Words by: Bryon Gragg
Published March/April 2011
One of my favorite material possessions is my satellite radio. I can tune into a variety of different channels and always find something of interest. It has music channels, talk channels, sports channels and comedy channels. Depending upon your mood, you can listen to alternative music from the 1980s, jazz, rap, rock and music from the 1940s or any other decade for that matter.
After a stressful week recently, I had the opportunity to spend about an hour and a half alone in my car while driving to my in-laws house. I had my large cup of coffee and the satellite radio set for the trip. The day was overcast but still nice enough to open the sunroof and enjoy the fresh air. So off I went, coffee mug steaming and channel 33 on the radio: life was good. Starting off with music from my college years, I listened to a couple songs, then switched the channel to a ‘70s station. I caught the last half of “It Never Rains in Southern California,” a song I remembered from my childhood and hadn’t heard in years. The next song wasn’t so good so it was back to channel 33 where I caught a portion of a Pixies song. Soon I was off to another channel and more song switching, never really getting to hear more than one or two complete songs at a time.
As my drive continued, I started thinking about what I was doing and how it is exactly what we advise against in dealing with the investment portion of a client’s financial plan. A lot of people continually chase the latest hot-performing sector or class. In doing so, they only capture a part of the performance and must continually switch between the sectors or different asset classes. It is almost impossible to predict which asset class will be the best-performing or worst-performing in any given year. I’m not saying it can’t be done, only that it can’t be done on a consistent basis. Each class can have drastic periodic changes. To have an effective strategy switching between the asset classes you must be right every time. That means you have to know when to get out, when to get back in, when to get out again, and on and on. Good luck with that method.
In our opinion, a better alternative, which is backed up by academic research and historic data, is a properly diversified portfolio that will allow investors to reduce the risks associated with investing. By allocating your assets over different investment classes as determined by your goals and risk tolerance, you can reduce the volatility of your portfolio. Asset allocation is one of the most important decisions you can make as an investor. Recent studies have found that over time asset allocation makes up approximately 91 percent of the factors contributing to the performance of a portfolio. Market timing contributes another 2 percent, security selection accounts for another 5 percent and all other factors total 2 percent. Obviously, you can control the asset allocation and security selection and in doing so control approximately 96 percent of the factors affecting performance. You can’t control what the market does but if you think you can, we would love to talk to you about it.
If you are thinking about mutual funds you’ve held for many years and how you haven’t deviated from “staying the course” with those, you may want to examine the turnover ratio of your fund. The turnover ratio is the percentage of the fund’s holdings which have been replaced during the year. A higher turnover ratio means there is more selling and buying going on within the fund. This constitutes a friction such as fees and taxes that reduce your investment gain. So even if you’ve held a fund for many years, the underlying holdings may have changed drastically.
Just as I was changing the stations and not getting the entire song, investors who change their strategy, or worse, don’t have one at all, tend to miss the greatest performances. Develop the appropriate strategy for you, monitor it carefully and stick with it. Sure, you may hear some bad songs along the way, but the end result will be a trip with less anxiety, work and stress when you arrive at your destination.