Cornerstone

It's Important To Be Educated

Overview: If the majority of investors understood the true benefits of a buy-and-hold strategy, some of the thousands of trades placed each day would likely not be made. Likewise, some of the products that thrive on being complex would see a not-surprising decline in popularity — if investors knew about their many disadvantages. The following are some key investing principles that investors should know.

 

 

The Importance of Education

It is our desire and intent to educate clients about how capital markets work and to provide them with the information necessary for their financial well-being.

 

The advice to invest in passively managed funds is significantly different from the advice of most investment advisor firms, and it also is different from the strategy followed by the typical individual investor. Therefore, we feel it is extremely important to be aware of the academic research demonstrating that markets are generally highly efficient.

 

Studies have shown that it is highly unlikely investors will be able to exploit market inefficiencies after accounting for the expenses of the effort. It is essential to know how a well-diversified portfolio can help manage risk, a message that often bears repeating as asset classes come in and out of favor over time. The same sentiment applies to understanding how attempts to time the market — either in terms of individual securities or asset classes — typically lead to realizing lower returns than those available from a buy, hold and rebalance strategy.

 

Because our investment approach is different from the average investment advisor, it is crucial for you to understand why we recommend it. Put simply, knowledge is the key to discipline. For example, in the late 1990s, when the growth asset class outperformed the value asset class, it became tempting to pour everything into that single asset class. Those who do not possess a basic understanding of passive investing are more likely to quickly become dissatisfied when their portfolio underperforms the latest hot asset class.

 

Essential Investment Education

What is the minimum basic knowledge needed to remain a disciplined passive investor? We believe the following five concepts form a strong foundation from which to build.

 

Point 1: Markets Are Efficient

Public information is of little fundamental value. New information is so quickly incorporated into asset prices that use of this knowledge cannot be expected to consistently yield superior risk-adjusted returns. Information that is not public is also of no value, since it is illegal to trade on it.

Point 2: Risk and Expected Reward Are Related

Investors who expect or need to achieve higher returns must accept the associated risk. The benefits of diversification are the only “free lunch” of investing. Restated, equity-like returns do not come without commensurate risks.

Point 3: Diversification Works

Global diversification across a variety of imperfectly correlated asset classes is the most effective way to reduce risk. (Correlation is how similarly different investments perform. The higher the correlation, the more similar the performance and thus the lower the diversification.)

 

Diversification is always working, whether we’re pleased with the immediate results. Diversification should be thought of as the equivalent of buying insurance against having all of one’s investment eggs in the wrong basket. From 2000 through 2002, those who had placed all of their eggs in the large-cap growth basket learned a painful lesson about the value of diversification.
 

Point 4: Markets Are Unpredictable in the Short Run and Even in the Long Run

In the short (or even long) run, anything is possible. In the long run, we expect that equity markets will rise more than fall. Individuals who correctly predict short-term market movements should likely attribute their results to luck rather than skill.

Point 5: Discipline Is Key to Successful Investing

For far too many investors, the variable that ultimately determines the results of their portfolio is not investment returns but investor behavior. Emotions can lead investors to make poor decisions at the wrong times. It is easy to remain disciplined during bull markets. However, it is far more important to do so in bear markets to avoid the far-too-human propensity to sell at market bottoms. Thus, the role that emotion plays in the success of an investment strategy cannot be overemphasized. Education is key to ignoring one’s emotional reactions and staying the course.

 

Summary

If you understand the above concepts, you will be well ahead of the majority of the investing public. No matter where your plan goes, we will continue to place importance on evaluating risk tolerance, building a globally diversified portfolio and implementing regular, disciplined rebalancing techniques. Having such knowledge changes the way you approach investing.

 

This material is derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice.

Finishing Strong

As you watch the 2006 Winter Olympics, you may note how the athletes make their sport look so easy.  We know, however, that much strategy and effort is involved in the competition.  In cross-country skiing for example, the athletes have to plan their warm-ups to avoid injury, choose the correct ski equipment and wax, and plan how much energy they will expend on the different parts of the course.  The athletes do this in order to have a solid race, and to finish strong.

This same principle of strategizing pertains to financial planning for you and your family’s future.  If your family lacks a strategic financial plan, you and your family will miss out on “Finishing Strong.”  Finishing Strong encompasses the following life goals for people and their families:

• Adequate Insurance Coverage:  Making sure that a premature death or disability of a breadwinner or spouse does not compromise a family’s desire to continue living in their home, does not compromise a family’s college education plans and does not compromise a family’s business due to a forced sale at an unfavorable price.

• Education Savings:  Making sure the family secures the very best education they can qualify for without incurring unplanned debt for themselves or their children and/or grandchildren.

• Retirement Planning:  Making sure the family secures a retirement plan to be used on their own time and terms and with a very high probability that they will never outlive their assets, even if one or both of the family partners live thirty years or more in retirement.

• Long Term Care Planning:  Making sure the family will never become a burden to their children, even if extended home health care or nursing home stays are required.

• Estate Planning:  Making sure the family wishes are fulfilled when it comes to leaving an ongoing legacy to future generations of the family or through a charitable legacy to the community.

• Estate Tax Planning:  Making sure the Federal and state taxation of assets held at death do not force the unplanned sale of assets to pay the estate tax.  This estate liability will be funded from planned capital resources or through insurance.

“Finishing Strong” by definition is a very personal statement of love and responsibility to one’s self and to one’s family.  It is not a zero sum game.  That is, everyone wins when a strategic financial plan is made, executed and monitored—there are no losers.  Finishing Strong provides the peace of mind in knowing that your future, and that of your family, is secure.

"Live Long and Prosper?"

I have a Hallmark Christmas tree ornament of a Star Trek shuttlecraft.  When I press a small button it speaks in Spock’s (Leonard Nimoy’s) voice saying, “Live Long and Prosper.”  After 30+ years in the financial advisory business, I’m beginning to wonder if that phrase is an oxymoron for most Americans.  Americans are living longer, but I question the prosper part, especially in the retirement years.  In fact, I believe the phrase should really be, “Live Long and Hope to Live Well.”  Most Americans have not planned for all the possible scenarios of living well, much less living with significant health issues.  Rather, retirement for most Americans appears to be pinned on false hope.

Hoping.  Hoping that they don’t outlive their money.  Hoping that they don’t die too soon or become disabled.  Hoping that neither spouse has a lingering long-term illness in their later years.  Hoping that they will not be a burden to their children and loved ones.  Hoping…hoping…hoping.

The remedy for false hope is action—decisive action to create a strategic financial, investment, and estate plan.  I know most people think they don’t need a plan, or that they can do it themselves.  Unfortunately, these same people do not realize that the odds are substantially against them.  Many think it cost-prohibitive to use a financial advisor.  In reality, the cost of not using a financial planner can be many times more expensive in the long run.  The process of strategic financial planning is entirely too important to leave to a do-it-yourself approach.  Why risk the results of your life’s work?

I like to weigh the cost and risk of not doing a particular action.  For example, if your furnace quit working, you would likely call a qualified (not a do-it-yourselfer) repairperson to fix it or replace it.  What’s the cost and risk of not calling a qualified repairperson?  No heat at a very inopportune time, or possibly death or serious injury due to carbon monoxide poisoning from an undiscovered crack in the unit.  Similarly, the cost of do-it-yourself financial planning or failing to have any plan in place can be enormous as compared to the cost of prudently implementing a financial plan with a financial advisor.  The peace of mind (and body) that comes from starting and working a strategic financial plan is liberating.  Know where you want to go, and enjoy the outcome.  "Live Long and Prosper!"

Proper Risk Management Doesn't Have to Cost a Ton of Money

I'm going to meet tomorrow with my son and my daughter-in-law regarding their financial planning and risk management planning issues.  You see, they are the proud parents of my six-month old grandson (of course, it goes without saying that my chest is bursting), and they need to consider a variety of matters affecting all new parents.  And that is, how to provide for the family should something happen to the breadwinner, in this case my son.

I have been thinking of a number of areas to cover with them, namely, life insurance for both dad and mom.  For dad, it's to protect the family's income, and for mom, its to protect the family's costs.  Mom obviously needs to replace dad's income generating ability.  Dad has to work, so who then will care for my grandson and at what cost.  Dad might need some funds to help with daycare, college, etc.  Since my son and daughter-in-law only need this insurance until my grandson (and maybe his future brothers/sisters) get out of college, I like to recommend 20-year and 30-year level term insurance policies guaranteed to the full term of the policy to cover these risks.  At a young age, these premiums are very affordable.

I also will review my son's disability policy that he has with his employer.  I'll see if it is adequate for their needs now.  I'll check for portability if he should leave this employer.  I'll examine the need to obtain his own policy.  Again, at this age these premiums are more affordable.

I know that all of us hate to think about risk management issues, but we can't afford not to, since your family's financial future is at stake.  It is imperative that you examine it thoroughly and then purchase only the insurance you need now and out into the very near future (i.e. 1-3 years out).  Otherwise, you'll have insurance that really doesn't meet your needs.