Investment management
If you listen to what so-called experts on TV, radio, and in the press say, you will probably hear a substantial amount of conflicting and, perhaps, confusing information about what you should do as an investor. One person tells you that the stock market is poised to double in the next few years, while another warns of an impending long-term bear market. What are you to believe?
The best thing you can do is to stop listening to predictions (or making predictions yourself) and to use what has worked in investing over the long history of the financial markets.
The following summarizes our philosophy about investing. In implementing this philosophy with our clients, we hope to provide them with a distinct advantage over most investors who “do it themselves.”
WE BELIEVE THAT INVESTORS CAN BE THEIR OWN WORST ENEMIES.You’ve probably heard the advice “buy low, sell high.” Unfortunately, many investors let their emotions get in the way of making well-informed, logical investment decisions. For one thing, many investors chase after “hot” mutual funds or stocks, investing in them well after they’ve already run their course (and when their prices are at, or near, their high points). This “buying high and selling low” approach has a significant adverse impact on the performance of a portfolio.
Many investors are also their worst enemies because they are overconfident. These investors trade (buy and sell) their investments more often, because they think they’re right. However, at least one study has shown that such overconfidence hurts the performance of a portfolio.
Finally, investors tend to hold on to their losing investments and sell their winners. The losers that investors hold on to generally go on to underperform the stocks that were sold.
WE AGREE THAT ASSET ALLOCATION HAS, BY FAR, THE LARGEST IMPACT ON THE PERFORMANCE OF A PORTFOLIO. Many professional money managers and other investors spend a large part of their investment decision-making time on which specific stocks, bonds, or mutual funds to buy or sell. However, a landmark study concluded that more than 90% of the return of a portfolio is due to how it is allocated among asset classes. In other words, your investment returns are dominated by how your portfolio is allocated, rather than by which specific investments you hold.
The primary points about asset allocation are:
- We can achieve greater expected returns AND lower investment risk (the volatility of a portfolio) via a well thought-out asset-allocation strategy, compared to a less comprehensive approach;
- It is best to allocate investments among a variety of asset classes based on the client’s risk tolerance, goals, and life factors;
- We include asset classes whose historical performances are not highly correlated with one another;
- Our goal is to stick to a desired allocation through thick and thin; our objectivity prohibits emotions, or current market situations, from changing an allocation strategy;
- We periodically determine if a client’s desired allocation should be revised based on changes in life factors, goals, and risk tolerance;
- There is no single “optimal” asset allocation. Each investor has his or her own risk tolerance, goals, and life circumstances that dictate the weightings of each asset class. Our advisors consult extensively with clients to help determine an appropriate mix.
WE WORK DILIGENTLY TO REDUCE THE COSTS OF INVESTING, BECAUSE COSTS HAVE A SIGNIFICANT IMPACT ON THE LONG-TERM PERFORMANCE OF A PORTFOLIO. A recent study by a well-known and highly-respected investment research and rating firm found that costs are a critical determinant in the performance of mutual funds. In other words, mutual funds with lower-than-average expense ratios tend to outperform funds with higher-than-average expense ratios. This advantage can be expected to be more prevalent over longer periods.
Other costs, besides internal expenses, can have an adverse impact on the performance of a mutual fund investment. For example, investors in “load” funds incur up-front, ongoing, or deferred sales charges that reduce the overall return on the investment. “No load” mutual funds – those with no sales charges – allow all of an investor’s initial investment to go to work for him or her. All else being equal, that can provide a significant advantage.
Costs of buying and selling individual stocks – primarily commissions and bid/ask spreads – reduce an investor’s overall return, especially if the investor trades frequently. At least one study has shown that frequent traders underperform those who trade less frequently, and trading costs are very likely one of the primary reasons for this difference.
WE KNOW THAT NO ONE CAN CONSISTENTLY OUTPERFORM, OR TIME, THE STOCK MARKET. The key word here is “consistently.” Sure, some professional money managers and individual investors outperform the stock market now and then, or on a short-term basis. Some people even get lucky and accurately guess what the market will do over a short period of time. Don’t be fooled into thinking that any such short-term “success” translates into long-term success. For example, over longer periods, a mutual fund’s performance tends to revert to the performance of the overall market.
The tendency of investors to be influenced by the recent success of a specific mutual fund or asset class results in many people chasing “hot” funds or classes and bailing out of recent poor performers. This is completely contrary to a disciplined asset-allocation strategy, where periodic rebalancing takes the emotion out of investing.
ALTHOUGH INCOME TAXES ARE IMPORTANT, THEY SHOULD NOT BE THE PRIMARY CONSIDERATION WHEN MAKING AN INVESTMENT DECISION.Oftentimes, investors hold on to investments simply to avoid, or postpone, paying capital gains tax. While tax implications should be ONE factor that is considered when determining whether to sell an investment, other very important factors should be taken into account. We also consider: Are you properly diversified? Is an investment perhaps significantly overvalued? Does the client need additional cash to implement other more important financial planning objectives? We weigh all these factors, plus others – along with tax implications – when making an investment-selling decision.
With capital gains tax rates currently at historical lows, and with the realistic possibility that these rates will be increased within the next few years, now is as good a time as any to evaluate your portfolio and determine whether it makes sense to eliminate, or reduce, any of your investments.
