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Have you been trying to invest on your own? After the past few years of stock market declines, are you wondering what to do next with your investments?
Investment gains achieved during the 1990s convinced a generation of investors—many new to the markets—that professional advice and management added little or no value to results they could achieve on their own. When the investment bubble popped in early 2000, many investors reconsidered the do-it-yourself approach, as they saw the value of their portfolios plummet.
The appeal of investing without professional guidance can be seen most clearly in the day-trading phenomenon of the late 1990s. Like first-time visitors to a modern art museum looking at an Andy Warhol painting and thinking, “I could do that,” many otherwise intelligent individuals quit their jobs to trade stocks through discount online brokerage services. Making money looked easy.
These same individuals failed to define investment objectives and strategic asset allocation plans. There was a general lack of portfolio methodology and planning. Investors instead relied on Internet websites, news media and dinner party conversations to determine their financial futures.
The exuberant days of the 1990s have passed, but the attitudes they spawned have not. Both individual investors and the media continue to look for the next “hot” trend—the sector that will spark a market revival and spur their portfolios to new heights. That makes it more important than ever to look beyond the hype, and address the question of value and the benefits of professional management.
Professional investment management offers benefits that include:
1.The strategic level of asset allocation and portfolio development, and
2. The tactics of day-to-day asset management.
The strategic role of an investment advisor is unrelated to providing investment tips or technical trading advice. The advisor is not a “salesperson.” His or her primary role should be that of a trusted counselor, providing investment insight and managing your portfolio in a way that can help you reach your goals.
As financial markets continually change, an investment advisor can offer the perspective and experience you need to keep on track.
That may sound simplistic, but in practice, can be extremely complicated—even for investors with modest assets. The reason is simple: Most people have multiple goals and pursue multiple, interconnected paths to reach them.
Developing a Comprehensive Strategy
The most urgent priority of a dual-income couple in their mid-50s may be to ensure they can pay for a child’s college education, but that is unlikely to be their only goal. In fact, by focusing only on one obvious need, they may overlook other long-term important objectives, such as saving for a comfortable retirement; managing their long-term tax position or assuring they have adequate liquidity to handle the challenges of a changing economy.
Investors also may have various investments in addition to their personal portfolios. They probably have savings, checking and money market accounts; pension plans and 401(k)s; stock options or other non-cash incentives granted by their employers; and other assets of significant value, including their home. There are opportunities and risks involved in all of those investments, which were probably acquired in a haphazard manner over many years.
This leads to one of the most important roles of an investment advisor: looking at your financial situation and helping determine if your total portfolio correctly positions you to reach your long-term objectives.
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The answers are often surprising. It is not unusual for many investors’ portfolios to be skewed heavily to U.S. equities—as a result of participation in employers’ 401(k) and stock-option programs. Some corporate employees often have a third or more of their total investments concentrated in a single company’s stock. Although long-term expected returns from stocks are much higher than those from bonds or money markets, too much stock concentration is unwise. It places a disproportionate amount of an investor’s net worth at risk to developments affecting a single market sector to events affecting a single company.
Investment advisors can identify these pitfalls and help clients develop diversification strategies and asset allocation approaches. By taking a comprehensive view of their clients’ financial positions, advisors can help clients work intelligently and consistently toward their goals.
The Importance of Discipline
Discipline is critical. In fact, asset allocation—determining your equity, bond and cash mix—is the single most important decision investors face.
Every individual has a unique set of needs. Each investors need to find a blend of asset classes with which they are comfortable, taking into consideration their goals and financial situation. Younger investors have more time to let compounding work for them and can afford to be more aggressive, while older investors usually want to steer a more conservative course.
In light of these accepted principles, why is professional advice essential? Because it helps investors avoid emotional financial pitfalls. Many years ago, Benjamin Graham summed this up in his landmark book, The Intelligent Investor. Graham writes:
“These copybook maxims (on asset allocation) have been easy to enunciate and always difficult to follow, because they go against that very human nature which produces the excesses of bull and bear markets. It is almost a contradiction in terms to suggest as a feasible policy for the average stockholder that he lighten his holdings when the market advances beyond a certain point and add to them after a corresponding decline. It is because the average man operates, and apparently must operate, in opposite fashion, that we have had the great advances and collapses of the past and—this writer believes—we are likely to have them in the future.”
Since Graham wrote his book, the stock market has experienced the boom years of 1965-70; the bear market of 1973-74, the bull market that began in 1982 and crashed in 1987; and the 1990s Internet-driven bull market and subsequent collapse. Few investors escaped unscathed. Those with appropriately allocated portfolios, however, generally fared better than those concentrated only in stocks. Professional advice keeps investors focused and less prone to emotional decisions.
Allocating an initial investment portfolio is only the first benefit of using a financial advisor. Very importantly, once the portfolio is developed, the advisor monitors changes in the economy, market values, and industry sectors. These are evaluated in light of your personal financial changes. With the assistance of your financial advisor, rebalancing your portfolio can help to maximize its potential goal over the long term. This is where professional portfolio management, as offered by mutual fund portfolios, becomes most valuable.
Why Use Professional Portfolio Management?
Professional portfolio managers enjoy many major advantages typically not available to individual investors. These include: financial training and experience specific to investments, superior market and security information, and reduced transaction costs. Because there are thousands of mutual funds and other securities in the financial markets, analysis is a full-time job – which most individuals are not prepared to do. A portfolio consisting of mutual funds, as opposed to individual stocks or bonds, offers a diversification benefit that can lower the portfolio risk compared to a |
stock portfolio. Also, mutual funds tend to be large investors that benefit from lower commissions and tighter spreads, and maintain relationships with a wider range of dealers than those offered to individuals. Mutual fund managers usually have superior information compared to individual investors, especially in their specific market areas. Also, fund managers are often major investors in a relatively specialized range of securities. They tend to be “plugged into” market information for their sector much more deeply than individual investors.
For example, mutual funds specializing in high yield debt develop tremendous expertise pertaining to a relatively small universe of companies. As a result, these managers have the opportunity to learn more about a particular company than most individuals. Fund size can generate other advantages as well. Managers dealing in emerging markets or regions can be among the largest investors in that narrow universe of securities. Beyond having superior market access, as major players they are often viewed as preferred buyers or sellers. As a result, these managers tend to understand pertinent news faster—a significant information advantage.
This kind of information is important to managers’ investment discipline in two ways. First, in-depth research and analysis is helpful in determining what securities to buy and when to buy them. Second, instead of following the crowd, managers use technical and quantitative analysis as well as qualitative data to identify investments whose prices do not accurately reflect their underlying values. This kind of disconnect between current prices and underlying values may occur for a number of reasons. In the stock market, “bad news” such as an earnings shortfall or business setback, may mask strong underlying cash flows or asset values. Similarly, a sector may move temporarily out of favor, affecting all companies in a given industry, including companies relatively unaffected by the events that caused the shift.
Similar forces are at work in the bond market. For example, credit ratings often do not accurately reflect a company’s true business strength or financial position. A manufacturing firm that invested heavily to diversify its business may have been downgraded by the ratings agencies, reflecting a higher debt load and spending levels. Since upgrades must be requested, they tend to lag behind sustainable improvements in revenues and earnings. Few individual investors have the research resources required to identify firms whose debt is poised to outperform.
Of course, professional portfolio monitoring works in the other direction as well. As many investors have found, investment success consists not only of maximizing gains in rising markets, but in also mitigating risk when markets turn down. Professional managers have a much better sense than individuals of when to sell through ongoing research. Mangers adjust portfolios to meet the demands of changing markets and the economy by using techniques such as moving sideline cash, upgrading stock sectors, changing bond portfolio maturities and rebalancing allocations.
Of course there are no investment guarantees. Even the best managed portfolios can’t promise returns. Professional management simply means that the portfolios are managed with greater access to financial information, more research, and more experience than individuals usually have. When combined with appropriate asset allocation and securities selection, this generally translates into better long-term results than individuals could achieve on their own.
Current market volatility has many investors revisiting the value of professional portfolio management. The right financial advisor can help you handle difficult financial markets by through their professional expertise. Although no one can guarantee future results, an advisors such as CPIC International can manage a diversified portfolio for you to help you achieve your financial goals.
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