Welcome to the Brighton Bulletin! Each month I cover 3 to 4 financial topics which I think may be of interest to readers. This month focuses on my portfolio management style which I believe is unique, teaching children about money management (without them knowing it!) and planning for college financial aid.
I welcome comments, questions and suggestions for future topics. Don't forget to check out our website at www.brightonfinancial.com - it contains a wealth of information on financial topics - under the "Information" tab, and www.brightonperspective.com - my blog, where I post on items of interest several times a week.
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How I Manage Portfolios.
Objective: Protect against loss and beat inflation
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Traditional asset allocation focuses on building a portfolio which
maximizes expected return while minimizing risk associated with that
return expectation. Asset classes are typically limited to equity and
fixed income and within each asset class, strategies are defined by
nine style categories. Investors build their asset allocation by
selecting strategies from these categories and assigning portfolio
weights which aggregate to the overall equity and fixed income
portfolio weights. For example, the overall target allocations may be
60% equity and 40% fixed income. Within equities, the allocation could
be 50% domestic large cap, 25% domestic small cap and 25%
international. Within fixed income, the allocation could be 50% core
fixed income, 30% foreign fixed income, 10% high yield and 10%
short-term fixed income. Implementation is achieved using a variety of
vehicles such as open-end, closed-end and exchange-traded mutual funds.
Rebalancing is done periodically to bring allocations back to the
target allocations. The process is straight-forward, easy to understand
but does have drawbacks. The primary drawback is common exposures
increase the correlations among the holdings leading to portfolio which
are frequently less diversified than owners may believe. Secondary
considerations are rebalancing frequency and costs.
Core/satellite
asset allocation is an alternative to the traditional approach to asset
allocation. This approach assigns strategies to either the "Core"
component of the portfolio or to the "Satellite" component of the
portfolio. The core component of the portfolio is often low volatility,
passively managed strategies. These strategies are intended to anchor
the portfolio and are traded infrequently. The core often comprises 60%
to 70% of total assets. The satellite component of the portfolio is
often comprised of higher volatility, higher expected return strategies
and is rebalanced more frequently in an attempt to take advantage of
investor insights or expectations for strategy out-performance. This
approach has become popular because it has the potential to reduce
portfolio volatility without reducing potential return and is typically
very cost efficient. Variants on core/satellite include anchoring the
core with lower volatility, active strategies and including alternative
strategies.
My investment management process involves implementing
a core/satellite portfolio. The core component typically consists of
lower volatility strategies, often employing hedging techniques. The
core will have equity and fixed income exposure and is rebalanced
strategically, that is, infrequently. Reasons for rebalancing can
include manager or firm turnover, change in management style, and poor
absolute and relative performance. The satellite component consists of
higher volatility strategies with higher expected return potential.
This component is rebalanced tactically, that is, frequently. Reasons
for rebalancing include changing underlying fundamentals, trailing
total return meeting or exceeding expectations, and better potential
return opportunities elsewhere. The typical portfolio has 10-12
positions, including cash, of which 7 to 9 are core and 3 to 5 are
satellite positions. The intent with both components is to construct a
portfolio of holdings with poor correlations. Hedged strategies and
long/short strategies fit very well in this context. Satellite
strategies tend to be very specific - a single sector, country, type of
security, etc.
Consistent with core/satellite theory, I use
open-end, closed-end and exchange-traded funds for implementation,
leaning toward open-end for most of the portfolio because they
typically offer better liquidity, transparency and fees. As the ETF
universe continues to expand, I fully anticipate using these vehicles
more frequently as well. Unless you're highly tolerant of volatility
and are focused exclusively on maximizing your potential return, give
this approach some thought. A well constructed core/satellite portfolio
can provide potentially lower volatility and lower expenses without
sacrificing expected return.
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Teach Your Children Well
Basic Financial Education
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If your children are like most, they fully understand the value of
money as a means to get what they want but have little understanding that your
money supply isn't infinite. Start early educating children regarding finances -
earning, spending and saving money. The earlier they grasp the basic concepts
the more responsible they're likely to be with their money. This is
particularly valuable when the go off to college! The college years are
critical to the establishment of good credit and to post-college financial
independence. Poor money management during the college years can leave your
college grad saddled with poor credit and heavy credit card debt which can negatively
impact their job search (prospective employers frequently check credit reports
of job applicants) and quality of life. There's nothing worse for new college
grads than seeing their entire paycheck going to pay their credit card bill.
Giving children allowances is a good way to begin teaching them
how to save money and budget for the things they want. How much you give them
depends in part on what you expect them to buy with it and how much you want
them to save. Some parents expect children to earn their allowance by doing household
chores, while others attach no strings to the purse and expect children to
pitch in simply because they live in the household. A compromise might be to
give children small allowances coupled with opportunities to earn extra money
by doing chores that fall outside their normal household responsibilities. When
it comes to giving children allowances:
- Set parameters. Discuss with your children what they may use
the money for and how much should be saved.
- Make allowance day a routine, like payday. Give the same amount
on the same day each week.
- Consider "raises" for children who manage money
well.
Television commercials and peer pressure constantly tempt children
to spend money. But children need guidance when it comes to making good buying
decisions. Teach children how to compare items by price and quality.
For "big-ticket" items, suggest that they might put the items
on a birthday or holiday list. Don't be afraid to let children make mistakes.
If a toy breaks soon after it's purchased, or doesn't turn out to be as much
fun as seen on TV, eventually children will learn to make good choices even
when you're not there to give them advice.
Teenagers should be ready to focus on saving for larger goals
(e.g., a new computer or a car) and longer-term goals
(e.g., college, an apartment). And while bank accounts may still
be the primary savings vehicles for them, you might
also want to consider introducing your teenagers to the principles
of investing. To do this, open investment accounts for them. (If they're
minors, these must be custodial accounts.) Look for accounts that can be opened
with low initial contributions at institutions that supply educational materials
about basic investment terms and concepts. Helping older children learn about
topics such as risk tolerance, time horizons, market volatility, and asset diversification
may predispose them to take charge of their financial future.
If older children (especially those about to go off to college) are
responsible, consider getting them a credit card. Most major credit card
companies require an adult to cosign a credit card agreement before they will
issue a card to someone under the age of 18 (as of February 2010, the Credit
CARD Act of 2009 will generally require this for consumers under age 21). Ask
the credit card company for a low credit limit (e.g., $300) or a secured card.
This can help children learn to manage credit without getting into serious
debt. Also:
- Set limits on the card's use
- Make sure children understand the grace period, fee structure,
and how interest accrues on the unpaid balance
- Agree on how the bill will be paid, and what will happen
if the bill goes unpaid
- Make sure children understand how long it takes to pay off
a credit card balance if they only make minimum
payments
If putting a credit card in your child's hands is a scary thought,
you may want to start off with a prepaid spending card. A prepaid spending card
looks like a credit card, but functions more like a prepaid phone card. The
card can be loaded with a predetermined amount that you specify, and generally
may be used anywhere credit cards are accepted. Purchases are deducted from the
card's balance, and you can transfer more money to the card's balance whenever
necessary. Although there may be some fees associated with the card, no debt or
interest charges accrue; children can only spend what's loaded into the card. One
thing you might especially like about prepaid spending
cards is that they allow children to gradually get the hang of using
credit responsibly.
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If you find this bulletin informative and useful, please consider forwarding it to friends, family, acquaintances, you believe may also find it beneficial. I'm always happy to have new subscribers.
Please let me know if there is anything I can do for you.
Sincerely,
John P. Middleton, CFA, CAIA
Brighton Financial Planning, Inc.
john@brightonfinancial.com
908-892-5958
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Financial Aid
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It's never too early to start planning for college. If college is still a number of years away, open a Section 529 account and add to the account annually. Ideally, by the time your child starts college you'll have at least 3 of the expected 4 years covered.
Parents of high school seniors will file the FAFSA (government financial aid application) in early January using their 2009 estimated tax data. So, if your child is entering
his/her Junior year of high school your first year financial aid will be determined using your calendar 2010 tax data. Thus, now is the time to get your ducks in row. For example, if you have UTMA or UGMA accounts for your child, consider moving them to custodial 529 accounts. This doesn't change ownership but does remove the accounts from the student assets reported on the FAFSA. This will help improve the possibility of receiving financial aid.
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