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Retirement & You

By Philip Kozloff, Kozloff Consulting, philipkozloff@mindspring.com

Prior columns have suggested a methodology for keeping track of the growth of your private investments. If you follow that approach, you can develop a clear view of how your financial assets are performing and how your personal spending relates to your personal net worth.

Achieving satisfactory portfolio performance is central to a prosperous retirement. Growth should be benchmarked to similar types of investments. Market averages, such as the FTSE 100 or the Dow Jones Industrial Average, are broadly cited as reference guides. But they only reflect the values of their components. There are other indicators for different types of investments. The Russell 2000 index aggregates US small companies’ performance. Non-US stocks can be held up to the MSCI EAFE index. Every financial publisher seems to have its own equities index. And there are indicators for debt positions, too.

Readers of this magazine do not have to be reminded that some caveats need to be understood, however, when it comes to comparing your own financial performance to an index. First, there is no broad index that matches your holdings or your objectives. The best you can do is to segment your portfolio and find public indicators that match these tranches.

Second, indices have neither expenses nor portfolio managers. Price movements are a reflection of other people’s market executions. Real market participants incur transaction costs when buying and selling securities that are the ingredients of the index proxy. In a sense, the individual investor has to outperform the market index to cover transaction and management costs and to achieve index results!

Third, there is the issue of survivorship. If a constituent company of the Standard & Poor’s 500 index becomes bankrupt (it happens!) and its equity value is erased, it is simply removed from the index and replaced by another company. The S&P index continues merrily on, but the owners of that bankrupt company have lost their investment and now have a hole that cannot be filled without the injection of new money. An index is made up of survivors; that is a hard track record for stock pickers to match.

If one had assembled a perfect mirror image of the S&P 500 in 1980 and held the shares until now, the value would be nothing like what the S&P 500 is today. Just look at the concentration of value in S&P 500 component companies today that did not even exist 20 years ago. These new companies have all replaced others who have disappeared one way or the other.

So, pursuit of excellent portfolio management is more athletic than might be otherwise appreciated. Reviewing funds management league tables makes that very clear. This begs a legitimate question for the private investor: how can you, with your limited resources, outperform the professional money managers, let alone the indices?

I doubt that you can. It is probably best to rely on others. That can be done by turning over your nest egg to a small number of fund managers or unit trusts. But there are risks there, too. A scan of investment manager league tables makes it abundantly clear that picking the right fund manager is as difficult as picking the right shares. Stick to the well-established managers with long and stable track records for most of your investments.

Fortunately, the investment industry is sufficiently large and visible to attract journalists and raters. Perhaps most prominent in this field is Morningstar in the US market. Whilst publishing subscription newsletters, some of its information is freely available on the company’s Web site, www.morningstar.com. Also, most brokers will subscribe to the service and will gladly share the information with their clients.

For investors with substantial personal holdings, investment advisory firms can help sort through the choices. Whilst some large accounting firms offer these services, independent specialist firms do very well, too. For instance, some target certain classes of investors, such as entertainment and sports celebrities or business executives. In this way, the financial advisor can recognise particular needs of individuals in those speciality classes and provide more appropriate advice.

These services are not free. Beware of those that are tied too closely to brokerage activity, as “churning” or over-active trading might result. Charges on a sliding scale based on the value of the assets under management are a more conventional approach. For a reasonably sized portfolio, this is often less than 0.5%. The direct benefit should be superior performance.

A first-class investment advisor will evaluate fund managers on a continuing basis. This is not something that you can realistically do yourself. After all, fund management is intensely personal. Just look at the high-profile comings and goings amongst the managers in the Soros group. Investment advisors, however, can stay in close personal touch with key fund manager personnel. In that way, the investment advisor can focus his efforts efficiently on a limited number of funds for all his investors who are interested in that fund style. This can be an enormous benefit in sifting through the myriad of fund management choices.

An investment manager can help the individual client build a balanced portfolio that strikes the appropriate balance between risk and reward. This will be achieved through taking proportioned positions in a range of investment vehicles. Done correctly, the occasional review and fine-tuning should be adequate to keep the portfolio within target bounds.

But the savvy private investor will also manage his investment manager. This can be done by occasionally questioning investment recommendations or by selecting an investment profile that more accurately reflects your interests and concerns. You do not have to accept the line that “all of our clients are in this”.

Some advisors understandably might be inclined to use measurement benchmarks that put their performance in the best possible light. The Bi-Modal Portfolio Analysis tool described in past columns can assure that you are measuring the advisor’s performance objectively and in your own way.

Profit & Loss

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