HOFFMAN, WHITE & KAELBER FINANCIAL SERVICES,
LLC
Investment managers & Financial Advisors
April 4, 2005
This is the April 2005 monthly Wealth Management newsletter from Hoffman, White & Kaelber Financial Services, LLC. If you do not wish to be included in our circulation, please reply indicating your desire to be removed and we will be happy to oblige. Alternatively, any of your friends or colleagues may receive this on a regular monthly basis by sending their name and email address to info@hwkfs.com. Feel free to forward this to any of your friends who may find it useful. Thanks for your interest and I hope you enjoy the letter.
In part one
of Investing Basics, I opened by discussing:
“What color is your parachute?
Richard Bolles’ book seemed an appropriate example to introduce the
importance of determining your investing style before determining what
investments you should be making. And,
from the feedback I received, many enjoyed that segue.
For this
letter, I will use another literary classic.
Last month, with my younger son, I re-read “The Little Prince” and was
amazed to be reacquainted with the valuable lessons found in it.
In Chapter
22 of this children’s classic, the prince comes upon a railroad switchman at
work. The dialogue seems to imply that,
for adults, train rides are rushed voyages that never result in happiness
because “no one is ever satisfied where [they] are”. As trains rush towards each other from
opposite directions, it is suggested that grown-ups are often preoccupied in
their pursuits. Yet, viewing the world
through a child’s eye enables another perspective. It is the children, with their faces pressed
hungrily against the windows taking in scenery that see the journey as more
important than the destination.
Antoine de
SaintExupery, writing at a level at which children comprehend, delves into a
social and psychological discussion regarding the human experience. His effort reflects on how 'adults' sometimes
narrowly view the world, its people, and what they have to offer. The lessons in this book range from personal
relationships to business, touching on the subjects of guilt, greed, power, and
love. This simple, 96 page story about a
little boy speaks volumes louder than you could imagine.
For adults,
this book can provide a lesson in the importance of self-reflection. For investing adults, gentle reader, starting
your journey through self-reflection and determining your investing style will
provide you increased chances of happy experiences in your journey toward your
goals, into retirement and beyond.
As mentioned in our prior newsletters, we strive to provide articles on various aspects of wealth management to assist your understanding of why planning for the present and for your future has importance. Yes, we also promote our services; yet, you will find that we always seek to present thought provoking topics that are relevant to our wide audience.
This
month’s letter will complete our two-part series touching upon various types of
investors, how to find your investment style, and how to find an investing
program that fits. From the comments
received on our prior letter, I’m very happy many of you have found this topic
useful. Thank you for your kind
feedback. Lastly, we will finish with a
review of the investing climate for the month past, our performance, and an
overview of how our investment team will be preparing to take advantage of what
we see in the markets lying ahead.
Investment Style
Categories
We left off last month discussing types of investors and some basic investment style categories: “Conservative investors, Moderate investors, and Aggressive investors”. Now we shall expand on this by discussing different profiles of investors in order to help you spot how some might be successful at investing and why others are not.
The
following is a brief mosaic of researched articles from MotleyFool.com’s
Selena, Psyconomics.com, Merrill Lynch and from the book “Mind Over Money”,
written by John Schott and Jean Arbiter.
Which of these, or combination thereof, sounds like you?
The
Cautious, “Make-Me-Safe”, Worried Investor.
Very conservative
and often self-critical about their decision-making, these investors cannot
stomach losing any money. These people
will avoid high-risk opportunities as well as listening to professional advice. They won’t rush into investing and give every
financial opportunity a great deal of thought.
This often paralyzes them into inactivity. These people are destined to earn low returns
that don’t keep up with inflation. This
type might benefit from putting forth an effort to learn about investment risk
or limiting themselves to money market funds.
The
Emotional, Impulsive, Gambler. Easily attracted to
fashionable investments or 'hot' tips, these investors act with their hearts
and not their heads. They are very
likely to invest based on past performance without considering risk. Often addicted to the thrill of the market, a
whim or a gut feeling leads their decisions.
They invest with the belief that things will come right in the end and
are often willing to take bigger risks to try to make up for their prior
losses. These people would certainly
benefit by hiring a professional or by doing research before buying and writing
down expectations and standards for selling.
The
Busy, Technical, Power Investor. Overly confident and
attracted to speculative situations, this type of investor is easily drawn to
active trading based on price movements.
As well, any tidbit of information they can glean is imbued with
significance and a cause to take financial action. Unless trading gets the best of them, these
people should excel in bull markets but are likely to get “wiped-out” in bear
markets. Always looking to gain some
advantage, they are inclined to buy the latest technology to help their
efforts. These do-it-yourselfers should
focus on doing thorough research and resisting impulsive trades.
The
Casual, Informed, Psychologically Successful Investor.
Self-confident and patient with reasonable expectations, they may
sometimes miss the best opportunities but believe that knowledge and experience
will always win out to give them long-term profits. They tend to believe that a good job or a
profession is the way to make real money and often leave the running of their
investments to their professional advisors.
This investor listens carefully to financial opinions and expert
assessments, only acting after weighing the pros and cons. Often hardworking and involved with work or
family, they remain open-minded and treat mistakes as learning experiences. These people should continue what they’re
doing.
The term
“investment style” refers to an investor's basic approach to choosing
investments, whether we’re talking about stocks, bonds, real estate, and so
on. If you're investing on your own,
your investment style will dictate how you make your choices. Similarly, if you invest with a professional
that makes the selections for you, you need to be sure that their style matches
your own.
By
selecting a style that matches your attitude about money and financial
situation, you boost your chances of getting what you want out of your
investment program. As well, during your
lifetime, you'll need to adapt your investment style now and then to match your
changing needs and finances. Bear in
mind, though, that your investment style must have a longer shelf life than a
year or two. An investment style is not
something to abandon because it's last year's model, or because you're
impatient for better results. Being
successful in investing depends on choosing an approach and giving it time to
work for you. You should only alter your
style when your life goals or circumstances change significantly. This will then call for making a similar
shift in your investment approach.
Finding
your investment style is the key to devising an investment strategy that takes
you where you want to go. Before you
adopt an investment style, however, you’ll need to examine several
factors. For instance, what is your risk
tolerance? This will depend partially on
your personality. Blunt realism is in
order here. Would you be able to take
losses in stride during the short term?
Or, would any losses now leave you financially strapped and unable to
pay your current debts and living expenses?
Are you able to hang on for the long haul, even through the market's
inevitable ups and downs?
Other factors to consider are your age, financial goals, and time frame. When will you need to use the money you're
investing? If you still have a few
decades before retiring, or if you'll have ample opportunity to regain whatever
short-term losses you might incur, an aggressive investment style might serve
you well. But if you'll need the bulk of
your retirement money all at once, or you'll be sending a child off to college
in five years, you simply can't afford to let your nest egg take a severe hit. You will be better off with a less risky
style.
Finding Suitable
Investments
Look at any
investment journal or Morningstar report and there is enough technical jargon
and numbers to make you cross-eyed. How
do you know what measures or indicators to consider when selecting investments?
First, it is important to know that different types of investments perform
better under different economic conditions.
By choosing investments that are generating the highest returns at any
given time, you may not end up with a broadly diversified portfolio. When conditions change over time, investment
results are likely to change as well.
Before focusing on individual investments, it is important to determine
an overall strategy that will include investments of different types, styles,
sectors and/or geographic influences.
This is referred to as a portfolio or asset allocation.
Second, and most importantly, annualized returns or average returns over time
do not tell the whole story! By focusing
the selection process on performance only, the average investor is ignoring
risk. Some of the top performing
investments may also have higher risks associated with them. One measure of risk is standard
deviation. I know it sounds like a
highly technical term, but it boils down to measuring how results vary in the
return of a particular investment over time.
The higher this number is, the larger the variation in results. Volatility is not always bad, but what level
is acceptable will depend on how long it will be before you might need to use
the money and how sensitive you are to seeing negative returns.
Other factors to consider beyond performance for professionally managed
investments include: how long a
particular manager has been managing investments and what their experience
level is, how closely they stay within their stated investment style, how many
or how broad are the portfolio holdings (the broader the holdings, the lower
the presumed risk) and how high the management fees are compared with similar
investments.
To invest
successfully, you need to assess your own attitude to risk when you start out,
then regularly reassess this factor in the light of your changing
circumstances. You can do this with your
investment adviser, but if you want to be guided rather than led, you can do it
on your own and I hope that this article gave you a few pointers.
Most
peoples' attitude to risk is defined by two of the basest human emotions, greed
and fear. Greed drives the profit motive
while fear of losing capital should control the level of risk we're prepared to
take. Yet attitudes can differ when it
comes to how much risk we should take.
For instance, an aggressive investor might view buying individual stocks
as being moderately risky and see futures and options trading as high
risk. While a more conservative investor
might see individual stocks as being a high-risk strategy and would prefer
diversified investments like mutual funds, which they would define as
moderately risky. This divergence of opinion exists not only between
individuals, but also between investment advisers; so what common standards
exist?
The most
accurate are those used by the investment industry and the best known measures
of risk are Standard Deviation and Sharpe Ratio. These are specific and excellent for
comparing relative performance and investment volatility. However, for many investors they may
represent two more terms used by professionals to confuse the public!
We’re At Your Service
At Hoffman, White & Kaelber Financial Services, our focus is to help our clients achieve a more certain future. As such, our wealth management clients gain comfort in knowing that we’ve helped them identify their investment style and that they’ve hired disciplined decision makers whose objective favors consistency of returns and capital preservation rather than magnitude of returns. Our best clients are those who are moderate to conservative risk takers. And, we’re always thinking of ways to help our clients’ keep what they’ve earned!
Hoffman,
White & Kaelber Financial Services Investment Performance Update
Both stock
and bond markets sold off during the month as fears of inflation grew
stronger. The Federal Reserve’s decision
to raise the Fed Funds rate to 2.75% on March 22nd marked the
seventh consecutive meeting at which it raised short-term rates. What made the markets react worse this time
than the previous six times was new language in the Fed’s statement voicing
concern about increased inflation risk.
The yield on the 10-year U.S. Treasury note, which had actually declined
during previous tightenings out of fear that the Fed’s actions could lead to an
economic slowdown, now shot up out of fear that the economy was
overheating. It now appears clear that
the Fed intends to continue raising interest rates until a “neutral” interest
rate policy is in effect. What
short-term rate currently constitutes “neutral” for the economy is unclear, but
most economists agree that it is at least 4 percent, which is 125 basis points
above the current level.
What does a
rising interest environment mean for an investment portfolio? With regard to the fixed income portion of
the portfolio, it means that interest rate risk should be minimized and
replaced with more credit risk. Thus,
U.S. treasuries, which have no credit risk and substantial interest rate risk,
should be replaced with instruments such as: (1) bank loans, whose repayment
terms reset to a higher interest rate every few months if prevailing interest
rates are increasing; (2) higher-yielding equity-like bonds whose performance
depends more upon a strong economy than upon the interest-rate backdrop; and
(3) foreign bonds that can benefit from a weaker dollar as a cushion against
higher rates.
With regard
to the equity portion of the portfolio, some caution is warranted because
higher interest rates mean higher borrowing costs for businesses, thus reducing
future profits, as well as lower price-earnings multiples, because future-year
earnings are discounted more heavily in valuation models as a result of eroding
effects of inflation. However, higher
interest rates also signify a strong economy in which current earnings and
profits can grow significantly. Thus, we
are expecting low, single-digit equity returns over the coming 12 months, with
most of this return occurring in the second half of the year as the market
rejoices at the prospect of the Fed ending its current tightening cycle.
The key to
investment success is to focus on those industry sectors that perform best in
the late stages of an economic cycle and that can benefit from inflation by
means of raising prices. Among the
sectors that we like now are health care, industrials, technology, and energy. Sectors we are avoiding or using as a hedge
include interest-rate sensitive spaces such as electric utilities, financials,
real estate, and consumer discretionary.
International equity markets remain somewhat attractive, both from a
diversification standpoint and as a currency play. However, higher
Of course,
a time always comes when the Federal Reserve overshoots and raises interest
rates too much and chokes off economic growth, resulting in a recession. We remain on guard for such a scenario
because the detrimental effect on equity markets is so severe when it does
occur. However, we do not believe that
the dangers of recession are great at the current time given that the treasury
yield curve (i.e., the spread between the Fed Funds rate and the ten-year
treasury note) is not only upward sloping but the spread has recently begun to
increase.
For the month ended March 31, 2005, our
one-month performance is off 0.09%, our three-month return is up 0.43%, and our
average annualized return since inception is up 8.96%. While volatility (risk) steadily continues to
increase in the equity markets, our risk profile has crept downward further by
0.09% to +/- 6.18%.
This conservatively low risk level remains consistent with our strategy. With our expectation that this statistic
gains increasing importance, our Sharpe Ratio improved to a very respectable
1.24.
Investment
pros borrow a tool from the statisticians—standard deviation—to measure
investment risk. It shows the range of returns that investments are
likely to earn over a given period of time and it has two sides, the
out-performance and the under-performance of an average rate of return.
The Sharpe Ratio is a commonly used measure of portfolio earnings quality. In short, the Sharpe Ratio is a measure of return achieved per risk taken. Sharpe ratios can be better than just looking at performance because it incorporates the issue of risk. Some would say it is a measure of a manager’s ability to perform consistently. The number by itself, however, is hard for many to understand without comparing it to something.
Let’s take a look at the S&P 500 Index
for a quick comparison. The Standard
& Poor's 500 Index is usually considered the benchmark for
Are you familiar with Morningstar, Inc.? They are a Chicago-based, global investment research firm, providing information, data, and analysis on the mutual fund industry. They say that a Sharpe Ratio of over 1.0 is "pretty good" and outstanding funds achieve something over 2.0. Using this “yardstick”, we are more than pleased with our accomplishment to date.
For most investors, the Sharpe makes
good intuitive sense because they not only hate to lose money but they often
compare the returns to risk free investing.
You owe it to yourself to understand and consider this measure when
making investment decisions.
Is a comfortable retirement or preservation of wealth important to
you?
Want better long-term results from your investments?
Choose
Us As Your Investment Manager!
Research
us on the web at www.hwkfs.com