Issue 38 • august 20, 2009

Investing 101: Why Not Just ‘Set It and Forget It?’

Why Proactive Diversification May STILL Be
Your Best Approach!

Several weeks ago, Weiss Capital Management launched a unique new investment strategy: The Weiss All Weather Managed Account. The goal: To provide investors with a reasonable rate of return over time without taking on unreasonable risks. This may sound like a simplistic investment objective, but in reality, there’s much more to this concept and to this program.

This new strategy invests in a diversified mix of securities, with potential holdings in everything from stocks to bonds to cash. The entire spectrum of global markets is fair game, even commodities and other “special situation” asset classes (using mutual funds or ETFs) may also be included.

We have found that a broad-based diversification model forms the cornerstone of many successful investment strategies, and so it is the bedrock of our Weiss All Weather Managed Account.

Yet, while diversification is key to a well-rounded portfolio, diversification alone may not be enough ... as many investors found out the hard way last year, when almost all asset classes plunged in 2008 (See graph, above).

That’s why a key factor in our All Weather Managed Account — and really MOST of our professional investment strategies at Weiss — is the ability to dynamically shift not only particular holdings, but also portfolio weightings among various asset classes with the goal of staying ahead of ever-changing market conditions.

At Weiss, our Financial Advisory team continually stresses the importance of proper diversification as a great starting point for every investor’s portfolio. I recently discussed this topic at length with Lance Millar, one of our Weiss Financial Advisors.

Lance works closely with a number of our clients to help determine which of our investment strategies are best suited to help them achieve their financial goals. And since I have a very busy schedule this week, I asked Lance to share his insights with you in today’s issue of Weiss Advice ...

As a Financial Advisor at Weiss, a big part of my day is spent listening and learning. Clients and investors talk to me all day — every day — about their money. I hear fascinating stories about how they’ve earned it ... and importantly, how they want to make their savings work for them.

Usually, the first step in this process is providing prospective clients with a complimentary portfolio evaluation. This is the first step in a “financial check-up” of your existing portfolio and something that we provide — at no charge — to give you a second opinion about your current investments and your portfolio allocation overall.

Just last week, I had a conversation with a prospective client that really struck a chord with me.

While reviewing and discussing his portfolio, he told me that his ultimate goal was to just sell out of the stocks, mutual funds and ETFs he owned. After more discussion, I realized that what he really wanted was not so much a portfolio “review” ... but a timing recommendation for liquidating all of his holdings, allowing him to leave the proceeds in cash.

After reviewing his past performance, I could see why. His investment net worth had declined over 50% during the worst parts of the market decline. And even though he had previously enjoyed excellent performance investing in stocks, bonds and mutual funds, his losses seemed too much to bear and he was now looking for a way to call it quits.

Like many investors, this gentleman was shell shocked by the extreme up and down volatility he had experienced in markets, and after losing over $1 million in the past 18 months, he had had enough and was ready to “throw in the towel!”

I can’t blame him for feeling this way but he certainly isn’t alone. Consider the facts: According to Bloomberg, US household wealth fell by $5.1 trillion in the last three months of 2008 alone!¹ Very few investors escaped this bear market unscathed. And countless investors I have talked with in recent months feel the same way.

That’s the reason I felt compelled to write this article for Weiss Advice ... to explain why “throwing in the towel” might not be the best investment strategy to follow right now.

‘I’ll Never Buy Stocks Again!’

First, let me provide you with some background: 2008 was a historic year for investors … to put it mildly. Just take one look at your year-end 401k or IRA statement and you’re likely already well aware of this fact.

Suffice it to say that few investments (besides cash and Treasury bonds) provided you with much, if ANY return last year.

As stocks moved higher from 2003 to the Fall of 2007, many investors who had turned sour on stocks after the dot.com bubble burst, decided to gradually ease back into the market again. But, as it turned out, this rally was only temporary.

Now, after suffering a SECOND epic bear market decline, triggered by an historic housing bust and financial crisis, many folks I speak with have sworn off investing in stocks for good.

Emotionally, such sentiment is understandable given the circumstances, but, given the larger picture, most likely it is still off the mark. In fact, throwing in the towel now could be just as big a mistake as piling all your money into stocks with reckless abandon near the peak in 1999 ... or into real estate in 2007.

Granted, those in the “never again” camp can point to statistics that show short-term Treasuries, CDs or other “safe” investments have outperformed stocks since 2000. When compared to the -3.1% annual returns of the S&P 500 over that same time period, cash may seem like the way to go as we get ready to close out this decade.²

But, I’ve found that history always tends to look different depending on which magnifying glass you use. If you look at a different time period … say the past 15 years (7/1/1994 to 6/30/2009), you’ll see that stocks returned nearly 7% per year. Going back 20 years, the return is almost 8% per year. It all depends on your point of view.³

Ultimately, you must realize that no single index, investment or strategy performs best ALL of the time. You can be sure that whatever strategy is in favor now will eventually fall out of favor. Unless you have a great sense of timing, or are just willing to take on a lot of risk, usually you’re better off if you use a time-tested investment tool like: DIVERSIFICATION.

Spreading Your Bets: How Proper Diversification Still Works for You

Diversification means spreading your money among different asset classes (stocks, bonds, cash and alternative investments) to help reduce volatility and provide the potential for more consistent returns over time. Why? Because you just can’t be sure which investments — or which asset classes — are going to perform best next year, or over the next five years and you want to be sure you benefit when they do. Take a look at the chart below ...

What this “checker board” tells us is that different asset classes, or “strategies,” perform very differently ... not just over a long period of time, but also from one year to the next.

Take a closer look at the chart (click on the graph to view in full-size), paying attention to the color of the assets that are at the top each year, and you’ll see that only once in the past 20 years has the same asset class delivered the best annual total return two years in a row (Emerging Market Stocks in 1988 and 1989).⁴

More common is the wide disparity in returns from one year to the next. Taking Emerging Market Stocks again as an example, 2007 shows a healthy +39.8% return ... at the head of the class! But only a year later, in 2008, this asset class tumbled to the bottom in terms of performance, plunging -53.2% for the year.⁵

The truth is … markets go up and markets go down. If markets are going up, human nature may persuade us to let down our guard and invest more aggressively in the areas that have recently performed well. If markets are going down, we want to be out of the market and into cash, for example.

In other words, investors want to be aggressive in bull markets and conservative in bear markets.

Ah, but this is easier said than done, because it requires excellent timing as well as the ability to predict future returns. A more realistic goal might be to invest knowing that you may forego some of the big gains in the good years for the benefit of limiting your losses in the bad years.

By avoiding BIG losses, you’ll usually come out ahead over the long term, even if you only earn modest gains during the good years.

This is a key point for investors to understand, because, after taking a big loss ... it takes an even larger gain just to break even. For example, if your portfolio falls 10%, it only takes a gain of 11.1% to get back what was lost. However, if you lose 50%, you’ll need to double your money ... you’ll need a 100% gain just to break even! You can do the math for yourself.

In addition to the mathematics involved in recovering investment losses, harder still can be the psychological impact of sustaining big losses. Many investors have not been able to bring themselves to wade back into stocks after suffering big losses recently, leading to even more uncertainty (“I lost a lot, sold everything … and now I’m sitting on the sidelines, missing my chance to make some of it back!”).

And this thinking is not just limited to individual investors either. In fact, as of last week, over $2 trillion was still sitting “on the sidelines” in institutional money market funds.⁶

All Weather Asset Class Diversification

The reality is that most investors seek to steadily grow their assets over a long period of time, and diversification should play a key role. Ideally, a properly diversified portfolio should contain several non- or, at least, low-correlated assets. In other words, different types of investments that DO NOT move up or down in lockstep with each other over a typical market cycle.

Not only should there be representation in your portfolio amongst the broad asset classes (stocks, bonds, cash and alternatives), but also in terms of the sub-categories for each broader asset class.

For example, within stocks, there are several sub-categories to consider:

Small-, mid- and large-cap stocks.

International- and domestic-based stocks.

Stocks representing different sectors, such as mining, utilities and consumer staples.

Within the fixed-income category, there are also different sub-categories of bonds:

International and domestic bonds.

Treasury, municipal, corporate and convertible bonds.

Bonds with short-, mid- and long-term maturities.

Instead of relying on market timing to keep your portfolio on track, a properly diversified (and hedged) portfolio should do the work for you — giving you the confidence to stay invested through all kinds of market conditions. But be careful not to confuse “staying invested” with “buy-and-hold” investing — there is a BIG difference.

Buying and holding tech stocks, for example, was a great strategy in the 1990s. Even if you held during periodic sell offs, you still came out way ahead ... that is, until 1999.

Over the next three years, however, tech stocks plunged 75% in value (using the Nasdaq as a proxy). Even today, 10-years later, buy-and-hold investors are STILL waiting to “break even” on the Nasdaq!⁷

By “staying invested,” what we mean is: you keep your portfolio invested, but in different asset classes all the time and at varying percentages, depending on changing market conditions. You’ll still experience losses from time to time in certain asset classes — because some losses just can’t be avoided — but you’re also likely to earn gains in other classes at the same time.

By using professional management approaches, which provide for proper diversification and active rebalancing, typically losses can be reduced. The goal is to keep your wealth growing over time at a reasonable rate, but without taking unreasonable risks to do so.*

For example, instead of selling everything and going to cash when the stock market declines, you might consider shifting your assets into a more defensive position (more fixed income, for example) to help lessen the impact of losses, while keeping your money “working” for you.

Finally, another important element of successful investing involves your expectations.

As much as choosing the right mix of investments, having realistic expectations about market returns should help temper the desire to “chase” good performance. Just think about all the investors who rushed into emerging markets after a +39.8% return in 2007... just in time to LOSE -53.2% the very next year.

It is tempting to want to “get in on the action” and be more aggressive when you see big gains, or to sell when your portfolio is declining in value, but experience has taught us that it is better to resist this urge, and stick to a prudent investment strategy in all markets.

That’s also a key advantage of active, professional guidance. At Weiss Capital Management, we do this all for you.

The Weiss All Weather Strategy

For more than 25-years, Weiss Capital Management has focused on protecting and growing wealth. We have developed 12 unique, customized investment programs that span the spectrum of return vs. risk ... from fixed-income strategies to more aggressive global investment programs. The ultimate goal of our core investment programs is to produce absolute returns that outperform the broad market indexes over a full market cycle ... in both good times and bad.

One of these strategies is specifically designed to provide an all-weather investment approach.

The Weiss All Weather Managed Account is a core strategy that invests proactively across many different asset classes. We designed this strategy to be diversified, hedged and opportunistic … the goal is to help you preserve, protect and potentially grow your wealth in all market conditions ... both good and bad.

To learn more about the Weiss All Weather Managed Account, or for more information about any of our professionally managed strategies that may be appropriate for your investment needs, contact any of our Weiss Financial Advisors today at: 1.800.814.3045.

Sincerely,

Lance Millar
Financial Advisor
Weiss Capital Management, Inc.

* All investments carry risk, the All Weather Managed Account strategy is no exception. It is possible to lose money by investing in this strategy. Before investing, please review all strategy materials & the firm’s ADV Part II.

¹ News N Economics: Record wealth loss in 2008; saving rises, 3/13/09
² Bloomberg market data, 8/19/09
³ Ibid
⁴ FMR Co. (MARE) as of 6/30/09
⁵ Ibid
⁶ Federal Reserve Bank of St. Louis: U.S. Financial Data, 8/13/09
⁷ Bloomberg market data: 8/18/09