return. Market Cycles All markets move in cycles that are impossible to predict. Many investors have been “betting” on a return of large growth stocks (pink squares) for many years. In the process, they have passed up significant returns elsewhere. The pattern is that there is no pattern. Academics refer to this as the “Random Walk”. The news that moves markets is, by definition, random. As a result, the associated returns will also be random.
Thoughtful asset allocation coupled with a plan for periodic rebalancing forces you to buy low and sell high. This keeps you focused on the portfolio results, not on individual investments. Prudent portfolio design combines assets with low or negative correlations increasing the chances that a “winner” will balance a “loser” in many if not most economic conditions. Unfortunately, most investors buy into rising markets, chasing last season’s hot returns. Buy the Market The largest part of any portfolio’s long-term return comes from the simplest investment decision that can be made: Buying the market! By focusing on market returns, you can reduce active management costs and improve tax efficiency. High-flying investments eventually come back to the market, frequently after most investors buy into them. Bottom-dwelling investments generally rise to market returns. Over time, each becomes priced to produce market return.
The only constant is cost — management fees,
trading expenses, etc. — which consistently reduces market returns. A one percent reduction in long-term cost
is equivalent to a one percent increase in return. While it may not seem like much of a
difference, one percent also represents roughly one tenth of the growth that
one might hope to achieve in a long-term equity investment. Historically, large company Be at Peace with Your Tolerance for Risk Many people experience great difficulty in coming to terms with their real ability to deal with investment risk. Risk comes in many forms but is not limited to market risk, purchasing power risk, interest rate risk, and even frame-of-reference risk. Market risk is the undiversifiable, systematic risk inherent in each and every equity investment — the tendency of an investment to be influenced by the market as a whole. Purchasing power risk is the uncertainty that future inflation will erode the purchasing power of assets and income, while interest rate risk is that risk associated with reinvesting earnings on principal at a lower rate than was initially earned. These last two are typical of fixed income investments. In the latter case, frame-of-reference risk, imagine an American investor who may have experienced disappointment with his portfolio’s return that averaged 7% over the last half of the 90’s. On the other side of the globe, a Japanese investor would probably have been thrilled with those results…it’s all a matter of one’s perspective. While this may be easily dismissed, some investors with truly diversified portfolios can realize difficulty in relating their results to reporting in the financial media as well as to the experiences of their friends and family. While CNBC may be discussing a recent crater in the S&P500, or one’s golf buddies are talking about their recent killing in the tech sector, the diversified investor will be left to wonder how, exactly, he has fared over the same time period. It’s unlikely that we’ll ever see media coverage of steady, but unspectacular growth in natural resources, real estate or international markets that moderates portfolio volatility…that doesn’t make for splashy headlines. Investors must realize, however, that the long-term real (inflation-adjusted) growth of a portfolio relies on exposure to equities (stocks or mutual funds invested in stocks). By way of example, a continuing one dollar reinvestment in one-month Treasury Bills made in 1926 would have the purchasing power of $1.69 today. After taxes and trading expenses, the profit from this 75-year-long investment wouldn’t buy a Sunday newspaper. In comparison, the same one dollar invested in the S&P 500 over the same 75 years would have grown to an inflation-adjusted $207.77.
Portfolio Risk Management Your portfolio needs to be diversified to reduce risk (typically defined as volatility). However, not all diversification reduces risk. Investing in mutual funds that hold similar underlying securities or buying Certificates of Deposit from ten different banks provides little benefit in this regard. Effective portfolio risk management involves investing in a variety of markets where returns do not rise and fall in tandem (low correlation). By selecting markets carefully, you can reduce your portfolio’s level of risk without sacrificing overall returns. In practice, diversification represents a different course to what is most frequently a similar outcome, with one key difference — that course is a much smoother one. While this strategy virtually eliminates the likelihood of “hitting a home run” or “making a killing”, the chances of experiencing steady, positive growth are greatly magnified. We like to track the risk-adjusted returns of our investment choices. A wise investor will demand higher return in exchange for accepting higher risk. We all have acquaintances who have boasted about enormous returns during the late ‘90’s due to their heavy investment exposure to technology and American equities in general. The operative element is that they should have experienced this type of reward because of the additional risk that they shouldered by not being adequately diversified. This type of investor will, most likely, never be adequately compensated for assuming the risk associated with his or her large holdings in a small portion of the economy. Few of these people care to admit that their investments in the NASDAQ fell roughly 60% since the first quarter of 2000. Careful analysis of one’s risk tolerance and time horizon will suggest a portfolio allocation in harmony with long-term financial goals. Most importantly, the peace of mind associated with an appropriate strategy frees us from the gut-wrenching concern that often accompanies a less elegant solution. Most Common Mistakes of Investors
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