August 31, 2011
During times when the markets decline sharply, it may be easy to lose focus on the investment strategy that was established to attain your long-term financial goals. We want to help you stay focused. One of the ways we assist you is that we mange your portfolio to reduce risks that aren't worth taking and take risks when there is an expected future return for taking that risk. In this letter, we'd like to give you information on three risks we take in your portfolio...and why.
Risks Worth Taking
The first is an obvious one...equity risk. We invest in equities (stocks held through mutual funds) because over the long-term, we expect the return on stocks to be greater than other investments (i.e. gov't/corporate bonds). The portion of your portfolio that is in equities vs. bonds has been determined with you based on your own individual life circumstances and risk tolerances.
Within the equity portion of your portfolio there are two additional risks that we take. We call them risk premiums because they are risks that have an expected reward for taking on those risks.
The first is referred to as the size premium. In short, investments in small companies tend to outperform investments in large companies over the long-term. As such, if you looked at your portfolio divided between small cap and large cap, you would see a slight tilt toward your investment in small-cap.
The second is referred to as the price premium. This refers to the stocks book value compared to its market price. Companies can be classified as value stocks (those having a high book to market ratio) or growth stocks (those having a low book to market ratio). In short, investments in value companies tend to outperform investments in growth companies over the long-term. As such, if you looked at your portfolio divided between value and growth, you would see a slight tilt toward your investment in value stocks. We've talked about this in the past and shown statistics supporting this which usually are for the past 40-80 years. However we've had questions and comments like, "What is long-term?" or "but I don't have 40 years".
The graph below looks at different rolling periods from 1926 through 2010; comparing the results of investments in domestic small vs. large and value vs. growth. The results are impressive and lend weight to the fact that investors who had portfolios tilted toward small cap and value were compensated for taking on those additional risks...even for periods as short as 5 years.
 Risks Not Worth Taking
Individual stock risk...putting all your eggs in just a few stocks. The mutual funds and ETFs you own in aggregate hold between 10,000 and 14,000 stocks. Even if you held an Enron, AIG, or the like, it won't materially affect your portfolio. You own a portfolio that captures broad market returns while reducing uncompensated risk arising in individual stocks.
Timing the market...research shows that, as a group, even professional active managers underperform the market by the amount equivalent to their average fees and expenses. Those managers that are in the top performance for one period tend to not be among the top performers in subsequent periods.
We've taken into consideration your individual circumstances and utilized these world class strategies to design a portfolio that will help you achieve your financial goals. We help you make smart decisions...and avoid bad ones.
Please don't hesitate to call and discuss any changes that have occurred in your life. We are here to help you. If you have a friend, neighbor or relative that you think could use our help, please invite them to contact us. We would be happy to visit with them. |
