Category Archives: Asset Allocation

What does planning mean for you?

Financial planning is about more than assets, investments and net worth.  It’s about what you want to do with your money and why.  It’s about identifying your concerns, expectations and goals.  It’s about how you feel and what you want.

Financial planning helps address common fears and concerns such as health care costs, outliving your money and the best time to file for Social Security benefits.

The “Confidence Meter” helps you gauge how likely you are to reach your goals and whether you are on track instead of focusing on headlines.

Financial planning takes your risk tolerance into account.  You will get a “Risk Number” that guides you to the kind of investment you should have.

Learn more about how financial planning can help you by contacting us at Korving & Company today.

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What does “diversification” mean?

 

Diversification is key - Wealth Foundations

To many retail investors “diversification” means owning a collection of stocks, bonds, mutual funds or Exchange Traded Funds (ETFs).  But that’s really not what diversification is all about.

What’s the big deal about diversification anyhow?

Diversification means that you are spreading the risk of loss by putting your investment assets in several different categories of investments.  Examples include stocks, bonds, money market instruments, commodities, and real estate.  Within each of these categories you can slice even finer.  For example, stocks can be classified as large cap (big companies), mid cap (medium sized companies), small cap (smaller companies), domestic (U.S. companies), and foreign (non-U.S. companies).

And within each of these categories you can look for industry diversification.  Many people lost their savings in 2000 when the “Tech Bubble” burst because they owned too many technology-oriented stocks.  Others lost big when the real estate market crashed in late 2007 because they focused too much of their portfolio in bank stocks.

The idea behind owning a variety of asset classes is that different asset classes will go in different directions independent of each other.  Theoretically, if one goes down, another may go up or hold it’s value.  There is a term for this: “correlation.”  Investment assets that have a high correlation tend to move in the same direction, those with a low correlation do not.  These assumptions do not always hold true, but they are true often enough that proper diversification is a valuable tool to control risk.

Many investors believe that if they own a number of different mutual funds they are diversified.  They are, of course, more diversified than someone who owns only a single stock.  But many funds own the same stocks.  We have to look within the fund, to the things they own, and their investment styles, to find out if your funds are merely duplicates of each other or if you are properly diversified.

You need to look at a “portfolio x-ray” which will show you how much overlap there is between two or more mutual funds.

Only by looking at your portfolio with this view of diversification can you determine if you are diversified or if you have accidentally concentrated your portfolio without realizing it.

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Why Re-balance Portfolios?

The market rarely rings a bell when it’s time to buy or sell.  The time to buy is often the time when people are most afraid.  The time to sell is often when people are most optimistic about the market.  This was true in 2000 and 2009.

Rather than trying to guess or consult your crystal ball, portfolio re-balancing lets your portfolio tell you when to sell and when to buy.

You begin by creating a diversified portfolio that reflects your risk tolerance.  A “Moderate” investor, neither too aggressive or too conservative, may have a portfolio that contains 40 – 60% stocks and a corresponding ratio of bonds.

Checking your portfolio periodically will tell you when you begin to deviate from your chosen asset allocation.  During “Bull” markets your stock portfolio will begin to grow out of the range you have set for it, triggering a need to re-balance back to your preferred allocation.  During “Bear” markets your fixed income portfolio will grow out of its range.  Re-balancing at this point will cause you to add to the equity portion of your portfolio even as emotion urges you in the opposite direction.

If properly implemented and regularly applied, this will allow you to do what that old Wall Street sage tells you is the way to make money: “Buy Low and Sell High.”

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Diversification and Emerging Markets

A well-diversified portfolio typically includes emerging markets as one of its components.  “Emerging markets” is a generic term to identify those countries whose economies are developed, but still smaller than those of the world’s superpowers (i.e., USA, Europe, Japan).

To professional investors, a well-diversified portfolio includes many asset classes, not just the most obvious: U.S. Stocks (the S&P 500) and a U.S. bond fund.

The following illustration is a great illustration of the relative performance of some of the major asset classes.

callan-periodic-table-of-investment-returns

Here we have ten key indices ranked by performance over a 20-year period.  The best-performing index for each year is at the top of each column, and the worst is at the bottom.

It is natural for investors to want to own the stock, or the asset class that is currently “hot.”  It’s called the Bandwagon Effect and it’s one of the reasons that the average investor typically underperforms.  The top performer in any one year isn’t always the best performer the next year.

A successful investment strategy is to:

  • Maintain a portfolio diversified among asset classes,
  • Stick to an appropriate asset allocation for your particular goals and objectives,
  • Rebalance your portfolio once or twice a year to keep your asset allocation in line, essentially forcing you to sell what’s become expensive and buy what’s become cheap.

In other words, re-balance your portfolio regularly and you will benefit from the fact that some assets become cheap and provide buying opportunities and some become expensive and we should take some profits.

Which brings us to emerging markets, which have been a drag on the performance of diversified portfolios for several years.

“It was a summer of love for investment in emerging markets,” according to the latest MSCI Research Spotlight.  For example, Brazil, Taiwan, South Africa and India have all been big winners, MSCI said.

The MSCI Emerging Markets Index ended August up for the year 15 percent compared to a loss of 20 percent the prior year.

“We are seeing very strong performance,” Martin Small, head of U.S. i-Shares BlackRock, told the conference.

Emerging market equities “have outperformed the S&P so far this year by more than 800 basis points and the broader universe of developed markets by almost 1,000 basis points,” according to the October BlackRock report, “Is the Rally in Emerging Markets Sustainable?” The report said EM outperformance “is likely to continue into 2017.”

For investors who have included emerging markets in their portfolios, their patience and discipline is being rewarded this year.  For those who want to have a portfolio that’s properly diversified but don’t have the expertise to do it themselves, give us a call.

 

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Single Women and Investing

Women are in charge of more than half of the investable assets in this country.  A recent Business Insider article claims that women now control 51% of U.S. wealth worth $14 trillion, a number that’s expected to grow to $22 trillion by 2020.

Single women, whether divorced, widowed, or never married, have been a significant part of our clientele since our founding.  Widows that come to us appreciate that we listen and take time to educate them, especially if their spouses managed the family finances.  Once their initial concerns are alleviated they’re often terrific investors because they are able to take a long-term view and don’t let short-term issues rattle them very much.

Unfortunately, we have had women complain to us that other advisors that they’ve had in the past did not want to discuss the details of their investments and the strategy employed. Other women have come to us with portfolios that were devastated by inadequate diversification.

Our female clients are intelligent adults who hire us to do our best for them so that they can focus on the things that are important to them.  We are always happy to get into as much detail on their portfolios as they require.  Our focus on education, communication, diversification and risk control has led to a large and growing core of women investors, many of whom have been with us for decades.

Our book, BEFORE I GO, and the accompanying BEFORE I GO WORKBOOK, is a must-have for women who are with a spouse that handles the family finances.  Men who have always handled the family finances should also grab a copy and fill out the workbook.  If something were to happen to them, it would be a tremendous relief to their spouse to have such a resource when taking over the financial duties.  The first three chapters of our book are available free on our website.

We welcome your inquiries.

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Are fees really the enemy?

The popular press puts a great deal of emphasis on the costs and expenses of mutual funds and investment advice. I am price conscious and shop around for many things. All things being equal, I prefer to pay less rather than more. However, all things are rarely equal. Hamburger is not steak. A Cadillac is not the same as a used Yugo.

The disadvantage facing most investors is that today’s investment market is not your father’s market. Those words are not even mine; they come from a doctor I was speaking to recently who uses an investment firm to manage his money. His portfolio represents his retirement, and it is very important to him. He knows his limitations and knows when to consult a professional. It’s not that he isn’t smart; it’s that he’s smart enough to realize that he doesn’t have the expertise or the time to do the job as well as an investment professional.

As Registered Investment Advisors, we are fiduciaries; we have the legal responsibility to abide by the prudence rule (as opposed to brokers, who only have to abide by a suitability rule). Some interpret our responsibility as meaning that we should choose investments that cost as little as possible, going for the cheapest option. But do you always purchase something exclusively on the lowest cost without taking features, quality, or your personal preferences into consideration?

As I drive to work each day, I pass an auto dealership featuring a new car with a price tag of $9,999 prominently displayed. I’m never tempted to stop in and buy this car, despite its low price. It does not meet my needs nor does it have the features that I’m looking for in a new car. Why would an investment be any different? Too many investors believe that there is no difference between various stocks, mutual funds or investment advisors. They focus exclusively on price and ignore risk, diversification, asset allocation and quality. People who go to great lengths to check out the features on the cars they buy often don’t know what’s in the mutual funds they own. Yet these are the things that often determine how well they will live in retirement. It’s this knowledge that professional investment managers bring to the table.

People who would never diagnose their own illness or write their own will are too often persuaded to roll the dice on their retirement. Don’t make that same mistake with your investments.

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The Folly of Trying to Time the Market (Illustrated)

The problems of market timing came vividly to our attention recently. We were shown the portfolio of someone that was actively involved with their investments and reads a lot about investing strategies. This person managed their retirement portfolio quite actively, often making substantial changes to their account. When the stock market began to drop in August, they watched the value of their account decline. (See chart below)

spx

This person had about 80% of their account in stock funds up until Friday, August 21st. On that day the decline got to him and he sold all the stock funds. It turns out that this person sold out of stocks within two trading days of the market bottom. By the time they came to see us, their account was mostly in bonds.

Referring again to the chart, notice that as of October 28th the market actually had a positive return year to date. By trying to time the market, this investor locked in a loss and was wondering what to do now.

This investor made two mistakes. First, they thought they could time that market and get out when things were bad and buy back in when things were better. Timing the market is a term that is used when people buy or sell based on market gyrations, often trying to get in when they think it’s at a low point and get out when they think it’s at a high point. Some people get lucky and may do it once or twice but it’s simply not possible to do this consistently. The second mistake was that they had created portfolios that were out of line with their personal risk tolerance – they started out much too heavily in stocks and then swung too far in a conservative direction when the stock market went down and is now too heavily invested in bonds.

Most people will look at the value of their investments only occasionally. Some will do it daily; it is like a game to them. It’s also counter-productive. The secret to long-term investing success is to create a portfolio that is properly aligned with your personal risk tolerance and financial goals, so that you don’t have to get concerned with every market move. .

Not every stock market recovery is as V-shaped as the one illustrated in this chart. However, it’s a great illustration of the opportunities that are missed by trying to guess short term market moves. We believe in prudent investing for the long term and design portfolios that reflect the risk tolerance of our clients. If you are interested in a free consultation of your portfolio, contact us.

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Want a Short Term Market Forecast?

John Kenneth Galbraith is quoted as saying that “The function of economic forecasting is to make astrology look respectable.”

One of the most common questions that we are asked at social functions when people find out that we are in the investment business is “where’s the market headed from here?” It’s an important question, but in the short-term the answer is unknowable.

Barron’s Magazine created a graph that tracked the average of Wall Street’s top strategist’s prediction for the past 15 years versus the actual return for the market. The strategists got it wrong every year. That’s why we really don’t react to the talking heads on the cable news shows and the forecasts in newspapers and magazines. We are not paid to make short-term predictions, we are paid to get our clients a fair return on their money and to avoid major losses that could lead to financial ruin.

Investment decisions are made based on factors that we know. Things such as our clients’ time horizon; the amount of money they have to invest, their tolerance for risk, and their income sources. Then we make sure we are properly diversified. Knowing what you don’t know is as important as knowing what you do know. Guessing is not a strategy and we have no interest in making astrology look respectable.

If you want more information on Korving & Company click HERE.  To read the first three chapters of our book BEFORE I GO click HERE.

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Reading the Tea Leaves

We are not big fans of fortune tellers, preferring to stick with what we can observe in the here and now. The here and now tells us that the American economy is getting better slowly and sluggishly, trending upward, something we refer to as the “Plow Horse Economy.”

We do, however, pay attention to what others are saying and if it sounds reasonable, we’ll share it.

Tony Crescenzi of PIMCO has made some points that seem reasonable and in line with our observations. Discussing the market’s reaction to the Fed’s non-move, he says:

“Investment implications and lessons for investors from this year’s tumult in the global financial markets: Rates are likely to stay low for longer … the Federal Reserve has demonstrated that it is likely to take a very gradual and cautious approach to its normalization of interest rates. Policy rates, globally, are likely to stay low through the rest of the decade, supporting equity and credit markets, as well as real assets.

Volatility will result from the unwinding of crisis-era policies…

Economic growth, rather than liquidity, is needed more than ever to bolster asset prices… investors are likely to focus …on economic growth and company cash flows when making investment decisions.”

Of course we think that economic growth, cash flows and profitability should always be the real basis for making investment decisions, and that a change in Federal Reserve policy (especially if it is as gradual as we anticipate) will have very little impact on these fundamental factors.

We received a call from a client the other day asking if we had a secret formula for coping with the recent market decline. We replied our formula was not secret at all. We adhere to our asset allocation strategy, which puts “shock absorbers” on the portfolios during times of market volatility. This means that our objective is to go through market declines with smaller losses than the overall market. While that strategy means that most of the time our portfolios won’t go up as fast or as far as the stock market during good times, it also means that during times when the markets are heading in the wrong direction our portfolios should outperform the stock market and we won’t have as much ground to make up when it begins to recover.

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On Recent Market Volatility. An Open Letter to Our Clients.

And you thought we saw volatility last Thursday and Friday?…

It is normal to for you to wonder how all of this volatility affects your wealth.  As we are hearing it, China seems to be the straw that broke the camel’s market’s back.  Other forces added to the weight, including uncertainty over the timing of the Fed raising interest rates and the Greek debacle.  However, we do not think that any of these things are cause for long-term concern regarding your portfolios.  If you are feeling some stress because of the recent market volatility, remember:

Stock markets are supposed to go up and down

There have been over a dozen market pullbacks of at least 5% since March 2009, so this isn’t unprecedented.  We all realize that stocks are inherently volatile investments, and we must accept the fact in order to earn the expected higher long-term returns.  You have all undoubtedly heard us preach asset allocation and the importance of having a long-term, strategic view.  Your portfolio is invested in a model based on your unique financial and personal circumstances.  It is important to take the long view and realize that it is typical for bull markets to have corrections of 5% – 10%.

Market timing is a sucker’s game

None of us has a crystal ball.  Not even the traders and speculators on TV that want you to think that they do.  Luckily, you do not need a crystal ball to be a successful investor.  In times like these, it is best to keep your cool and stay invested.  Studies consistently show that missing just a few days of strong returns can affect your performance dramatically.  It is important to stay disciplined and not make short-term trading decisions based on fear and emotion.

Your portfolios are properly diversified

This is our most important point.  As we mentioned, we have invested your money in an appropriate allocation for you, so those investments that have not done as well as the stock indices the past couple of years (looking at you, bonds) should help cushion the blow from this market correction.  That is exactly why they are in there.  Having a mix of different types of investments is like having shocks and struts on your car – these things provide a smoother and more stable ride for your portfolio.  When the stock markets are going great, these other investments do cause drag, but we do not invest to beat an arbitrary benchmark, rather we invest to help you achieve your financial goals with the least amount of risk possible.

The things that are causing this correction are just noise

China is slowing.  So what?  To say that their growth rate is slowing is admitting that they are still growing, just at a slower pace.  Did anyone really expect them to grow at 20% per year forever?  Moreover, if you look at it from a numbers perspective, exports to China only account for 0.7% of U.S. GDP.

The Yuan is falling.  Just a few months ago weren’t the talking heads lamenting the thought of the Chinese yuan as the world’s new reserve currency?  Now that talking heads who brought you that idea are being proven wrong, they want you to believe that this is supposed to be bad, too?  Which is it that we are supposed to fear again?  We wrote a blog piece about this last week, so we won’t go into great detail rehashing it here, but our general reaction is, again: So what?

The Fed is going to raise interest rates. (Eventually.)  It was not that long ago that tapering was supposed to bring financial ruin to us all…  Look, we all know that the Fed is eventually going to raise rates.  We can argue about the timing, but whenever it finally happens and the federal funds rate increases by 0.25%, does anyone really think that will keep Apple from introducing the latest re-iteration of their products?  Or keep anyone from buying them?

We realize that we have been having some fun with things that may cause some of you serious concern.  What we do not take lightly as your advisors and financial fiduciaries is the amount of concern and care we place on your financial well-being.  In times like these, it is important to stay calm and avoid making hasty decisions that could harm you financially.  We will continue to monitor your portfolios with vigilance, and as always, please do not hesitate to contact us if you have any questions or concerns.

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