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How To Use Strategic Asset Management To Build Wealth
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The How-To Business Book
11/20/2000
By: Mitchell Young
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Last year at this time, when the NASDAQ was soaring, a colleague said he wanted to talk stocks.
When I was 11 I learned that people will take stock tips from anybody, and I haven't recommended a stock since.
But he said he wanted to “share,” so finally I said investing is simple and that if he asked any stockbroker they could tell him about regular working folks who have accumulated large portfolios by saving and investing over the course of their lives.
Being that he was in his 30s and making a decent living he could count on having plenty of dough when he retired, if he followed some simple rules:
Buy a few quality mutual funds, and take a set amount of money (as much as he could spare, and then some) and, come rain or shine, add to his investment regularly. As it gets bigger spread it out a bit. Place the maximum amount you can in a tax-deferred account like an IRA, or 401(k) and let the progress of man and the miracle of compounding interest take care of the rest.
As you may have guessed - that's not what he had in mind.
“I was in this chat room and I want to know what you think of this company. It's about to split and it's gone up 4,000 percent and I've made $7,000.” I said getting stock advice from me wasn't a good idea or - hadn't he noticed? - I wasn't already rich.
Many investors, however, need to move beyond the basics and add more sophistication to their portfolios. An approach that is attracting increasing interest is Strategic Asset Management. It's a thoughtful process to deal with the “algebraic” formula of investing.
Like many formulas, it has variables and constants and can get quite complicated, requiring for typical investors the guidance of an experienced mathematician (read: investment advisor) to apply it properly.
We spoke to some and here's some of what heard.
Know thyself.
Answer questions about yourself before asking about investments:
What is the objective of the investment - starting a future business, retirement, children's education, overall sense of security?
What is the time horizon for the investments: five years until I start my own company, 15 to retirement, she's an infant now but I see her in the Yale class of 2020?
How much risk can I tolerate?
What is my disposable income going to be over the life of my time horizon?
The answer to each question plays to the last. How much risk and your time horizon are directly linked because there are constants in this formula, too.
Frankly, while the questions appear simple they really are not and often are complicated by family and personal issues. Working with an experienced advisor will move the process along more smoothly.
The house has rules.
Think what you may about new technologies and economies changing everything. But remember this: Electricity was once new, and automobiles “changed everything,” too. Indeed, many argue that it was the amazing possibilities generated by the entrepreneurs like Henry Ford that spread the speculation that caused the Great Depression.
The stock market historically has returned between ten and 12 percent per year, measured over a broad index of stocks.
Strategic Asset Management aims to remove speculation by adding more process to the investor's decisions. Done successfully, it will match the time horizons and objectives of the investor.
After an investor accepts the house rules of typical returns, it gets a lot easier to invest successfully. If we're aggressive, we're shooting to beat the range by a couple of points. We'll be happy with the low end if we're conservative.
The Strategic Asset Manager starts with suggesting a balanced portfolio depending on the investor's goals and horizon.
A simplistic example for this aggressive investor can show how this part of the equation works.
• 25 percent in aggressive small-capitalization stock fund (companies with valuations of $1 billion to $5 billion);
• 25 percent in aggressive large-cap stock fund (companies with valuations over $5 billion);
• 25 percent in medium-term corporate bonds;
• 25 percent in a Dow index fund (a mutual fund designed to track the index of all stocks in the Dow).
As the portfolio performs, perhaps the corporate bonds rise in value and the index fund is down. On a targeted time (annual) basis, the investor then reallocates back to his original strategy, taking his profits in bonds and adds those funds to the index fund.
As the original ratios stay the same, eventually, the index fund will likely have its day and the bonds will get hit. On the way there, the small-cap fund may go through the roof, while big cap take a hit. When it does, the portfolio is rebalanced.
This rebalancing is often hard for an individual investor to do - dropping a winner and adding more to the loser. Remember, though: This isn't a stock but an asset class, and that class of assets will have a historical return (more house rules) and over time it will move toward that return. With Strategic Asset Management, the investor is potentially buying low and selling high, and we all like that.
Creating and managing a SAM portfolio, including identifying complimentary investments while maintaining the investor's appropriate risk and returns levels, requires professional assistance for most investors. But do it, and you can take me out to dinner in Scottsdale in 20 years.
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