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HBO has a popular series they air in the fall called “Hard Knocks.” The aim of the program is to uncover the intricacies and nuances that make the training camp of an NFL team so fascinating.  They pull the curtain back and give us a peek at the events that lends a revealing perspective to how the football preseason transpires.  In a similar vein, over the past few posts, we’ve given an insider’s view to our investment review process.  This week we profile the final steps involved in our individual portfolio analysis.

The Dreaded Check Engine Light

Check that Engine!

One of the more standard ways your car will alert you of a problem is by triggering the check engine light.  Usually once illuminated, the check engine light can be decoded by running a diagnostic test on the car.  When we first meet with clients, we’ll often hear the statement, “I want to make sure I’m doing all I can with my investments.”  By running our version of the diagnostic test each quarter, we spot tune-ups and efficiencies that otherwise may be missed.  Our checklist includes:

• Handling required minimum distributions
• Identifying opportunities to fund more tax advantaged accounts (Roth IRA’s, IRA’s or qualified plans)
• Verifying funds will be available for short-term cash needs
• Minimizing transaction fees
• Evaluating if a lower cost investment could fill the role of a current one
• Determining if any accounts can be transferred for cheaper or better investment options
• Considering if any other account openings or transfers would be beneficial (college planning accounts/life insurance/1035 exchanges/annuities)
• Keeping investment allocations in line with your risk capacity and our investment themes

Some of these items occur every year and some every quarter.  Staying on top of each one keeps your portfolio in good working order.

Photo Credit: Robert Couse-Baker

This is the third and final installment of our “Behind the Scenes” series.  It is our hope that this series gave our clients a more transparent look at our business so they can better understand the diligence we employ with each client review.

No one likes potholes.  Not only because of the annoyance they create, but also the added cost of getting your car realigned as a result. Often times, you may not hit anything major but your steering wheel begins to shake and your car starts to pull to the left after reaching 45mph.  This more subtle warning sign lets you know it’s time for an alignment to prevent extra wear and tear on your tires or even worse, a blow-out.

Watch Out For Potholes

Unfortunately, with an investment portfolio we don’t always hit a pothole or get a steering wheel shake to let us know it’s time for realignment.  In fact, when investors do begin seeing bad returns, it often leads them to make bad choices with their investments resulting in costly mistakes. We have become well aware of this natural human tendency which is why we rely heavily on our research themes.  By conducting our investment review process quarterly, we can review client portfolios and realign according to our research themes if necessary. During our analysis, we monitor how closely the client’s current investment mix matches our long-term investment strategy.  We also measure the level at which our clients’ stocks are positioned within the allocation ranges we establish during our initial planning work.  If the stock percentage is above or below the range, we know an adjustment should be made.

Mental Accounting

Many investors have a tendency to bucket their investment accounts.  They assign different purposes for their accounts which in turn require different investment strategies for each account.  For an investor to reach their optimal portfolio return, we feel it’s vital to have a coordinated investment strategy across all investment accounts.  Qualified plans give us the best example of this philosophy.  Many investment choices offered in 401k’s and 403b’s are limited compared to what you might be able to access in other accounts.  In a 401k, there may be a great international fund choice but only average domestic choices.  In this scenario, we may want to use the attractive international investment for all the funds in the 401k and surround it with more quality choices in other accounts where we have more investment selection.

I’ll Owe More in Taxes?!?

Don’t let the tax tail wag the investment dog.  In other words, there are times when heavy realized gains in a holding could lower the motivation to sell if you were strictly looking at the scenario from a tax perspective.  However, if this same security represented 75% of the portfolio and was comprised of one individual stock, the concentration risk would most likely outweigh the desire to hold on to the stock to avoid incurring a large capital gain.  Decisions such as these take careful evaluation and can only truly be assessed by taking the “big picture” into consideration.

Other Factors

Our investment review process allows us to assure our client’s portfolio is in good working order. To accomplish this, we also consider specific factors such as a client’s age, family relationships, tax considerations, risk levels, and the latest notes and communications with the client to assure we are not missing any potential improvements that could be made to their overall investment situation.  Our investment review process helps us take great care in assuring our client’s investment mix matches their risk preferences. Do you have a review process for your investments?

This is the second part of a 3-part series we’re calling “Behind the Scenes.” It is our hope that this series will give our clients a more transparent look at our business so they can better understand the diligence we employ with each client review.

On most days when people start their cars, they trust that by pressing the pedal, their car will run smoothly. They don’t have to think about the complicated mechanics of how the engine will power the car to their next destination every time the key is turned.  Many investors have a similar mindset when thinking about their portfolios.  They trust that a certain level of performance will be delivered, but they don’t want to spend a lot of time analyzing the detailed steps of how they will get there.

UNDER THE HOOD

In order for a car to stay in good working order, regular maintenance is required.  For investments, our routine maintenance checks occur regularly as we apply our review process to client portfolios on a quarterly basis.  If you popped the hood on our system, you would first notice the engine, our unique research process.  To keep this engine running at a high level, each member of our investment team spends time uncovering their own individual research in order to keep the bearings well-oiled.

We regularly conduct monthly meetings in which we discuss and debate our opinions to develop overarching economic themes and strategies.  These strategies are derived from multiple thought-provoking writers, money managers, and trusted economic researchers.  We also employ several statistical models of our own which are the basis for our estimate of the markets fair value.  After running through likely scenarios and or debunking biased theories, we craft our own strategic calls that we feel hold the most potential for future returns.  Several examples of questions we investigate while making these assumptions include:

• What is a healthy balance for splitting assets between US/Foreign holdings?
• Based on market valuations, which position should we be targeting in your allocation ranges?
• What specific sectors are likely to benefit going forward?
• How long of a maturity and what grade of quality should we be targeting with our bond holdings?
• Do large or small companies possess more potential return?
• Is any particular asset class over or undervalued?

AVOID IMITATIONS

When you encounter a maintenance issue with your car, there can often be ancillary problems that crop up if you try and make the fix with an imitation part.  To have the most confidence, you would prefer to replace with a part made by the manufacturer of the car for the best performance long-term.

The second leg of our unique research process is very similar as we are searching for specific funds to make a client’s portfolio run more efficiently. We run multiple screens in hopes of discovering quality funds that could potentially earn their way into our preferred fund rotation.  These funds go through a rigorous 18-point qualification test which helps us to judge if they deserve the right to be discussed in our Security Selection meetings.  These meetings, which also take place once a month, are where we peel the onion on funds we are considering for usage in our client portfolios.  We do our best to put a fund through the ringer, by evaluating everything from how the manager is compensated, to judging the culture of the mutual fund business.  Once a fund makes the initial cut, we try to find reasons why not to include it in our preferred list.  Several questions usually develop at this stage that gives us a reason to interview someone at the fund company.  Only after this type of meticulous analysis do we upgrade a fund to be used in our client portfolios.

This is the first part of a 3-part series we’re calling “Behind the Scenes.” It is our hope that this series will give our clients a more transparent look at our business so they can better understand the diligence we employ with each client review.

Watch out for scammers trying to take advantage of the current confusion on the new health care law.  They are banking on folks not knowing enough of the details in order to con them into buying bogus policies.  If you are contacted by anyone trying to sell you a health insurance policy by saying it is a requirement under the new health care law don’t believe them.  If possible, try to get them to provide contact information.  Call our office and we will relay that information to the appropriate authorities.

http://www.lifeandhealthinsurancenews.com/News/2010/4/Pages/Sebelius-Warns-Of-Health-Care-Reform-Scams-.aspx

In this issue of “Under the Hood” we reference an article written by Bob Veres and give some insight into our decision-making process when it comes to evaluating different mutual funds.  We also include an excerpt from an interview with one of our mutual fund managers.

HOW TO LOSE MONEY IN THE TOP-PERFORMING FUND

by Bob Veres

An article in the December 31st issue of the Wall Street Journal makes a point that many of us in the financial planning world have long suspected. It says that the CGM Focus fund was the top performing mutual fund, by far, over the past ten years, generating an annualized return of more than 18% a year since January 1, 2000.

Now here’s the punchline: the average investor in this top-performing fund lost an average of 11% a year over the same ten-year period.

How is it possible for investors to lose their shirts in a fund that posted outsized returns?

Most planning professionals know the fund’s manager, Ken Heebner, as a swing-for-the-fences investor, somebody prone to huge runups and equally scary drops.

A Chicago-based investment research firm called Morningstar – whose data is used by most financial advisors — calculated what is called the “dollar-weighted” return of the CGM Focus fund, which gives a picture of what investors in the fund actually experienced.

If you had bought and held Ken Heebner’s portfolio throughout the 2000s, you would indeed have received returns of 18% a year. But the fund was so up and down that investors were alternately panicked and selling out or optimistic and crowding back in.

The article says the most dramatic example came after the fund was up 80% in 2007. Investors flocked in, putting $2.6 billion into the CGM portfolio — just in time to catch its equally-dramatic 48% drop through the end of 2008.

There have been credible studies showing that the average investor underperforms the market, and this illustrates exactly how it happens. Right after an investment generates strong returns, people tend to jump on the bandwagon — and then they experience the subsequent return to reality.

When an investment is struggling, people tend to abandon it, and miss out on its recovery. Missing the upside and catching the downside, consistently, is human nature, perfectly understandable behavior.

But it inevitably leads to dismal investment results — as it did for the battered, unhappy, money-losing investors in the best-performing mutual fund of the 2000s

WHY WE PASSED ON CGM IN 2007

Bob Veres’ commentary illustrates why we were not recommending CGM in 2007 when it was generating so much excitement. That same sentiment is why we are currently emphasizing funds like Allianz NFJ Dividend Value Fund, which may not be popular at the moment, but have proven to outperform after periods of lackluster results.

ALLIANZ NFJ DIVIDEND VALUE, PNEAX

The following is an excerpt from an interview with Ben Fischer, portfolio manager of NFJ Investment Group, on the recent performance of Allianz NFJ Dividend Value Fund:

(The Full interview can be found at www.AllianzInvestors.com)

Q: Why haven’t the financials in the portfolio fully participated in the rally?

A: You need to remember that NFJ seeks to invest in low-priced stocks with attractive fundamentals. NFJ believes that many of the benchmark constituents that have driven recent index performance have not done so because of their fundamentals. In fact, many of the stocks that improved the most were those that declined most precipitously in 2008.

Further, among financials, it is the very lowest quality stocks that have delivered the best performance since the market bottom on March 9.

While we are not limited to investing in only high-quality names, our process does prevent us from owning the lowest quality names. This positioning has served our shareholders well in the past, and will do so over the long term.

Q: Your Morningstar rankings have been affected. Explain a bit about that.

A: Morningstar rankings can be useful, but must be understood in context. Growth has significantly outpaced value year to date. In that environment, a deep value manager like us will likely underperform relative to its Morningstar peer group.

Further, deep value funds like NFJ Dividend Value will lag traditional and relative value peers. In addition, given the way the rankings are weighted, one-year performance has a greater effect on longer-term rankings, so any performance lag over, say, four months, will have an unusually significant impact on three- and five-year rankings.

Q: Has the portfolio ever lagged its benchmark and Morningstar peers in the past?

A: Yes, in the late ’90s, when growth outpaced value, the portfolio lagged both its benchmark and peer group. Again in 2003, when lower quality names outperformed, the fund lagged the benchmark and its peers.

However, both of these periods were followed by periods of outperformance.

Q: What are you doing to protect your shareholders in this environment?

A: We are focusing intently on absolute yield. We are also focusing on the cushioning effect of dividends.

To the latter point, though dividend cuts by many companies have been well publicized, among the Fund’s holdings, raises have actually outnumbered cuts three to one. Only eight of 45 holdings have reduced payouts over the past year, and the median holding still pays more than it did one year ago.

We have also emphasized companies with no looming debt maturities or pension plan concerns. We have highlighted companies that have recently hiked their payouts, even in the midst of the current economic malaise, as NFJ views these companies as less likely to turn around and slash their dividends.

Further, in the future, dividends may become rarer, and company managements will probably think twice before instituting standard payout hikes unless they are certain that they can be maintained.

Thus, going forward, increasing dividends may work even better as an indicator of quality and management confidence.

We in the financial planning community believe that something called a “fiduciary standard” is the very best framework for professionals to work with our clients.  That’s why we’re so angry over something that happened in the Senate over the weekend: Senator Tim Johnson of South Dakota inserted an amendment into the new regulatory reform bill–and, with the casual stroke of a pen, eliminated an important and powerful consumer protection.

This amendment cuts out a part of the original bill that would have required everybody who gives investment advice to the public to act as a fiduciary.  Senator Johnson wants the Senate to “study” the issue instead.

Why should you care?

The fiduciary standard is a legal concept, but its core idea is not complicated.  To act as a fiduciary means we professionals have to put aside our own financial interests, and also put aside the business/financial interests of any company we work for, and give recommendations that are solely and completely in the best interests of people like you, our customers or clients.

In other words, our recommendations have to be made with only one concern: is this the best thing I (the professional) can do for you, given what I know about who you are and what you want and need?

So what does it mean NOT to be a fiduciary?  Imagine that there were two kinds of health practitioners in the world.  One group functions much like doctors do today: they work out of independent offices, meet with you, diagnose your ailments, prescribe a medical solution that they believe is the very best course of treatment, and you pay them directly for this service.

The other group of health care providers operates somewhat differently.  They’re employed in the branch office of a large multinational health conglomerate which requires its employees to recommend certain treatments which are most profitable to the company, so long as these treatments are considered to be “suitable.”

These might not be the best treatments, but under a set of very complicated regulations, these less-than-ideal prescriptions are deemed to be legally-defensible ways to address certain medical problems.  These other health care providers are paid by the company according to how many of these treatments they can sell.

Now imagine that these larger companies, because of the very high profits they’re making on these treatments, are able to gain a lot of influence over the process that decides which treatments are “suitable.”  In fact, their executives sit on the governing board of the organization that makes these determinations.

Finally, imagine that something went horribly wrong.  Several of the most popular treatments that these non-fiduciary medical professionals were eagerly peddling to their “patients” were not at all as their companies had portrayed them.  The result: catastrophic consequences, pain and suffering throughout the world.  An enormous mess.

To bring the analogy back to the financial world, these terrible treatments (investments) actually DID bring the global economy to the brink of financial collapse, a mess that required our taxpayer money to fix.  These companies had become so entwined in the system that the government had no choice but to help them recoup the staggering losses they brought upon themselves.

Not surprisingly, an outraged public demanded that this must never happen again.  To the real fiduciary practitioners, the solution is obvious: require everybody to act in the best interests of their customers/clients by imposing a fiduciary standard.  No more shady “suitable” treatments.

We were encouraged when Congress drafted legislation which, among other things, would bring every provider of financial advice under a fiduciary standard.

So here’s why professional financial services providers are angry.  Now that the catastrophic global meltdown, TARP, massive losses in the stock market and the longest recession since the 1930s is beginning to fade from memory, those companies that provide “suitable” non-fiduciary advice have gone back to business as usual–and very quietly, a Senator from South Dakota has now inserted a provision into the reform bill saying that instead of imposing this fiduciary requirement, that instead Congress will “study” the issue.

The Senate has decided to leave fiduciary out of the final bill.  Even the Wall Street Journal is outraged–here’s a link to a strongly-worded column that clearly explains what happened: http://online.wsj.com/article/SB10001424052748703940704575089413832399630.html

And here’s a link to another article which talks about how the legislative process favors the organizations that take the most money out of the pockets of their customers: http://www.financial-planning.com/fp_issues/2010_1/angels-and-demons-2665124-1.html

It would be nice if everybody called their Senator and Congressperson and said that they were just as angry as we are in the professional community.  A groundswell of public opinion might make our elected representatives understand that we haven’t forgotten TARP and all the rest of it.  Right now, the only people lobbying on your behalf are the professionals themselves, and there apparently aren’t enough of us to get the attention of the Congressional representatives who may be looking out for their own interests more than ours.

• This article is written by Bob Veres, publisher of Inside Information.  Inside Information is a journal that keeps financial advisors on the cutting edge of industry news. We found this piece particularly relevant to the heated debate surrounding the fiduciary vs. suitability discussion.

Investing in gold is on the tip of many investors’ tongues these days. The fact that gold has tripled in value over the last seven years and recently has been hovering at a price of $1,100 an ounce, has certainly helped.  This is coupled with the realization that gold has outperformed most of the major asset classes over the past several years.  But, is this enough evidence to make it worth investing a significant portion of your portfolio in gold?

The uncertainty in the economic environment as a result of the government’s growing deficit has provided the perfect storm for gold’s move to the top of the list for investors. With the risk of heavy inflation and a weaker dollar, people’s fears have driven them toward the implied security that gold can hold during these conditions.  To make matters worse, the exaggerated rise in gold since 2003, only compounds investors “being left out” reflex.  It’s very difficult to see and hear how an asset class is rising and not want to be a part of it.

In our evaluation of assets, we lean toward long-term trends.  If you look at a chart of gold prices since 1975 (like the one below), you notice that the price of gold had a similar run in the late seventies hitting a record of $750 an ounce or so in 1980.  Moving forward to 1999 the price was closer to the $300 an ounce range.  Taking a look at the chart, if you invested in gold in 1980, you would have had to wait 27 years just to earn your money back.  This example emphasizes the importance of understanding where you are in a market cycle, before investing in a specific asset class.

The speculative nature of investing in gold is eerily similar to the speculation that we observed with oil in 2007-2008.  With both of these asset classes, there have been multiple reports in the news of how high the prices might rise, which is one of our clearest warning signs for an overheated investment.  One of the latest price targets being promoted for gold was that it could rise to $5000 an ounce.

It’s important to remember that gold itself is not a cash-generating asset.  It may be tangible, but if you are holding gold it can actually cost you money in the transportation and storage of it.  In this article, Vitaliy Katsenelson does a nice job describing the concept of gold as an investment.

After going through multiple investment bubbles, a severe credit crisis, and two painful recessions, the “Lost Decade” for stock investments has come to an end.   In fact, the latter half of 2009 left us with a rather robust recovery and the idea that we may be participating in a sustainable economic recovery.

At the beginning of every month, during what we’ve coined our long-term investment “Outlook” meeting, our investment team gets together to debate different investment ideas of where we each see opportunity in the marketplace, while also trying to identify potential risks that could trip us up.  This process involves detailed discussions in which we compile a healthy collection of economic data and opinions to determine where the financial markets may be headed.  One of the things we have learned in our meetings is that a big part of being a successful investor is understanding where and how you have a competitive advantage over another investor.  A key to identifying these opportunities is knowing which sources are worth listening to vs. which ones are using biased assumptions to create support for their opinions.  After formalizing how these scenarios may or may not develop, we investigate specific ways that we can position our clients’ assets with the expectation that their portfolios will most advantageously benefit.  So without further ado, following is a summary of a few of the issues we discussed in our January “Outlook” meeting:

• Even though the unemployment percentage still hovers around 10%, this could be yet another positive for future stock market growth.  Typically, high unemployment coincides with the start of an economic expansion which is good for the stock market.

• Consumers and US corporations continue to improve their balance sheets.  Both groups have built up a healthy amount of pent-up demand which will likely continue to fuel the recovery.

• The average age of a car on the road is now 9.5 years old (which is the oldest average ever) and 2009 saw new car sales reach their lowest unit level since 1982, even with the added cash for clunkers steroid shot.

• China is now the largest consumer of cars in the world, which increases global demand for oil however; at some point other energy sources will become viable which would reverse this trend.  We realize that as oil prices rise, pressure for alternatives will continue but in the short-term we are not decreasing our energy holdings.

• One of the pressing primary risks is how smoothly the hand-off will be from government stimulus to private sector growth.  It’s important to remember that discussions about the removal of stimulus funds, interest rate increases, the speed of recovery and inflationary threats are a part of all economic recoveries and are typical for a bull market as it climbs its wall of worry.

• On average the market experiences a 10% drop at some point every year, so it’s not out of the realm of possibility that these lingering fears could cause some short-term market fluctuations.

• We feel that US high quality dividend focused companies’ likely hold the most opportunity for 2010.  However, we’re still allocating a significant portion to foreign stocks as a way to add diversity to client portfolios as well as provide a hedge against the US dollar.

• We still see little threat of inflation in the short term as the world has substantial under utilized resources. It will likely take years to re-employ those resources, though we may still get an up tick in inflation in the medium term.

How did your investments fare during the Lost Decade?

In response to the many fears and uncertainties that arose during the recent economic crisis, The National Association of Personal Financial Advisors (NAPFA) Consumer Education Foundation sponsored multiple financial advice events around the country as part of the “Your Money Bus” tour.  On Tuesday January 19^th, the “Your Money Bus” rolled in to downtown Raleigh, in partnership with NC State Treasurer Janet Cowell’s office.

With unemployment hovering around 10% and dramatic swings in the stock market, the need for financial advice was very apparent in the crowd of more than 85 that showed up at the State Government Complex in downtown Raleigh.  The impressive turnout of people came with a wide mix of questions that dealt with everything from how much and in which accounts they should be saving to which debts they should be paying down the quickest.

Partners of Financial Symmetry, Allison Berger and Chad Smith, participated in the event for the second consecutive year.

“We’ve really enjoyed being involved with the ‘Your Money Bus’ tour over the last two years.  It’s a great opportunity to spread financial literacy and make a difference in our community.” -Allison Berger

“Volunteering our advice has been a neat way to provide people with action steps that can help them gain some peace of mind when dealing with their finances.” -Chad Smith

There’s no better time than the beginning of a new year to implement a new budget in order to gain control of your spending.  In the final installment of our series on Quicken, we provide a few pointers to make using Quicken more meaningful so that you can better track where your money goes.

Should I be trying to hit the same number every month?

Comparing expenses on a monthly basis can be another source of frustration. There are many fluctuations that occur throughout the year, like holidays, summer vacation, and surprise home/car maintenance issues.

This is why it’s most helpful to measure your progress against a rolling year period. For example: You’ve just finished November, so you will want to measure December 1st of last year to November 30th of this year against the calendar year amount of your budget. If the amount is more, then you know you are a little ahead of pace and you should scale back.

If you’ve been diligent enough to hang in there for a year of budgeting, then you are fortunate enough to have a full year of meaningful comparison points.  So for this month, it would be best to investigate how January 2010 is comparing to January 2009’s data.  Barring any unusual spending activities in Jan. 2009, you should have some useful targets to compare to this year’s spending.

Performing this exercise monthly can greatly improve your overall financial picture as it allows you to have greater control over your regular expenditures.

How many categories should I be using?

Trying to determine which category your expense should go can be very confusing when you have forty to choose from.  Add in multiple subcategories for each of the main categories and you’re about ready to pull your hair out.

Luckily, Quicken allows you to edit the category list which should be your first action step when loading the software.  We recommend using 8-10 categories that will capture all of your spending.  This list includes:

• Clothing
• Communication (Phone, TV, Internet)
• Discretionary (Cash, Travel, Fun, Church/Charity Contributions)
• Food (Dining Out, Alcohol, Groceries)
• Debts (Mortgage, Equity Line, Car Payments, Credit Card or Student Loan Payments)
• Education (Books, Private School, College Tuition)
• Health & Hygiene (Gym Membership, Doctor Visits, Prescriptions)
• Household (Maintenance, Home Improvements)
• Investments (Roth/IRA Contributions)
• Risk Management & Financial Services (Bank Charges, Insurance)
• Taxes
• Transportation (Gas, Repairs, Car Insurance)

By practicing these two steps you should be well on your way to becoming a successful budgeter.