Bloomsday

Planning to me is really a way of answering questions. Comprehensive planning brings the client's entire situation into focus, resulting in better decisions. When this is cheapened by those who purport to be planners but are really just salesmen, it hurts the entire industry. There is a silver lining here. The existence of this "sales" approach provides me with a competitive advantage. You see, it's easy to make a clear distinction between that and what I'm doing.

Portfolio Management

Let's move on to portfolio management. There are many different ways to create and manage a portfolio. Some practitioners believe in a passive strategy, others prefer an active approach, and the rest fall somewhere in between. I believe both passive and active have merit. If I use a passive strategy, I'm more inclined to use it in the large-cap stock area since it's a more efficient market than small caps or emerging foreign stocks. Obviously, portfolio management is an art as well as a science. Here's how I do it.

First, I will determine the client's approximate required rate of return (ROR). This is usually derived from their financial plan. Once I know this, I look to my nine model portfolios to see which portfolio has an expected return (ER) close to the client's ROR. In calculating expected return, I use a weighted average where stocks are assigned a return of 10%, bonds 5% to 6% depending on their tax status, cash is at 3.5%, and alternative assets vary depending on the type.

Then I'll look at the risk of the portfolio as measured by the standard deviation, and compare it to the client's risk tolerance as measured by a questionnaire I use. If their tolerance for risk varies greatly from the risk of the model portfolio, further discussion is needed.

When I created my model portfolios, I began by selecting broad asset classes. I use four: stocks, bonds, cash, and alternative investments. Within the stock category I use: large value; large growth; mid cap; small value; small growth; large foreign; and diversified emerging markets. Generally I favor value over growth and large cap over small cap. With bonds I use: ultra short term; short term corporate; short term government; mortgage backed; intermediate term corporate; and inflation protected securities. The alternative category includes real estate; market neutral vehicles; hedge funds; and structured equity.

With bonds, I have three primary sub categories. They are intermediate term corporate, inflation protected securities, and mortgage-backed. Generally speaking, assuming they are option free, intermediate term corporate bonds do well when interest rates are declining, mortgage-backed securities favor a more stable interest rate environment, and inflation protected securities should hold up better when rates are rising.

The objective is to create a positive return from the bonds regardless of interest rate movements and should be achievable unless rates are increasing at a rapid pace and in large chunks. However, if rates are rising, it's possible that the Fed is raising them to suppress inflation. If inflation is threatening, it's likely that the velocity of money is increasing as demand outstrips supply. If the velocity of money is increasing, then it's very possible corporate revenue is rising and presuming those corporation aren't spending foolishly, their profits are improving. If their profits are improving then I would assume, in the absence of scandals, terrorist attacks, or other anomalies, that the stock market is improving.

I'm also looking for managers who have low expenses and have consistently outperformed their peer group; I use a market filter on a daily basis to monitor this comparison.

I've adopted a strategic asset allocation policy but will make tactical moves at times. For example, when rates were at historic lows I increased short- and ultra-short-term bonds as well as inflation protected securities. To assist, I subscribe to Morningstar Advisor Workstation which gives me access to all mutual funds, stocks, closed end funds, variable annuities, ETF's, and hundreds of indexes. With this tool I can track client portfolios, monitor changes, and conduct research as needed.

Before adding a holding to an existing portfolio, it must be determined that it will enhance the diversification of the portfolio by either increasing the return or decreasing the risk. The correlation matrix is essential here.

Practice Management

Efficiency in execution is vital. As an independent, there's never enough time in a day to accomplish everything you want to do. Having the right tools can provide the leverage necessary to carry out the plan. The first piece of the puzzle to me was a good contact management system. I've chosen ACT basic and have customized it by adding tabs and fields to reflect my business needs.

There are many more things we could discuss but they'll have to wait for the next installment which will as of now is scheduled to run in the November issue. Until then, please feel free to visit my blog at www.investmentadvisor.com and post your comments and questions there or send an e-mail.