There are many strategies for making investments. One strategy that you might consider is to pick investments called indexed funds. You can buy mutual funds or exchange traded funds that follow, and try to produce the same results, as a given market index. Buying a mutual fund that tracks the S&P 500 would be an example.

Why be happy with average?

The common thinking in choosing an index strategy is that you can’t beat the market. So, you should be happy to have a return equal to the market average. That works if you are satisfied with the market average. You will want to go up at exactly the rate that the market goes up, and you will be OK to go down at the same rate as the market goes down.
Consider putting together a baseball team that has a player at every position who hits exactly at the average of all the players at that position in the league. If you have everyone hitting at his average for the league, your team might do pretty well; maybe finish near the midpoint in the league standings. No year-end excitement here, but no shame either. They gave us a good show. On the one hand, that sounds pretty good.
But suppose you have eight players hitting at their averages, and you have an opportunity to add one superstar at third base. This player consistently outperforms, gets hits in important situations, and drives in a lot of runs. You have to trade an average player to get him. But you add a player who really makes a difference.
Now that makes even more sense. With one player doing better than the average, everyday player, your team might just finish at the top of the league.

Don’t be rigid in your investment strategy

There is a time for index investing, and there is a time for going outside that single strategy. Consider using index investing in areas where it has proved extremely difficult to outperform the market average. However, there are areas of the investment market that are not quite that efficient. There are places where active investment managers have done better than average. When we see that opportunity, we depart from the index method and sign on a manager who has performed above average.

Use a broad field of investment funds

We don’t believe that an investor should limit the choices from which to make investment decisions. Some investment managers use only one family of funds, either their own company’s funds or a program that they single-mindedly promote. We find fund choices in several different families of funds. Once again, the baseball team analogy applies. Your team is not going to get all of its baseball players from one minor league system or even one baseball-rich country. The team is going to go where the best player is available. We have the same philosophy in picking our investment fund managers.

Stay involved with your investments

Often an investment manager who picks a balance of investments based on index funds also tends to stay with that investment mix, without making many changes over time. Going back to our baseball team analogy, that is like having a coach who doesn’t make changes in the lineup based on the game situation. If you are batting against a pitcher who has a record of poor results against a left-handed batter, it makes sense to put in a substitute to take advantage of that situation. In the same manner, we continue to look at the investment markets. Where we see some strong likelihood of a change in direction in the markets, we make changes in our investment lineup. We invest long term. We don’t make changes on a short-term shift, but we do take into account where the long-term markets seem to be going. We make changes that are appropriate to help us outperform the average market results.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

Suppose that you buy a newly issued, ten-year, 4% bond for $1,000. You know that you will receive a $20 interest payment every six months for nine-and-a-half years and a final payment of $1,020 at the end of ten years when the bond matures. In all, you will receive 20 interest payments totaling $400.
That’s 4% simple interest, or current yield, disregarding the possibility that you may choose to reinvest your interest in order to keep your money in productive use. This is where the idea of yield-to-maturity (YTM) comes in. Buying that newly issued bond, you normally would be quoted a YTM of 4%—based on the assumption that you’ll be able to reinvest all your interest payments to earn the same 4% return.
Market risk
In the real world, however, bonds trade in a marketplace in constant flux. Market risk arises as interest rates change in response to economic conditions. These changes affect the value of existing bonds. A rise in prevailing rates makes the interest paid by existing bonds less attractive to investors. Falling rates, on the other hand, boost a bond’s value.
When you buy a bond at a discount, that current yield will be supplemented by a return of the full face value at maturity. So the YTM will be higher than the current yield. Paying a premium, however, you won’t get back your full purchase price when the bond is redeemed. So your YTM is lower than the current yield. The YTM, although not perfect, provides the more accurate projection of your total return.
What’s the duration?
Just how much will a given change in interest rates affect the value of a bond in your portfolio? That depends on several factors, including the time to maturity and the difference between prevailing interest rates and the rate at which the bond was issued. (Bonds trading at a discount to their face value will swing more sharply than comparable issues trading at a premium.)
A measure that takes all the relevant factors into consideration is a bond’s duration or the average duration of a bond fund or individual portfolio. Derived by a complex formula, duration is the average of the present values of a bond or bond portfolio’s cash flows weighted by the time remaining until they are payable. Duration can be quite useful in estimating market risk—providing a close approximation of the effect of changes in interest rates on a bond’s value:
• If a 20-year bond’s duration is 12, you know that a change of 1% in interest rates will cause the bond’s price to rise or fall approximately 12%.
• If an intermediate-term bond fund has a duration of 3.5, that 1% change in interest rates will raise or lower the fund’s share price by about 3.5%.
A bond’s duration also can help an investor compensate for reinvestment risk. Although a rise in interest rates lowers a bond’s market value, it also gives an investor a higher yield on reinvested interest payments. Likewise, lower rates raise bond values but reduce reinvestment yields.
A bond or bond portfolio’s duration approximates the time in years at which the price change from a change in interest rates will be balanced by the increased or decreased return from reinvestment. Thus, by matching a bond investment’s duration to the time at which you will have need of the proceeds, you can be fairly certain that your total return will meet your expectations.
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As you can see, managing a bond portfolio can be a challenge. Of course, we’ll be happy to calculate the YTM and duration of your existing holdings or intended purchases, and help you to make adjustments to fit the requirements of your financial plan.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

Finding a reliable source for investment advice always has been a challenge. It’s especially difficult in today’s investment environment.

There’s no shortage of places to turn to for advice. The shelves at bookstores are filled with works from “experts” offering their perspectives as to how, where and when to invest. The Internet and the financial pages of newspapers and magazines are crowded with articles and advertising hype. Not to mention family members and friends with their own particular brand of wisdom.
Where should you turn for professional, trustworthy guidance? The choice to put part of your financial future in someone else’s hands should not be made hastily or without gathering crucial information. Even the wealthy and the financially sophisticated can be trapped, as we have seen in the revelation of the alleged Madoff Ponzi scheme.
Here are several suggestions to help you in your quest to find the investment advisor right for you.

Interview extensively
Parents who hire a nanny for their children talk to many applicants and are scrupulous about checking references. You should be no less careful when entrusting your money to a stranger.
You should expect that the investment advisor you choose will undergo a thorough study of your financial picture, your tax situation and your long-term goals. Develop a custom-tailored investment strategy based upon these factors. Select the investments to implement that strategy. Monitor your holdings, making changes or new recommendations whenever new developments appear to make changes desirable.

Look for depth
You will want to look for someone with considerable experience, with a solid theoretical background as well as real-world practice in investment management. Your advisor should be able to draw upon a wide variety of investment choices, not just a family of mutual funds.
You should feel comfortable talking to your advisor. Make sure that he or she listens to you. A successful investment management relationship is based upon clear and consistent communication.
Test the advisor with a few questions. For instance, ask the advisor about his or her approach to investing. Is that approach plainly expressed and clearly articulated? Does that philosophy match your own?

Understand the compensation structure
Having a firm grasp of how your investment advisor is compensated may well be the single most important issue for you to understand. Stockbrokers, for instance, are typically paid commissions based upon the number of trades executed for clients. So brokers are transaction driven; the greater the number of trades that they make, the greater their compensation.
Financial planners are another source for investment advice. Their recommendations may carry a fee, or, more likely, they earn commissions when the products that they recommend are purchased. Some financial planners earn fees both ways.
Institutions such as ours generally charge annual fees for investment services, and the fees are based upon the amount of assets under management. A graduated fee schedule usually is employed, which means that larger accounts pay lower fees, on a percentage basis, than smaller accounts. Similarly, investment counselors or advisory firms impose a percentage fee, based upon the amount and type of assets being managed.

Additional pointers
Some brokers and commission-based financial planners, may have an incentive to encourage frequent investment trades in order to increase their compensation. With a fee-based manager, compensation rises and falls along with the value of your portfolio. The advisor can prosper only if you do.
Look for someone who offers personalized service. Some accounts, for example, require an investor to review an assortment of model portfolios created by different money managers and to choose the one that’s closest to his or her needs. An investment advisor should be available to review your needs and preferences in detail, then tailor investment selections accordingly. As your situation changes, appropriate adjustments to your portfolio can be made.
Consider, too, what the advisor has to offer in terms of experience, quick access to research and technological support. It’s a combination unlikely to be available at small brokerage houses or through financial planners.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

The reason that the Bernie Madoff investment fraud continued for so long is that he didn’t promise investors that they would get rich quick. He promised steady returns without risk. An offer of a 25% return in one year should set off alarm bells for most investors. Offers that downplay the risk of loss should also.

Recent stock market volatility and the Federal Reserve’s policy of low interest rates have driven more and more investors to unconventional assets, styled “alternative investments” or “exotic investments.” According to one estimate, Americans have some $712 billion in complex investments that claim to provide higher returns without the volatility of the stock markets. Savers are looking for a stable source of income, something that was not so very hard to do years ago. Some of these alternative or exotic investments have soured, leading to action by securities regulators. Among exotics mentioned in a recent New York Times article:

• Part ownership in a fleet of luxury cars;
• An interest in a company supposed to produce a bilingual television show, “Hacienda Heights”; and
• Interests in nontradeable real estate investment trusts (REITs). In fact, Massachusetts regulators fined a major brokerage firm for selling these securities to investors who were not sophisticated enough to understand them. The firm promised to reform its sales process.

Be an informed investor

The Securities and Exchange Commission (SEC) offers a wide variety of resources to those who are willing to investigate before they invest. For example, offers of the sale of securities must be registered with the SEC, and important details about them may be found in the SEC’s EDGAR database or by calling its toll-free investor assistance line at (800) 732-0330. The SEC also provides information on the background and qualifications of investment professionals.
Commonsense financial advice also may be had from the SEC investor bulletins, available at its Web site. For example:

• Paying off high-interest debt may be the best investment strategy. Eliminating credit card interest rates that easily may exceed 20% annually has no risk and provide an immediate, above-market return.
• It can be costly to ignore the fees associated with buying, owning and selling an investment product. One of the usual characteristics of “alternative investments” is a high commission for the broker who sells it. High costs make it very difficult to achieve high net returns. Surrender fees also must be taken into account.
  
• Active trading and some other very common investing behaviors actually undermine investment performance. A large body of academic research supports this assertion.
  
• Research shows that con artists are experts at the art of persuasion, often using a variety of influence tactics tailored to the vulnerability of their victims. The SEC cites tactics such as phantom riches, source credibility, social consensus, reciprocity and scarcity as techniques to watch out for.
  
• The key to avoiding investment fraud, including scams that target specific groups, is using independent information to evaluate financial opportunities. Such information needs to come from outside one’s family or social community.

We can help.

For a second opinion on your investment ideas, call on us.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.