Welcome to the Kalorama Wealth Strategies Quarterly Market Review.
These quarterly briefs update the performance of the financial markets
and provide commentary on topics affecting investments.
Building on first-quarter gains, bullish sentiment and continued
mergers & acquisitions activity led stock indices higher in April and
May. Despite a choppy June, broad stock measures posted across-the-board
advances in the second quarter of 2007. Leading the way was
International Emerging Markets, leaping 15.1%. The runner up was
Domestic Large Cap Growth, rallying 6.9%. Reversing a long-term trend,
Domestic Large Caps outpaced Domestic Small Caps, while Growth bested
Value. On the downside, after multi-year advances, real estate stocks
hit the skids, retreating 9.7%.
Bond yields moved up in the quarter, leaving most bond indices in the
red. International Emerging Markets dipped
1.1%, Global Aggregate lost 0.9%, Municipals shed 0.7%, and U.S.
Aggregate slipped 0.5%. The only winner for the period was U.S.
Corporate High Yield, eking out 0.2%. Although the Federal Reserve
maintained the Fed Funds rate at 5.25%, the yield on the 10-year
Treasury Note added 39 basis points for the quarter to 5.03% (the yield
as of July 10th was an unchanged 5.03%). Concerns about inflation saw
the yield on the 10-year Note rise upwards of 5.25% during the quarter.
Below are rates of return for selected market indices for the second
quarter of 2007, year-to-date 2007, and the three, five, and 10-year
averages as of December 31, 2006.
Commencing Countdown, Engines On!
Does Your Financial Advisor Follow an Investment Management Process?
Ground Control to Major Tom, commencing countdown, engines on! From
David Bowie's fictional Major Tom to NASA's space-shuttle astronauts,
aviation engineers follow a process to achieve their goal of executing a
successful mission. Do you or your financial advisor follow a process to
reach financial goals? Although probably not quite as complicated as
rocket science, whether your countdown is to retirement, education, or
another important goal, using a process should enhance your chances for
success.
In April, we wrote about Portfolio Spring-Cleaning (See Portfolio
Spring-Cleaning Revisited at
www.kaloramawealth.com/news.html) to provide a framework for
"what" should be done to organize and optimize the performance of your
portfolio to achieve your goals. This article discusses the "how" of
Portfolio Spring-Cleaning by providing the steps in the Investment
Management Process.
There is much more to investing than simply buying the next great idea.
What a disciplined investment process lacks in excitement, it more than
makes up in long-term profits. Whether your portfolio is large or small,
you or your advisor should follow a disciplined process which begins
with a thorough understanding of your long- and short-term financial
goals, tolerance for risk, and tax situation. Only after these items are
known, can an appropriate asset allocation strategy be developed which
is consistent with your unique situation. The portfolio is then
constructed with specific investments to fill the proposed allocations.
The process becomes continuous with ongoing monitoring, periodic
rebalancing, and performance reporting.
This process, which is the same approach used by large institutional
investors such as pension funds and endowments, should also be used by
individual investors. The process is summarized in seven steps:
Step 1: Define Investment Objectives and Constraints
Each investor has a unique combination of goals, time horizons,
liquidity needs, tax circumstances, risk tolerances, and attitudes
towards investing. These investment objectives and constraints are
defined to determine investment strategy and which types of investments
are appropriate for the construction of the portfolio. A questionnaire
and interview are typically used to assess your objectives and
constraints.
Step 2: Develop Target Asset Allocation Strategy
Once your objectives and constraints are known, a target asset
allocation strategy is developed to reflect risk tolerance and desired
rate of return. Asset allocation is the distribution of investment
dollars among various asset classes, such as stocks, bonds, and cash,
and the diversification of investments within each of those asset
classes.
The asset allocation strategy should be formulated through a disciplined
methodology. The first and most important step is to determine the broad
portfolio balance between equity (stock) and fixed- income (bond)
investments. This decision concurrently determines the portfolio's
long-term expected rate of return and the level of volatility around the
rate of return. The next step is to diversify the portfolio within the
broad stock and bond asset classes with a strategic mix.
Step 3: Evaluate Current Portfolio Asset Allocation
Your current asset allocation and investment positions are evaluated to
determine which asset classes are over- or under-weighted compared with
the proposed target allocation.
Step 4: Develop Investment Policy Statement
An Investment Policy Statement (IPS) is prepared which describes your:
goals, objectives and constraints, and risk tolerance; asset allocation
strategy; performance measurement criteria; as well as any special
considerations in the management of your portfolio. An IPS provides a
description of how the portfolio will be constructed and managed and
helps to keep you committed as markets rise and fall. It also helps to
ensure that your portfolio remains within your stated risk tolerance.
Step 5: Portfolio Construction and Asset Location
Portfolio construction is the selection of specific investment vehicles
to fill the proposed allocations. Investments available include
individual securities (stocks and bonds), mutual funds, or
exchange-traded funds (ETFs). Your IPS should state which investment
vehicles will be used to construct the portfolio.
Portfolio construction also includes asset location, which involves the
strategic placement of your investments in taxable, tax-deferred, or
tax-free accounts to achieve the highest level of tax efficiency.
Step 6: Portfolio Monitoring and Rebalancing
You or your advisor should monitor your investments and portfolio to
ensure that assets are invested in a manner which is consistent with the
original investment strategy and risk tolerance. This includes a
periodic review of the strategic asset allocation to rebalance the
portfolio by restoring it to the original target allocation, or to
determine whether the allocation should be adjusted and the portfolio
rebalanced to agree with the new allocation. A new allocation may be
required for significant life changes which would cause an investor to
reconsider financial objectives and constraints. You should also assess
the impact of taxes and transaction costs as a result of portfolio
changes.
Step 7: Performance Reporting
On a periodic basis (at least annually), you or your advisor should
review the performance of your portfolio. This review will allow you to
determine whether you are on track to reach your goals. Reviewing
portfolio and investment performance relative to a benchmark will also
provide insight into how your portfolio and its holdings stack up
against other similar or alternative investments.
So now we know the "what" and "how" of Portfolio Spring-Cleaning. In our
next newsletter we will cover the "why" (Does Your Financial Advisor
Have an Investment Philosophy?) of organizing and optimizing the
performance of your portfolio to achieve your goals.
Whether your countdown is to retirement, education, or another important
goal, Kalorama Wealth Strategies can help you create a plan to invest
your assets in a manner providing professional management,
diversification, marketability, and liquidity. For more information,
please see our web site at
www.kaloramawealth.com.
Thank you for your business, trust, and referrals. Please feel free to
forward this email to friends and colleagues who can benefit from
information about investing and financial planning. If I can be of any
assistance to you or anyone you know, please do not hesitate to contact
me.
Sincerely,
David
_______________________________
David M. Taube, CPA, CFA, CFP®, CRI
Founder and President
Kalorama Wealth Strategies
202-550-7262
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Investment advice offered through Medallion Advisory Services, LLC*,
Registered Investment Adviser. *Wholly owned subsidiary of TMG Holding
Company, Inc. T/A The Medallion Group. Kalorama Wealth Strategies and
TMG Holding Company are not affiliated companies.
Logo: Kalorama in Greek means "beautiful view." Through our planning
process, our goal is to provide you "A Beautiful View To Your
Financial Future."
