Broker Check

Wealth Building Approach

We Build Wealth

Investing your money is the last thing we want to do. That may sound like a strange statement from a money management firm. We really do want to manage your money. However, we do it right. And doing it right means knowing what we are doing before we start doing it.

Developing your financial plan is the first and most important step. A financial plan gives us the roadmap for your financial future by incorporating where you are today and where you want to be tomorrow. Once we have a good picture of your current situation, and once we understand your goals – both financial and personal – we can then develop the blueprint to build the financial structure that takes you where you want to go.

As an example of one piece of the financial plan, we will know how much money it may take to educate your children given your goals in that area (you`re willing to fund 100% of a state school but only 50% of private school). To project this need, we need to know what you have saved so far and in what form (UTMAs, 529plans, stock portfolio, etc.) We also need to assess your ability to put money towards this goal in the next many years. What other goals are competing with this one? Retirement? And which is more important to you if we can only afford to reach one of these competing goals? Can we compromise between the two? How flexible do you want the savings to be in the event you need to access them for another purpose? How will your taxes be affected by the method of saving for education? Might there be gifts from grandparents during the next few years? How should this gifting be done to minimize estate taxes and not affect possible financial aid adversely? These are only a few of the questions that need to be answered for just one goal of an average financial plan.

And we have not invested one dime yet.

By the time we have worked through your financial plan, we have assessed all of your financial goals, understood your personal goals, taken a snapshot of your current financial situation, estimated your insurance needs, established savings needs for each goal, developed strategies to minimize income and estate taxes, projected your retirement needs, and – finally – calculated your personal "required rate of return." This required rate of return is the earnings we need to make on your savings in order for you to reach your goals. You will need to save a certain amount of money at this rate of return in order to fund your goals.

We are getting closer to investing now.

The next step is to develop an asset allocation plan based on the findings in your financial plan. Our asset allocation model is based on Modern Portfolio Theory ("MPT"). Let us explain the history of MPT. In 1952 Harry M. Markowitz published his ideas on portfolio design, having completed his studies at the University of Chicago and joining the Rand Corporation. His dissertation explained models for applying mathematical methods to the stock market. Later publications of his groundbreaking book on portfolio theory earned him the Von Neumann Prize in Operations Research Theory in 1989 and then a Nobel Prize in 1990. His body of work has become know as Modern Portfolio Theory. While we usually label something that is 50 years old as an antique rather than modern, Professor Markowitz`s ideas were far ahead of the capabilities of computers to apply the theory. The computer hardware and software advances of the past two decades have changed this so that we may now actually apply the principles of MPT in our client`s portfolios. Professor Markowitz` theory head four basic premises:

Investors are inherently risk-averse. Investors are not willing to accept risk except where the level of returns generated will fairly compensate for that risk.
Markets are basically efficient. With advances in information technology and more sophisticated investors, the markets are likely to become even more efficient.
Portfolio characteristics, not individual security selection are the key to performance. The focus of attention should be away from individual securities analysis to consideration of portfolios as a whole predicated on explicit risk-return parameters and on the identification and quantification of portfolio objectives.
An optimal portfolio exists for any given level of risk. In other words, for any level of risk that one is willing to accept, there is a maximum rate of return that should be achievable in the long run. Quantitative methods are used for measuring risk and diversification, making it possible to create efficient and theoretically optimal portfolios.
While it is tempting for investors and professionals to focus entirely on investment returns, Markowitz emphasized risk and its relationship to investment return. Further, he focused attention on the overall composition of the portfolio rather that the traditional method of analyzing and evaluating the individual components. He discovered that you could design portfolios based on specific risk-reward descriptions and on the identification and quantification of portfolio objectives.

Markowitz`s theory has been proven by studies of actual portfolios. The studies found that efficiently allocating capital to specific asset classes is far more important than selecting the "right" components of those asset classes. A study conducted in 1986 by Brinson, Hood & Beebower, determined that on average 93.7% of the variability in the risk and returns of a portfolio could be explained by the asset allocation policy. These studies have dramatically supported the concept that asset allocation is the primary determinant of portfolio performance, with market timing and security selection playing minor roles. In other words, it`s more critical to be in the "right asset class" than the "right investment."

Given the above framework, we can now develop your asset allocation plan for your portfolio. Actually, we split all of your investments into three categories: 1) Non-Qualified assets – those not in retirement plans such as 401(k)s, 403(b)s, Roth IRAs, traditional IRAs, annuities, life insurance or any other specifically tax-advantaged investment. 2) Qualified assets – those assets that are not non-qualified and not invested in life insurance or annuities. 3) Annuity assets – assets invested in life insurance and annuities. Your assets are divided into these three categories primarily because of the differing tax ramifications of each investment. Each category will have a unique portfolio allocation, even at the same required rate of return.

We are back to that "required rate of return" from your financial plan. We take that required rate of return and build a portfolio for each category mentioned above. We can then examine the potential risks of investing at this rate of return. If you are comfortable with the ups and downs that this portfolio presents (based on back tests using historical returns and projections based on assumptions for future returns, standard deviations and correlations between asset classes) we move forward. If you are not comfortable, we find a rate of return representing a portfolio that lets you sleep at night. But then, of course, we need to go back and plug that new required rate of return into your financial plan and determine how to deal with the slower growth of your money towards your goals – find more money to save, postpone a goal, lower the goal`s need, etc. Conversely, we may find that you feel a portfolio is not aggressive enough for your tastes. Again, we would revisit the financial plan to see how a higher required rate of return impacts your goals. Once this iterative process is complete, we will agree on a portfolio (actually three of them) that work for you.

Finally, we determine the actual investments to utilize within each new portfolio. Examples could include stocks, bonds, exchange-traded funds ("ETFs"), mutual funds, separate accounts, variable universal life, 529 plans, SIMPLE plans, SEP plans, Roth IRAs, traditional IRAs, 412(I) plans, etc. We may invest funds all at once, dollar cost average, or a combination of the two methods. We determine the ownership of the assets based on your financial plan`s estate planning section in order to coordinate the investing and the estate planning. Depending on your tax planning within the financial plan, we may hold an investment in a child`s name, a trust, retirement plan, tax shelter, etc. Investing is not simply finding the "hot tip" and plunking some money down. We hope you appreciate the work and value of our approach. But we are not done yet.

We continually track each individual investment against its peer group and against its applicable index to determine its relative performance. We also review any management changes both at the fund level (if the investment is a mutual fund) and the corporate level. If an investment doesn`t stack up, it`s out.

We also periodically rebalance the portfolio to get you back to your original asset allocation mix. Over time, riskier investment classes (such as small cap growth) tend to grow faster than less risky investment classes (such as intermediate term government bonds). Thus, the small cap growth would become a larger percentage of the portfolio than originally desired. Essentially, we sell some of the small cap growth and buy some of the intermediate term government bond to get us back to the original allocation. We do this at least once per year, and in times of extreme market volatility, we may rebalance at differing intervals.

Finally, we revisit the asset allocation plan at least bi-yearly to completely recalculate the portfolios because the assumptions within the model will have been updated, your financial plan will have been revised, and the financial markets will have evolved to the point where new categories of investments may need to be added to the mix.

This is obviously an exhaustive process. But it is the right process. It mitigates the tendency to follow trends (such as the recent technology and telecommunications debacle). Through rebalancing it forces us to buy low and sell high; it includes more esoteric asset categories such as small cap value and global bond that normally would not be considered when investing and it works.

This is how We Build Wealth.