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Main Street Investors Largely Manage Their Own Finances

Less than one-third of Main Street investors works regularly with a financial advisor, according to Millionaire Corner research, which explores why the client-advisor relationship may be breaking down.
Main Street Americans, those with investable assets of $100,000 up to $1 million, are most apt to describe themselves as “self-directed” or “event-driven” investors, according to a study on advisor relationships conducted by Millionaire Corner in the third quarter of 2011.
The self-directed (35 percent) manage their finances without any professional help, while the event-driven (34 percent) seek financial advice concerning certain life events, such as planning for retirement. Only 10 percent rely entirely on an advisor to make all their financial decisions and describe themselves advisor-dependent. Twenty-one percent consult with an advisor, but make their own decisions, and are considered to be advisor-assisted.

Excerpt – Article | Wed, 08/01/2012 – 16:36 | By Adriana Reyneri

Developing an Investment Philosophy: The Step

Aswath Damodaran. Professor of Finance at the Stern School of Business at New York University & author of several highly-regarded and widely-used academic texts on Valuation, Corporate Finance, and Investment Management.
If every investor needs an investment philosophy, what is the process that you go through to come up with such a philosophy? While portfolio management is about the process, we can lay out the three steps involved in this section.
Step 1: Understand the fundamentals of risk and valuation
Before you embark on the journey of finding an investment philosophy, you need to get your financial toolkit ready. At the minimum, you should understand
- how to measure the risk in an investment and relate it to expected returns.
- how to value an asset, whether it be a bond, stock or a business
- the ingredients of trading costs, and the trade off between the speed of trading and the cost of trading
We would hasten to add that you do not need to be a mathematical wizard to do any of these and it is easy to acquire these basic tools.
Step 2: Develop a point of view about how markets work and where they might break down
Every investment philosophy is grounded in a point of view about human behavior (and irrationality). While personal experience often determines how we view our fellow human beings, we should expand this to consider broader evidence from markets on how investors act before we make our final judgments.
Over the last few decades, it has become easy to test different investment strategies as data becomes more accessible. There now exists a substantial body of research on the investment strategies that have beaten the market over time. For instance, researchers have found convincing evidence that stocks with low price to book value ratios have earned significantly higher returns than stocks of equivalent risk but higher price to book value ratios. It would be foolhardy not to review this evidence in the process of developing your investment philosophy. At the same time, though, you should keep in mind three caveats about this research:
a. Since they are based upon the past, they represent a look in the rearview mirror. Strategies that earned substantial returns in the 1990s may no longer be viable strategies now. In fact, as successful strategies get publicized either directly (in books and articles) or indirectly (by portfolio managers trading on them), you should expect to see them become less effective.
b. Much of the research is based upon constructing hypothetical portfolios, where you buy and sell stocks at historical prices and little or no attention is paid to transactions costs. To the extent that trading can cause prices to move, the actual returns on strategies can be very different from the returns on the hypothetical portfolio.
c. A test of an investment strategy is almost always a joint test of both the strategy and a model for risk. To see why, consider the evidence that stocks with low price to book value ratios earn higher returns than stocks with high price to book value ratios, with similar risk (at least as measured by the models we use). To the extent that we mismeasure risk or ignore a key component of risk, it is entirely possible that the higher returns are just a reward for the greater risk associated with low price to book value stocks.
Since understanding whether a strategy beats the market is such a critical component of investing, we will consider the approaches that are used to test a strategy, some basic rules that need to be followed in doing these tests and common errors that are made (unintentionally or intentionally) when running such tests. As we look at each investment philosophy, we will review the evidence that is available on strategies that emerge from that philosophy.
Step 3: Find the philosophy that provides the best fit for you
Once you understand the basics of investing, form your views on human foibles and behavior and review the evidence accumulated on each of the different investment philosophies, you are ready to make your choice. In our view, there is potential for success with almost every investment philosophy (yes, even charting) but the prerequisites for success can vary. In particular, success may rest on:
a. Your risk aversion: Some strategies are inherently riskier than others. For instance, venture capital or private equity investing, where you invest your funds in small, private businesses that show promise is inherently more risky than buying value stocks – equity in large, stable, publicly traded companies. The returns are also likely to be higher. However, more risk averse investors should avoid the first strategy and focus on the second. Picking an investment philosophy (and strategy) that requires you to take on more risk than you feel comfortable taking can be hazardous to your health and your portfolio.
b. The size of your portfolio: Some strategies require larger portfolios for success whereas others work only on a smaller scale. For instance, it is very difficult to be an activist value investor if you have only $ 100,000 in your portfolio, since firms are unlikely to listen to your complaints. On the other hand, a portfolio manager with $ 100 billion to invest may not be able to adopt a strategy that requires buying small, neglected companies. With such a large portfolio, she would very quickly end up becoming the dominant stockholder in each of the companies and affecting the price every time she trade.
c. Your time horizon: Some investment philosophies are predicated on a long time horizon, whereas others require much shorter time horizons. If you are investing your own funds, your time horizon is determined by your personal characteristics – some of us are more patient than others – and your needs for cash – the greater the need for liquidity, the shorter your time horizon has to be. If you are a professional (an investment adviser or portfolio manager), managing the funds of others, it is your clients time horizon and cash needs that will drive your choice of investment philosophies and strategies.
d. Your tax status: Since such a significant portion of your money ends up going to the tax collectors, they have a strong influence on your investment strategies and perhaps even the investment philosophy you adopt. In some cases, you may have to abandon strategies that you find attractive on a pre-tax basis because of the tax bite that they expose you to.
Thus, the right investment philosophy for you will reflect your particular strengths and weaknesses. It should come as no surprise, then, that investment philosophies that work for some investors do not work for others. Consequently, there can be no one investment philosophy that can be labeled best for all investors. (excerpt from “What is Portfolio Management” – source: Damodaran Online)

BILL GROSS: If I Were An Individual Investor, This Is What I Would Do

William Hunt “Bill” Gross is an American financial manager and author. He co-founded Pacific Investment Management. Gross also runs PIMCO’s $252.2 billion Total Return Fund.
Most individual investors don’t have the privilege of time nor the choice of risking their investment dollars while being able to recoup it only at .1% money market or CD rates. An investor, it seems, must learn a new dance to fit the diminished return size of the modern dance floor.
If I were an individual investor, I would do this: Balance your asset mix according to your age. Own more stocks if you are young, but more bonds if you are in your 60s, like myself. If you choose an investment advisor, a mutual fund, or an ETF, make sure that your fees are minimized. After all, if overall returns average 3–4% annually how can you possibly afford to give 100 basis points of it back? You cannot. And be careful. The age of credit expansion which led to double-digit portfolio returns is over. The age of inflation is upon us, which typically provides a headwind, not a tailwind, to securities price – both stocks and bonds.
If you are an institution be cognizant as well of the above, but in addition, recognize that higher returns – from both stocks and bonds – usually emanate in countries and economies which exhibit higher growth. And don’t trust any country, including the United States, to forever remain a clean dirty shirt. There’s mud aplenty in our future, which I’ll expound more about in next month’s Investment Outlook.
Until then, like Chuck Prince and his buddy Wimpy, you should keep on dancin’. It won’t likely be the Lindy or the Quickstep, because our credit-based financial system is burdened by excessive fat and interest rates that are too low. It will be a new, slower-paced dance by necessity but Chuck was right: it’s better to be on the dance floor than a wallflower on the sideline. You’ve just got to watch your step.

Affluent Investors Identify Smart Investing as a Key Factor in Obtaining Wealth

Smart investing begins with an understanding of a number of personal investment factors, including attitudes towards risk, also known as risk tolerance, and financial goals such as purchasing a home, saving for college and retiring, according to the Financial Industry Regulatory Authority or FINRA. The agency recommends investors establish time frames for reaching their goals, and also assess their current net worth, as well as their debt obligations, calculate their cash flow, set aside an easily accessible emergency fund and review their credit score and its impact on household finances.
Smart investing also draws on basic concepts such as asset allocation, or investing wealth across a range of financial products. The practice requires an understanding of basic assets classes, such as stocks, bonds, savings accounts, real estate and precious metals, and the subclasses within these categories. Stocks, for example, can be broken down by market size, industry sector and style. An investor who has a good understanding of available financial products can optimize the strategy of diversification, a tool highly prized by millionaires. Diversification refers to the practice of investing across a wide range of asset classes that perform independently of each other. In a strategically diversified portfolio, gains in one asset class can offset losses in another.

Excerpt – Article | Wed, 03/21/2012 – 07:56 | By Adriana Reyneri