NEWSWEEK: There’s a big industry devoted to telling folks they can handle their investments themselves. So why do we need you guys?
HOPEWELL: Let me explain it with a metaphor. If you were planning your dream home, you wouldn’t talk about nails or bricks or paint. You’d talk about the number of bedrooms and bathrooms, and whether vou want a gourmet kitchen. You’d talk about how your lifestyle would influence the home’s design. Form follows function in architecture, and it should be the same way in investing. That’s exactly the opposite of how most people do it-most people back into their investment strategy. They eclectically collect odds and ends, a fund here and a stock there, instead of having a deliberate plan. You should design and then build. A professional helps you create the best design.
First we look at “investment policy,” which is just a fancy name for how long your money will be invested, your tax situation, your liquidity needs and your risk tolerance. From there we get into the portfolio design, which is where the action is-it’s where professionals like us really earn our keep. The product of this is an asset allocation, which is basically a pie chart that divides up where you should invest your money There’s a danger in trivializing this because it looks simple, but research has shown that asset allocation accounts for more than 90 percent of investment results. Here’s what that means: the decision on how to combine the fund in your portfolio is paramount. The value added by picking individual securities is very small compared with the value of getting the combination right.
To keep it simple, someone who’s got a long horizon-say someone who’s 30 and is investing for retirement, should be 100 percent in stocks. But it’s not that simple. For example, even a retirement portfolio that’s 100 percent in stocks should be split between U.S. and international, growth and value, small and large companies. The best thing amateurs can do is make sure they’re fully diversified: that a piece of their portfolio is invested in each of these categories. This will increase return and reduce risk. It’s counterintuitive, but adding a risky asset, like an international fund, can reduce the risk of your portfolio because it will perform differently at different times than a safer asset, like a bond fund.
As you get older, you have less time to recover from mistakes. If yoifre 30 and the market drops 25 percent, who cares, but if you’re 60, it matters a lot more. So as people get into their 40s and 50s, they have to slowly start backing away from stocks and expose themselves to less risk. Planning for people at this age can also be more complicated because they’re investing for different purposes. For example, a 40-year-old might have to plan for his retirement while at the same time he’s saving for his 15-year-old’s college education. So he must segregate the college money and invest it in safer assets, while he’ll be much more aggressive with his retirement portfolio. But even as you approach retirement, you can’t back away from stocks too much, because you have to worry about maintaining the purchasing power of your money and beating inflation. Our clients who’ve just retired and are in their 60s are still 60 percent invested in stocks. They could easily have 25 or 30 years of investing left, and we have to remember the later years as well as the early ones. If you opt for a “safer” strategy and put all your money in CDs, you’ve solved one kind of risk, but you’ve opened yourself up to inflation. There’s no getting away from risks. There’s only recognizing them, managing them and deciding which ones you can afford to take.
We don’t use any tangible assets, like gold or cattle. Somebody once said that if it grows, eats or glitters, we don’t use it. It’s not that you can’t make money in commodities, but it takes an expert to make money in them. We also don’t invest in emerging markets. They’re too speculative for most peoplethey’re as likely to drop in half as to double. Deciding what not to get into is as important as deciding what to get into.
You really have to do your homework and kick the tires, just like when you buy a car. There are really two levels to the process. The first is deciding what kind of fund you need, which is like deciding between whether you need a truck or a convertible. If you need a domestic large-company value fund, you need that and not something else. You can’t expect the funds to be much help with this -the fund names are of almost no use -but you can find out what a fund does if you look at it closely enough. This is called “style analysis,” and it’s a hot topic right now. Take Fidelity’s Magellan Fund. Over the last 10 years it’s gone from a small company fund to a large-company fund. There’s nothing wrong with that, but there are Magellan shareholders who don’t know that-their portfolio may be overweighted with large-company stocks as a result. Understanding the true nature of a fund and making sure that it stays true to its role in the portfolio is important. When you’re building your dream house and you hire the electrician, you don’t want to find him fiddling with a piece of plumbing. It’s the same thing with funds. Morningstar’s newsletter features an investment-style box, and it’s the most useful piece of information in the publication.
Once you’ve found the funds that fit the style you need, look at each one and decide whether the manager does his job well. We don’t focus on performance-over time, managers’ performance tends to be all over the map. We do focus on the fund’s expenses, especially with bond funds, where it’s difficult to beat the market by much. But for all types of funds, if you can increase returns by decreasing costs, you’ve increased returns with no added risk. What a deal!
It’s not. What’s absolutely deadly for people is for them to get excited about investing. The most important parts are dull, and they should be -they involve technical concepts like standard deviations and correlations of return. What’s exciting about investing most of the time is the gambling element: making bets and winning and losing. It’s the same thing that’s exciting about roulette and poker. I don’t deny that those games are exciting-I enjoy playing them myself-but you don’t want to gamble with your investments, to turn it into a game or a hobby. I tell my clients to cancel their subscriptions to The Wall Street Journal. It just gets them in trouble by focusing their attention on the short-term.
PHOTOS:I tell clients to cancel subscriptions to the Journal: Hopewell in Manassas, VA
As Hopewell says,designing the perfect portfolio takes technical skills most amateurs lack. But don’t give mutual-fund worksheets create a portfolio of funds, and the, two big discount brokers, Schwab and Fidelity, offer software that makes the calculations even easier. And cybersavvy investors who opt to go it alone can find some decent advice on the World Wide Web.
Many of the big fund companies, from Fidelity to Twentieth Century to Invesco, have set up pages on the Web, the fastgrowing portion of the Internet that users navigate with browsing programs like Mosaic. At Fidelity’s home-page users can get detailed information on any of Fidelity’s funds, complete a simple worksheet that calculates a rudimentary asset allocation or enter a contest to win a CD-ROM drive by guessing the Dow’s close. Perhaps the best all-around “Net” resource for fund investors is a site called NETWorth. Its advantage: unlike the fund companies’ pages, it contains data on funds from a different companies. It also has a screening function. Looking for a small company fund with a sales charge of 4 percent or less?, NETworth will list dozens in less than a minute.
To find these and other Web sites with information on fund investing, find your way to Yahoo (http://wwwyahoo.com/) and plug in ‘mutual Fund" to its search engine. The advice won’t be as custom-tailored as you’d get from a professional, but the price is right: other than what you pay to get onto the Net, it’s free.
