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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.

World history supports this as well. From the Panic of 1785 in the United States to the Post-Napoleonic depression in the 19th century and even the Latin American Debt Crisis in the late ’70s and early ’80s, financial crises are no strangers to investors or wealth managers.

While history does not necessarily repeat itself, it certainly rhymes. What do we mean by that? Well, we don’t know what the next financial disaster will be, but we are sure there will be one. Unfortunately, that is simply the reality. It is both normal and expected.

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 website 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. Although it can be a tough pill to swallow, you simply cannot let your emotions get in the way of your financial success thwarting your financial planning. Ultimately, holding onto your wealth is important and usually necessary to living the life you want.
  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. If there are such unpredictable and rapid changes, it can truly wreak havoc on both your financial management, aspirations and even your overall wealth.
  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. For this reason, you will want to make sure that you are maintaining the proper market segment allocations for your own portfolio.

  1. Global dissimilar market movements present opportunities we can take advantage of to reduce your portfolio volatility.
  2. 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, hedge funds and investment companies 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.

If you should take away something from this article, it is that your financial planning and aspirations will not succeed unless you take them seriously and employ a competent advisor.

If you have ever wondered, “Is there a financial advisor near me?” the answer is most likely yes. Whether you need to hire a new wealth manager or you are looking for your first one, there are many financial advisors in Tampa, Florida who are ready to take your investments to the next level.

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 925-356-6780.

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