Dialogs Spring 2010


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Dialogs Spring 2010

  1. 1. Dialogues WEALTH STRATEGIES FOR DISCUSSION Baby Boomers are redefining retirement, and we take a fresh approach to helping clients plan for this new set of values and associated challenges. We advise clients at every stage of retirement planning to be financially prepared in order to live fully during their retirement years. SPRING 2010 COURTESY OF Approaching the Unpredictable HARVEY J. ZIEGLER If you could predict the future, just think how different your life would 101 S. Hanley Rd. be—you’d always know which day to bring an umbrella, you’d never have to Suite 600 grapple with tough choices like whether to accept that new job offer or buy Clayton, MO 63105 Phone: 314-889-4888 that new house and you’d be hailed as a genius for your uncanny ability to Fax: 314-854-5606 pick the Super Bowl winner each year. Tollfree: 800-325-0630 harvey.j.ziegler@smithbarney.com But you can’t predict the future, so you do what everyone else does—you try http://fa.smithbarney.com/harveyziegler/ to make the best possible decisions for your situation based on the informa- HARVEY J. ZIEGLER, CFP® Financial Advisor tion that is available. As a prudent investor, this approach should carry over to your investment portfolio, which is why you hear and read so much about the concepts of asset allocation and diversification. The whole point of asset allocation (the spreading of funds across different asset categories, such as stocks and bonds) and diversification (the spreading of funds across different investments within each asset category) is to help smooth some of the surprising and turbulent price swings that are an inevitable part of life in the financial markets. By spreading out your invest- ments, you also spread out—and possibly reduce—your overall risk. What’s more, you may improve your longer-term returns as well, by giving your portfolio the opportunity to spend more time compounding and growing and less time trying to play the market’s ups and downs. A prudent, long-term investment strategy built on the sound principles of asset allocation and diversification may help your investment portfolio be more successful in today’s uncertain world. We can review your current strategy and allocation to see if there’s an opportunity to make your wealth work harder for you—and to do so with less risk. And take comfort in knowing that life is much more interesting when it includes the occasional surprise. I Diversification does not ensure against loss. Morgan Stanley Smith Barney LLC. Member SIPC. 153678
  2. 2. DIALOGUES//2 The Diversification Advantage Sharp price swings like the ones seen in the past year are an inevitable part of life in the financial markets. They also serve as an important have given the word a much more partially offset each other, reducing over- reminder of how diversification—the specific meaning. Beginning in the all portfolio volatility. The chart on this spreading of funds across different invest- 1950s, financial researchers realized page shows the historical correlations ments within asset categories such as that by combining different assets, they between a number of popular asset classes stocks and bonds—can reduce the risk of could, in theory, create portfolios that and the Standard & Poor’s 500 Index. a single catastrophic loss, such as a com- would deliver higher returns with less pany bankruptcy or a bond default, wip- risk than any one asset would by itself. Correlation isn’t the only factor that needs ing out an entire portfolio. This insight spurred the creation of a to be taken into account when building disciplined, fact-based approach to diversified portfolios. The expected risks But the potential benefits of this approach diversification, sometimes known as and returns for each asset also help deter- actually go much further than that. Modern Portfolio Theory (MPT). mine whether including it can produce Diversification may also help you achieve gains. Other things being equal, the higher higher returns—at lower risk—than any One of the keys to MPT is the fact that the expected return, the more likely it is single asset in your portfolio could by returns on different assets usually aren’t that adding an asset to a portfolio will itself. Even assets with relatively low fully correlated—meaning they don’t improve performance. Likewise, the lower returns may actually boost overall invest- always move in the same direction at the the expected volatility, the more likely an ment performance, if their risk and return same time or by the same amounts. This asset is to improve performance. characteristics are sufficiently different means that returns on different assets may from the other assets in the portfolio. It may be hard to understand how investing in an underperforming asset could lead to A Question of Correlation better portfolio performance. But that is Correlation is measured on a scale of -1 to +1. If the correlation between precisely what makes diversification such a the returns on two different assets is +1, they are said to be perfectly powerful tool. Just as a high-grade steel correlated. Their returns always move in the same direction at the same alloy can be created by combining other time and by the same amounts. materials, it may be possible to create a stronger portfolio by combining stocks, If correlation is less than +1 but more than zero, assets are said to be bonds and other financial assets. Properly positively correlated. Returns move in the same direction more often done, a sound asset allocation strategy may than not. If correlation is less than zero, assets are said to be negatively reduce portfolio volatility and may lead to correlated. Their returns tend to move in opposite directions, by opposite faster growth over time. amounts. Positive correlation reduces but doesn’t eliminate the benefits of diversifi- A THEORY OF DIVERSIFICATION cation. As long as the correlation between two assets is less than +1 (less Prudent diversification isn’t just about than perfect) it may be possible to improve performance by including them adding more stocks or bonds to your in your portfolio. portfolio. Years of investment practice
  3. 3. THE DIVERSIFICATION ADVANTAGE DIALOGUES//3 Notice the line connecting the portfolios This same basic logic still applies when CORRELATION WITH THE S&P 500: 1990 THROUGH 2007 isn’t straight, but rather curves up and to other asset classes—such as small-cap the left before swinging around toward the stocks, international equities or even 0.90 0.79 0.83 all-stock portfolio. This is the diversification alternative asset classes such as hedge 0.70 0.61 0.61 dividend in action. funds or real estate—are added to the portfolio. But the process of deciding 0.50 Historically, equity returns have tended 0.30 0.10 0.07 what share, or “weight,” in the portfolio -0.10 -0.04 to be more volatile than bond returns. should be given to each asset class does -0.30 Investment- Grade Bonds T-Bills High-Yield Bonds Emerging Markets International U.S. Small- Developed Cap Stocks Yet, because bonds and stocks are not become more complex. perfectly correlated, adding stocks to an Markets -0.50 Source: Citi Global Investment Committee all-bond portfolio historically has reduced You do not have to grapple with the com- volatility—at least, up to a point. Lower plexities of diversification or portfolio opti- volatility has also improved returns, mization on your own. Speak with us for Correlation, return and volatility—all three pushing the line up and to the left. more information about these processes and need to be taken into account when design- how you might be able to get more out of ing diversified portfolios. This process is Over the period shown, the portfolios to your portfolio over time—with less risk. I called portfolio optimization. It’s a complex the left of the dotted line on the chart procedure, in which mathematical formulas delivered better performance than the all- are used to compare the returns, volatility bond portfolio, even though they contain RISK AND RETURN RESULTS FOR and correlation of each asset class. increasing amounts of stocks, a riskier asset. STOCK AND BOND BLENDS: TWENTY Eventually, though, the higher volatility YEARS ENDING DECEMBER 2007 associated with stocks overwhelmed the RISK AND RETURN diversification effect, pushing the line back 12% The chart to the right is a simple example toward the right-hand side of the chart. 100% of how diversification can influence ANNUALIZED RETURN Stocks 50% Stocks performance. It displays risk-and-return The bottom line: Over the period shown, a 11% results for different portfolios consisting of blend of 50% bonds and 50% stocks was large-cap U.S. stocks and long-term govern- less risky than an all-bond portfolio, but 10% ment bonds. The portfolio at bottom left is produced more than two percentage points 100% 100% bonds; the next one is 90% bonds of extra return. 9% Bonds and 10% stocks; the next is 80% stocks 6% 8% 10% 12% STANDARD DEVIATION 14% and 20% bonds; and so on until you Over a 20- or 30-year period, this can Source: Smith Barney reach the portfolio at upper right, which add up to a big increase in the value of is 100% stocks. a portfolio. 1 Investments: Analysis and Management, Sixth Edition, by Charles P. Jones, Wiley & Sons, 1998; Modern Investment Management: An Equilibrium Approach, by Bob Litterman, Wiley Finance, 2003, and the Private Bank Brochure Whole Net Worth Asset Allocation, Citigroup, 2003. Diversification does not ensure against loss. The S&P 500 Index is an unmanaged, market-value-weighted index of 500 stocks generally representative of the broad stock market. An investment cannot be made directly in a market index. Bonds are affected by a number of risks, including fluctuations in interest rates, credit risk and prepayment risk. In general, as prevailing interest rates rise, fixed income securities prices will fall. Bonds face credit risk if a decline in an issuer’s credit rating, or creditworthiness, causes a bond’s price to decline. High-yield bonds are subject to additional risks such as increased risk of default and greater volatility because of the lower credit quality of the issues. Finally, bonds can be subject to prepayment risk. When interest rates fall, an issuer may choose to borrow money at a lower interest rate, while paying off its previously issued bonds. As a consequence, underlying bonds will lose the interest payments from the investment and will be forced to reinvest in a market where prevailing interest rates are lower than when the initial invest- ment was made. As further described in the offering documents, an investment in alternative investments can be highly illiquid, is speculative and not suitable for all investors. Investing in alter- native investments is only intended for experienced and sophisticated investors who are willing to bear the high economic risks associated with such an investment. Investors should carefully review and consider potential risks before investing. Certain of these risks may include: loss of all or a substantial portion of the investment due to leveraging, short selling, or other speculative practices; lack of liquidity in that there may be no secondary market for the fund and none is expected to develop; volatility of returns; restric- tions on transferring interests in the fund; potential lack of diversification and resulting higher risk due to concentration of trading authority when a single advisor is utilized; absence of information regarding valuations and pricing; complex tax structures and delays in tax reporting; less regulation and higher fees than mutual funds; and advisor risk. Individual funds will have specific risks related to their investment programs that will vary from fund to fund. Actual results may vary and past performance is no guarantee of future results. Past performance is no guarantee of future results. These strategies do not guarantee a profit or protect against a loss and may not be suitable for all investors. Each customer’s specific situation, goals, and results may differ. This data is being presented for il
  4. 4. DIALOGUES//4 Ten Steps to Selecting an Elder Care Attorney Finding a Compassionate and Experienced Professional An elder care attorney can provide 3. Determine if the attorney is qualified. 7. Prepare for the second interview. Ask advice in a range of areas, including: At the first interview, ask basic questions: follow-up questions, and bring personal disability issues, health care proxies, living What percentage of your practice is devoted documents you wish to discuss, such as wills, powers of attorney for health care and to elder care law? What types of problems estate-planning instruments and insurance finances, plans in the event of incapacity, have you handled? Ask for references. policies. long-term care insurance, Social Security claims, guardianship issues, general life 4. Understand the network of 8. Get specific. Ask each attorney how he insurance, trusts and wills. professionals. Elder care requires a or she would address a particular situation; holistic approach that involves a team of a proposed plan should make sense to you. specialists; your attorney should not be HERE ARE TEN STEPS TO GO ABOUT the lone ranger. 9. Select your elder care attorney. You FINDING ONE: want someone who is qualified, with 1. Identify prospective attorneys. Talk 5. Discuss fees. You want someone who whom you are comfortable, who has a to people who work with elder care is reasonably priced and has a fee schedule network of people they work with and is attorneys. Consult the AARP, the local that is comfortable for you. The most reasonably priced. state bar association and the National expensive is not necessarily the best. Academy of Elder Law attorneys. 10. Put it in writing. Having a written 6. Contact references. Was the attorney agreement (or a retainer agreement) 2. Schedule screening interviews. Find proactive? Responsive? A good advocate? can help ensure that your expectations an elder care attorney with whom you feel Any regrets or concerns? are met. I comfortable working. Do they call you back promptly? How do they sound on the phone? What is their office like? © 2009 Morgan Stanley Smith Barney LLC and its affiliates do not provide tax or legal advice. To the extent that this material or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Any such taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.