What should smart investors do?

Subprime woes, hedge fund collapses, market volatility

East Bay Business Times | September 14, 2007
By Hutch Ashoo & Christopher Snyder

smart investors

• Rise above the noise.

• Follow the five key concepts to investment success.

• Pay less in taxes, have lowers costs, pocket more money and have more confidence in achieving their goals.

As sure as the sun will rise and set tomorrow smart investors know that subprime woes, the real estate bubble popping, the Internet boom blowing up, the savings and loans debacle, hedge funds collapsing, derivatives and collateralized mortgage obligations plummeting, interest rates rising and the stock market collapsing are all but events that recur in some shape or form.

We don’t know what the next financial disaster will be, but we are sure there will be one.

So what is an investor to do? In our white paper titled The Informed Investor: Making Smart Decisions in Today’s Volatile Markets (at our Web site at www. pillaronline. com) we describe how to rise above the noise. We also describe the five key concepts to investment success. Rising above the noise details four investing quadrants.

The five key concepts discussed:

1. How we are poorly wired for investing. Emotions are powerful forces that cause you to do exactly the opposite of what you should do. Your emotions lead you to buy high and sell low. If you do that over a long period of time, you’ll cause serious damage to not just your portfolio, but more importantly, to your financial future.

2. How dissimilar price movement enhances returns. As a prudent investor you want less volatility not only because it helps you ride out the emotional curve, but more importantly, because you will create the wealth you need to reach your financial goals.

3. Why institutional-style investing can lead to better returns.
Here are the four parts of institutional-style investing:

  • According to Morningstar, the average annual expense ratio for all retail equity mutual funds is 1.54 percent. The same expense ratio for institutional asset class funds is typically only about a third of that. All other factors being equal, lower costs lead to higher rates of return.
  • Most money managers do a lot of trading, thinking that this adds value. The average retail money manager has a turnover ratio of 83 percent. This means that 83 percent of the securities in the portfolio are traded over a 12-month period. Each time a trade is made there are transaction costs, including commissions, spreads and market impact costs. These hidden costs may amount to more than a manager’s total operating expenses if the fund trades heavily, or if it invests in small company stocks for which trading costs are very high.
  • Lower turnover resulting in lower taxes. In one study, Stanford University economists John B. Shoven and Joel M. Dickson found that taxable distributions have a negative effect on the rate of return. They found that a high tax bracket investor who reinvested the after-tax distribution ended up with an accumulated wealth per dollar invested of only 45 percent of the published performance. Therefore, by lowering turnover you would expect to pay less in taxes and end up with more money in your pockets.
  • Consistently maintained market segments. Studies have shown that maintaining the correct market segment allocations within your portfolio can generate more than 90 percent of the return on your portfolio. Many retail managers are not bound to remain within particular market segments, effectively putting you at a huge disadvantage.

4. Global dissimilar market movements present opportunities we can take advantage of to reduce your portfolio volatility.

5. Most investors have inefficient portfolios. The process of developing a strategic portfolio using modern portfolio theory is mathematical in nature and can appear daunting. Rational and prudent investors will restrict their choices to efficient portfolios.

Wall Street wants to sell you its latest and greatest money managers or hedge funds while newspapers and magazines are in the business of increasing their circulation. As investors we must rise above the noise and follow the five key concepts to investment success.

Investing is about managing our returns and risk to maximize our ability to live and enjoy the one life we have to live. Don’t let Wall Street, your stock broker or newspapers and magazines dupe you into believing they have a silver bullet.

Authors Haitham “Hutch” Ashoo and Christopher Snyder are partners at Pillar Financial Services Inc. in Walnut Creek. Ashoo is founder, president and CEO. Reach them at PFS@PillarOnline.com or 925-356-6780.

 

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