Risk: too much or not enough?

Many of the new clients who have come to me in the last 6 months did not have a strong understanding of the composition of risk in their investment portfolios and in the structure of their net worth prior to the economic downturn and ensuing stock market volatility last year.

Just like any business enterprise , the composition of your family's net worth is crucial in determining where you sit on the risk spectrum.

Now that your investment assets ( stocks, bonds, managed funds, private equity holdings, etc. ) have bounced from the early March lows, it may be considerably less painful to spend the time to re-assess your current balance sheet.

Breaking your holdings out into %'s on a relative basis will give you a general overview :

Assets:
1) Investment (non-reg. / reg (RSP/RIF)
a) Liquid
b) Less liquid (penalties for early selling/ limited market for re-sale)

• Asset class : Fixed Income (Bonds/Debentures), Preferred Equity, Common Equity, Private Equity (including your own business)
• Economic Sector
• Geographic Location

2) Fixed assets: property

Liabilities:

Debt should be assigned to any of the above asset classes for a true picture of (net assets) risk.

After establishing your Net Worth and the risk apportioned to each sector and/or sub-sector, it is necessary to create a cash flow analysis from which to regard your lifestyle needs.

Simply:

Income (less taxes) less Lifestyle Expenses = either positive cash flow to be added and apportioned to your investments or negative cash flow from which we need to draw from your liquid investments (and cash holdings).

Your cash flow, now and projected into the future (either negative or positive) will then determine how your investments need to be structured.

In which case you need to look back to those %'s that you attached to your assets and make sure that there is appropriate liquidity, appropriate (or not) income being generated, appropriate allocation (or not) to investments with greater potential for growth ( and likely greater volatility).

Now that your statements are looking a little better and interest rates are the lowest in years (and will likely not remain low beyond the next 6 months) it is worth taking the time to re-assess.

There is still considerable uncertainty over the fragility of the economic rebound, which has gathered strength with enormous assistance from government spending.

There is substantial debate amongst the experts as to the timing of the recovery and the possible consequences that may result.

Understanding the risk that you carry becomes even more important as a result of this uncertainty.

I have spent 28 years analyzing risk, let me know if i can help you.

The mistakes we make—and why we make them

The Wall Street Journal, September 2009

How investors think often gets in the way of their results.

Meir Statman looks into our heads and tells us what we’re doing wrong.

(Dr. Meir Statman, Glenn Klimek Professor of Finance at the Leavey School of Business at Santa Clara University, is an industry expert and consultant to the Nxt Funds and Wellington West Asset Management Inc. Investment Committee)

What was I thinking?

If there’s one question that investors have asked themselves over the past year and a half, it’s that one. If only I had acted differently, they say. If only, if only, if only.

Yet here’s the problem: While we know that we made investment mistakes, and vow not to repeat them, most people have only the vaguest sense of what those mistakes were, or, more important, why they made them. Why did we think and feel and behave as we did? Why did we act in a way that today, in hindsight, seems so obviously stupid? Only by understanding the answer to these questions can we begin to improve our financial future.

This is where behavioral finance comes in. Most investors are intelligent people, neither irrational nor insane. But behavioral finance tells us we are also normal, with brains that are often full and emotions that are often overflowing. And that means we are normal smart at times, and normal stupid at others.

The trick, therefore, is to learn to increase our ratio of smart behavior to stupid. And since we cannot (thank goodness) turn ourselves into computer-like people, we need to find tools to help us act smart even when our thinking and feelings tempt us to be stupid.

Let me give you one example. Investors tend to think about each stock we purchase in a vacuum, distinct from other stocks in our portfolio. We are happy to realize “paper” gains in each stock quickly, but procrastinate when it comes to realizing losses. Why? Because while
regret over a paper loss stings, we can console ourselves in the hope that, in time, the stock will roar back into a gain. By contrast, all hope would be extinguished if we sold the stock and realized our loss. We would feel the searing pain of regret. So we do pretty much anything to avoid that pain—including holding on to the stock long after we should have sold it. Indeed, I’ve recently encountered an investor who procrastinated in realizing his losses on WorldCom stock until a letter from his broker informed him that the stock was worthless.

Successful professional traders are subject to the same emotions as the rest of us. But they counter it in two ways. First, they know their weakness, placing them on guard against it. Second, they establish “sell disciplines” that force them to realize losses even when they know that the pain of regret is sure to follow.

So in what other ways do our misguided thoughts and feelings get in the way of successful investing—not to mention increasing our stress levels? And what are the lessons we should learn, once we recognize those cognitive and emotional errors? Here are eight of them....

No. 1: Goldman Sachs is faster than you.
There is an old story about two hikers who encounter a tiger. One says: There is no point in running because the tiger is faster than either of us. The other says: It is not about whether the tiger is faster than either of us. It is about whether I’m faster than you. And with that he runs away. The speed of the Goldman Sachses of the world has been boosted most recently by computerized high-frequency trading. Can you really outrun them?

It is normal for us, the individual investors, to frame the market race as a race against the market. We hope to win by buying and selling investments at the right time. That doesn’t seem so hard. But we are much too slow in our race with the Goldman Sachses.
So what does this mean in practical terms? The most obvious lesson is that individual investors should never enter a race against faster runners by trading frequently on every little bit of news (or rumors).

Instead, simply buy and hold a diversified portfolio. Banal? Yes. Obvious? Yes. Typically followed? Sadly, no. Too often cognitive errors and emotions get in our way.

to be continued..........

Capital Market Perspective

I have listened recently to quite a few portfolio managers offer their views on the future as they discussed their Q2 performances:

There are a wide spectrum of opinions:

Most pessimistic:

That we are 10 years into a 20 year Bear Market, which should end in 2020.
Basically, this camp has drawn the parallels to the market recovery that occurred in the 1930's post crash.

Obviously there are many significant differences between then and now:

One of those has been the ability of corporations to make adjustments. Something that has stood out in this economic crisis has been the flexibility and quickness that has been demonstrated by Q2 earnings results.

Over 75% of S&P companies beat earnings estimates. Not on revenue increases, but on cost cutting measures. Getting lean and in a hurry has had a significant impact.

Productivity

Nonfarm business productivity rose 6.4% at an annual rate last quarter, the Labor Department said Tuesday. The biggest gain in output per hour worked since the third quarter of 2003 suggested companies have adjusted to the recession by slicing jobs and workers' hours. The data help explain why companies can post good earnings figures, having moved quickly to cut costs.

As the economy recovers and demand increases, profit margins should benefit.

There is reason to be optimistic:

Yesterday the US Federal Reserve adjusted it's outlook: "Information received since the Federal Open Market Committee met in June suggests that economic activity is levelling out."

They have decided on a gradual removal of the excess liquidity that they had originally provided to stabilize the markets when they were in crisis.

In the interim Investors have been getting anxious about the extremely low rates offered in short-term "safe havens" in t-bills, GIC's and money market funds and there is plenty of money still parked there.

As equity markets defy the negative prognostications and better economic conditions begin to appear in the monthly statistics, Investors who have been waiting (and who are anxious because they have missed a considerable rally since early march) will be forced back to the equity markets and this will likely push them higher.

Each corrective pull-back in the equity markets has brought significant buying, which has further buoyed equity markets to continue to rally.

How far?

In all likelihood, farther than most think, because as momentum builds, risk appetite increases and further drives prices higher and those anxious about missing a further rally will be finally convinced to re-enter.

Unfortunately, as the markets got emotionally panicked on the downside in February, they will get emotionally euphoric on the upside (barring any negative economic or political shocks).

There could be some considerable upside potential building because for the time being short-term interest rates are not going up, confidence is returning and Investors appetite for risk is increasing.

For more regular updates you can follow me on Twitter: http://twitter.com/JSTomenson

Thinking Ahead of the Curve.

Wealth

http://www.wealthstrategistnetwork.com/

In our continual search to upgrade our own education in how to better look after our clients Wealth Management needs we come across a significant number of publications.

Currently we are reading one that we think is very accessible and certainly is very client oriented. (link above for more info).

"Wealth" (by Stuart Lucas) is written for anyone concerned about wealth creation, wealth management, families with wealth, retirement planning, and multi-generational estate management. Most of the book's guidance applies whether you are worth a few hundred thousand dollars or a few hundred million, and whether you are a wealth owner or advisor. Affluent professionals and successful entrepreneurs can use "Wealth" to adopt a strategic, focused, and disciplined approach to growing and diversifying their financial assets. "Wealth" is equally useful to wealth industry professionals who want to strengthen their relationships with clients by better serving their long-term interests.

We have also just finished reading the Capgemini and Merrill Lynch Global Wealth Report, 2009.

This report focuses on and analyzes the macroeconomic factors that drive wealth creation and helps us (wealth management consultants) better understand the key trends that affect High Net Worth Individuals (HWNI's) around the globe.

Some highlights:

At the end of 2008, the world's population of HNWI's was down 14.9% from the year before.

Their wealth dropped 19.5%

Equities as a % of HNWI portfolios dropped from 33% to 25%.

Cash holdings increased by 7% to 21%

HNWI's are expected to remain fairly conservative in the short-run.

More than 1/4 of HNNI clients surveyed withdrew assets from their wealth management firm or left that firm altogether in 2008, fueled by lack of trust/confidence.

Service quality was by far the top driver of client retention in 2008.

On-line access and capabilities was deemed very important by 66% of clients.

Risk management and due diligence capabilities, 73%

Fee Structure, 48%

There is plenty more at http://www.capgemini.com/resources/thought_leadership/2009_world_wealth_report/

The Elite Circle

Last Tuesday I presented two of my investing team at One Capital Management: Andrew Buckley, a retired Special forces Green Beret, sniper team leader(Alpha company) in the U.S. Armed forces and now a client services associate and Patrick Bowen, President, with previous experience in Private Client Wealth Management at two of the finest Wealth Management institutions (Bernstein, Oppenheimer) in the U.S.

In a Q and A format, Pat quizzed Andrew about some of his experiences in the special forces and Andrew regaled us with some powerful stories (he could only tell us of things that were not "classified" ) with some very interesting slides to accompany them:

Like the time in Haiti when he was dropped in to secure a section of the city and ensure that senior negotiators had safe passage to their location for talks.

Interrupted by an ambush, Andrew and his team of 15 had to ensure the safety of very high level VI P's : Colin Powell and Jimmy Carter.

As Andrew told a riveted audience quite succinctly: the first 1.8 seconds of an ambush is crucial to survival.

He also told us that each team member had a very specific role to play in any circumstance which required 100% trust in each member: believing that they could perform their role as you carried out yours, was the only way that the team would be able to survive that first 1.8 seconds.

This was called "The Elite Circle".

According to Andrew: casualties occurred only when one of the team members stepped out of this circle of trust. Taking on a role that was not theirs to perform.

One can draw many parallels to a "team" situation that are not as life and death oriented, but the message is clear: In times of crisis, we need to count on our team members to perform their roles, so we better have 100% faith their abilities.

We have just endured a significant economic setback, some have referred to it as a crisis.

Tony Fell, retired chairman of RBC Capital Markets and one of the most highly regarded investment professionals in Canada recently described the last 2 years as the most devastating that he had witnessed in his 50 years in the investment industry.


How have you fared through this time?
Has your financial team been working with you in a consultative, coordinated and comprehensive manner?
Do you have 100% confidence that they are looking out for your best interests?
What are your end goals? and where abouts are you on the path to achieving them?

Andrew and Pat will be back with their stories in the fall, if you would be interested in hearing them, let me know.

Current Thoughts on the state of Capital Markets 2

On Dec. 14th, 2008, in this blog, I wrote that I expected markets to turn in March or April of '09.

The TSX bottomed on March 6th at 7479.96. Yesterday, June 2nd, it closed approx 40% higher at 10,588.79. The TSX is still some 30% below it's June 08 highs of 15,154.77.

In Sept. '00 the TSX hit a high of 11, 423.70, before falling 50% to 5678.28 in Oct. '02.

If one were to have bought the TSX index in Oct 2002, at current levels you would be up approx 10% yr/yr. after approx 8.5 years. Some would say that is a reasonable return.

But what a ride to get there!! Most, it appears, have no stomach for the violent volatility of seeing a portfolio cut in half at any given time.

What are your goals?
Why are you investing in the first place? You have a goal, usually it is a lifestyle goal (sometimes it is a legacy goal) : you want to achieve and maintain a certain lifestyle once you have moved to the next stage of your life.

When do you need the money?
How can you even begin to understand what risk you can take if you do not have a grasp of your cash flow: now, in 5 years, 10 years, 20 years, 30 years....do you have an idea?

How can you invest if you do not understand what risk you can take?
Many advisors will sell you an investment, touting it's merits for potential appreciation. But how does it fit into your cash flow plan, that is really the key. It has to fit into your plan. You have to have a plan.

The markets will go up, the markets will go down. If you need cash flow and the markets are down and you have no liquidity then your plan (if you have one) is not working.

Did you invest new money when the market was down?
If you were too emotionally charged by the on-going media circus of negativity and were unable to participate, then you need 3rd party money managers who understand the necessity to remain emotionally detached and systematically capture the opportunities that are available when the market makes new lows.

What is the next move in capital markets?:
1) The expectations that are being built into current markets are for economic recovery:

• the fear of "depression" has been taken out of expectations
• some improvement in consumer attitudes is being built in

2) Investors are coming back, equity mutual fund sales are improving

• there is still a significant amount of "fear" money parked on the sidelines in money market funds earning close to no return

3) As economic statistics are announced there could be surprises that either do or do not meet expectations, the markets will be vulnerable to those, especially if they are negative, because the markets are expecting better things moving forward.

4) TSX is likely to be bound by a trading range until there is more clarity: 9,000 to 11,500.

• remember the trading range on Oct. 14, 2008 was 9065 to 10,700 , approx. 18%. One day!

5) Early next year, 2010, providing global economic recovery stays on track and rising interest rates (governments funding deficits and inflation) do not choke it off (and there are no unforeseen economic shocks) we may be able to break out of this range to the upside.

How are you positioned?

Are you positioned to take advantage of the opportunities that exist now to positively impact your future goals?

Do you have an idea of your future cash flows?

Do you have a strategic plan?

We can help: www.jstomenson.ca

Thinking ahead of the curve: Solutions to your Challenges.

"For Sale By Owner"

I had a conversation with a prospective client the other day, someone unhappy with her current advisor. The conversation was not centred around the state of the markets or their portfolio, it was about contact. She just did not feel that her advisor was staying in touch.

The discussion at a certain point turned to fees. Turns out that she is very cost conscious and has a diversified basket of global index funds or ETF's, which mimic various indexes (the S&P 500 for example) around the world. It is a good strategy, because, historically, few portfolio managers are able to beat the indexes (approx. 30% or less). This means that paying a portfolio manager 2% or more (most mutual funds) vs. the fee for an index fund which is a fraction of the cost (approx 0.5% depending on the index) is not worth it.

Problem for her, she paid an up-front transaction fee for the advisor to buy the fund, 1%, based on the advisor's asset allocation model. When the advisor wants to earn another bit of commission, he "updates" the asset allocation model and will call the client to do so. But that's the only time he calls.

This same prospect told me that it was difficult to understand the "wealth management model". Why pay the fees?

It really depends on what you are trying to accomplish:
If you are a do-it-yourself person and feel that you have all the tools that you need to accomplish your financial goals, then by all means.

It reminds me of the house that sat on the corner of our street that had the "for sale by owner" sign out front for about 2 years. After giving up on that method the owner tried the "old fashioned" but more costly method of hiring a real estate agent and it was sold in a month.

As a professional "Wealth Management Consultant", I will charge you for our services, depending on the size of your portfolio and the complexity of your financial affairs, somewhere between .75% and 1.5% (of your invested assets, annually). In most cases add between .50% and 1.0% for an experienced portfolio manager who have proven to me that they have the ability to beat "the indexes" (some of whom will add a performance fee when they do) . In most cases and on average, clients pay 1.5%-1.75% all in.

What do they get?
Stewardship: a consultative, comprehensive and coordinated plan that we create (according to their goals), implement and monitor for as long as they and their family (we work with multi-generational families) are happy with what we provide.

Contact: regular emails, phone calls, monthly webcasts (multiple wealth topics), quarterly or at least semi-annual face to face meetings to discuss progress and any necessary adjustments that need to be considered.

We earn our fees and you have the right to question them at every meeting. If we aren't earning them, we'll adjust them.

visit our website: www.jstomenson.ca
or contact me at jstomenson@wellwest.ca