Investor Education
The following pages are designed to provide current financial information that will be of interest and assistance to you in making disciplined and informed financial decisions. Gardey Financial Advisors emphasizes comprehensive financial service individually designed to secure your financial future. This commitment has allowed us to grow into the largest fee-only Registered Investment Advisory firm in northeastern Michigan. We manage investment assets in excess of $200 million for clients in 21 states.
Investor Education articles are written by the staff of Gardey Financial Advisors.
DO YOU KNOW WHAT YOUR ASSET ALLOCATION IS? AND IS IT THE RIGHT ONE FOR YOU?
The most important factor in determining how well your investments perform is your asset allocation. Over and over, studies have verified this principle. Given its significance, do you know what your present asset allocation is and, more importantly, what it should be?
What is Asset Allocation?
There are three basic types of investments: stocks, bonds and cash. How your investments are divided among these three categories is your asset allocation.
How do you determine your present Asset Allocation?
Categorize each of your investments as either stocks, bonds, or cash. Then add up the market value of each investment category. Finally, calculate the percentage that each category represents of the total.
For example, let’s say that you have $350,000 invested in stocks, $280,000 in bonds, and $70,000 in cash. First, you add up the amounts:
Stocks $350,000
Bonds $280,000
Cash $ 70,000
Total $700,000
Then you calculate the percentage of each by dividing the value of each investment category by the total assets:
Stocks $350,000 ÷ $700,000 = 50%
Bonds $280,000 ÷ $700,000 = 40%
Cash $70,000 ÷ $700,000 = 10%
In this example, your asset allocation is 50% stocks, 40% bonds and 10% cash.
What should your Target Asset Allocation be?
Before you invest, you must determine what is the right asset allocation for you. Your proper asset allocation is determined by a number of factors. These include the size of your portfolio, your income and its sources, your financial goals, and the level of risk that you are willing to incur.
What do I do once I determine my proper Asset Allocation?
You need to adjust your present asset allocation to bring it into line. You do this by selling securities from categories that exceed their target and buying securities in categories that are below their target.
Is adjusting my Asset Allocation an ongoing process?
Yes, as the value of your investments fluctuate, your asset allocation changes. For example, if the stock market rises in value, the stock portion of your investments will increase and become a larger and larger percentage of your total investments. When this happens, your asset allocation needs to be adjusted. You will need to sell stocks and buy both bonds and cash.
What role does Gardey Financial Advisors play in the matter of the Asset Allocation?
Your asset allocation performs a central role in the investment management process of Gardey Financial Advisors. Based on a careful analysis of your present financial situation and your financial goals, we assist you in establishing your proper asset allocation. And once this asset allocation has been established, we bring your investments into line through a carefully planned program of purchases and sales approved by you. But this is only the beginning of the process. We monitor your portfolio to keep your asset allocation in line. And we periodically review your asset allocation to ensure that it continues to be appropriate for you.
What do you need to do?
Whether you do it yourself or have a professional financial advisor like Gardey Financial Advisors do it for you, you need to establish the proper asset allocation of your investments and you need to monitor your investments to ensure that they reflect this asset allocation as conditions change over time.
We invest your money using a strategy that is used by the country’s largest pension plans.
In constructing a client’s stock portfolio, we use what we call a “multiple-manager strategy.” In this approach, the portfolio is divided into a number of strategies, and the responsibility for each strategy is assigned to a mutual fund investment manager who has met our selection criteria. We draw these managers from a universe of no-load stock mutual funds. We have access to background and performance data on several thousand managers, and we use this data to select the best managers. In our selection process, we place particular emphasis on consistency of performance.
The Challenge – There are a number of strategies that can be used in managing a stock portfolio. These strategies can be characterized by such factors as a) the size of the company, b) the location (foreign or domestic), c) earnings expectations, and d) undervaluation. Historically, no one strategy has consistently outperformed the other strategies, and the problem is that it is next to impossible to determine which strategy is going to provide the best performance at any given time.
The Solution – The solution to this dilemma is to implement a multiple-manager strategy by constructing a portfolio that contains each investment strategy. In this way, one is protected from having one’s assets all concentrated in a single poorly-performing sector of the stock market. This strategy of selecting a number of high-performing managers, each with a different investment strategy, is a practice that is used by the country’s largest pension plans. The trustees of these plans have long recognized the value of this strategy and almost universally use the multiple-manager strategy.
The availability of many no-load stock mutual funds, each with different investment strategies, allows us to adopt this multiple-manager strategy. Without the use of mutual funds, this strategy would be impossible for all but the largest portfolios. By purchasing shares in a mutual fund, we, in effect, hire that mutual fund’s manager to manage a portion of the portfolio. And, if the manager does not meet our expectations, we can fire that manager simply by redeeming the shares of the mutual fund.
The multiple-manager strategy is a proven effective means for investing in common stocks.
WHY A PORTFOLIO SHOULD CONTAIN FOREIGN AS WELL AS DOMESTIC SECURITIES
As little as 30 years ago, the bulk of the world’s securities were issued within the United States. This situation has changed drastically since then, and this change has provided an important opportunity for portfolio management.
Following are five reasons for including foreign securities in an investment portfolio:
- One, diversification is a crucial part of prudent portfolio management, and the use of foreign securities provides a means of significantly increasing the diversification of an investment portfolio. The addition of foreign securities to an investment portfolio will reduce the level of risk of the portfolio and should increase its average return.
- Two, the rates of return on foreign securities have periodically exceeded those obtainable within the United States. These higher rates of return can be justified by the higher rates of economic growth experienced by those countries. These rates remain attractive even when adjusted for the higher level of risk incurred in foreign investments.
- Three, there is a wide variety of foreign securities now available. The world economy has experienced extensive growth in the past 30 years. Along with this has come growth in foreign financial markets and the availability of foreign securities. At the same time, U.S. securities firms have expanded their operations worldwide, and telecommunication systems have developed to provide for rapid movement of information.
- Four, ignoring foreign markets reduces an investor’s choice of securities by over 50%. Years ago, an investor could confidently ignore non-U.S. securities knowing that they represented a small portion of the total world securities. Now, however, foreign securities have grown to such a size they are too big to ignore.
- Five, a large number of mutual funds specializing in either foreign stocks or foreign bonds are available. They can be used as an effective low-cost means of adding foreign securities to an investment portfolio. These mutual funds provide a widely diversified group of securities selected and supervised by experts in international investing.
Based on this analysis, we believe that foreign securities should be a part of every investment portfolio.
What is a Mutual Fund?
A mutual fund is a company that invests in a diversified portfolio of securities. People who buy shares of a mutual fund are its owners or shareholders. Their purchases provide the money for a mutual fund to buy securities such as stocks and bonds. A mutual fund can make money from its securities in two ways: a security can pay dividends and interest to the fund, or a security can rise in value. A fund can also lose money and drop in value if the securities which it holds drop in value. The fund passes to shareholders in the form of dstributions any dividends, interest or profits on the sale of its portfolio securities, less fund expenses. Fund expenses include the manager’s salary, commissions to purchase securities for the fund, costs to print statements, legal fees, etc.
Why Invest in Mutual Funds?
The advantages of mutual funds include professional management, diversification, choice, liquidity, and risk control. They are subject to strict government regulation and full disclosure, and may be commission-free.
- Professional Management
In a mutual fund, professionals manage a portfolio of securities and decide which securities to buy and sell. A fund is usually managed by an individual, or a team of individuals, who chooses investments that best match the fund’s objective. Professional mutual fund managers have access to a research staff to decide which securities to buy and sell. - Diversification
A mutual fund holds a wide variety of securities, reducing your exposure to the risks of individual securities. Pooling your assets with other investor assets allows you to obtain a more diversified portfolio than you would probably be able to assemble on your own and at a fraction of the cost. - Choice
Within the broad categories of stock, bond, and money market funds, you can choose among a variety of investment approaches. Today, there are many thousands of mutual funds available in the U.S., with goals and styles to fit most objectives and circumstances. - Liquidity
Liquidity is the ability to readily access your money in an investment. Mutual fund shares are liquid investments that can be sold on any business day. Mutual funds are required by law to buy, or redeem, shares each business day. The price per share at which the shares are redeemed is known as the fund’s net asset value (NAV). NAV is the current market value of all the fund’s assets, minus liabilities, divided by the total number of outstanding shares. - Risk Control
There are a number of investment strategies that can be used in managing a portfolio. A portfolio made up of individual stocks will normally represent a single investment strategy. This commitment of the portfolio to a single investment strategy involves a significant level of risk. Alternatively, the use of a number of mutual funds to construct a portfolio can result in a portfolio that represents a number of investment strategies and produces a portfolio with a much lower level of risk. - Investor Protection
Mutual funds are highly regulated by the federal government through the U.S. Securities and Exchange Commission (SEC). As part of this government regulation, all funds must meet certain operating standards, observe strict antifraud rules, and disclose complete information to current and potential investors. These laws are designed to protect investors from fraud and abuse, but they do not help you pick the fund that is right for you or prevent a fund from performing poorly. Despite very strict government regulation, you can still lose money by investing in a mutual fund. A mutual fund is not guaranteed or insured by the FDIC, even if fund shares are purchased through a bank. - No-Load
There are a number of mutual funds that may be purchased without payment of a commission.
Different Funds, Different Features
There are three basic types of mutual funds: stock (also called equity), bond, and money market. Stock mutual funds invest primarily in shares of stock issued by U.S. or foreign companies. Bond mutual funds invest primarily in bonds. Money market mutual funds invest mainly in short-term securities issued by the U.S. government and its agencies, U.S. corporations, and state and local governments.
- Stock Funds
Stock funds invest primarily in stocks. When you buy shares of a stock mutual fund, you essentially become a part owner of each of the securities in your fund’s portfolio. Stocks have historically been a great source of financial growth, even though the stocks of the most successful companies may experience periodic declines in value. Over time, stocks historically have performed better than other investments in securities, such as bonds and money market instruments. That’s why stock funds are best used as long-term investments.What is a Stock?
A share of stock represents a unit of ownership in a company. If a company is successful, shareholders can profit in two ways: the stock may increase in value, or the company can pass its profits to shareholders in the form of dividends. If a company fails, a shareholder can lose the entire value of his or her shares; however, a shareholder is not liable for the debts of a company. - Bond Funds
Bond funds invest primarily in bonds. A bond fund share represents ownership in a pool of bonds and other securities comprising the fund’s portfolio. Bond funds tend to be less volatile than stock funds and often produce regular income. For these reasons, investors often use bond funds to diversify, provide a stream of income, or invest for intermediate-term goals. Like stock funds, bond funds have risks and can make or lose money.What is a Bond?
A bond is a type of security that functions like a loan. When a bond is purchased, money is lent to the company, municipality, or government agency that issued the bond. In exchange for the use of this money, the issuer promises to repay the amount loaned (the principal, also known as the face value of the bond) on a specific maturity date. In addition, the issuer typically promises to make periodic interest payments over the life of the loan. - Money Market Funds
A money market fund share represents ownership in a pool of short-term, interest-bearing securities comprising the fund’s portfolio. Money market funds are most appropriate for short-term investment and savings goals or in situations where you seek to preserve the value of your investment while still earning income. In general, money market funds are useful as part of a diversified personal financial program that includes long-term investments.What is a Money Market Instrument?
A money market instrument is a short-term IOU issued by the U.S. government, U.S. corporations, and state and local governments. Money market instruments have maturity dates of less than 13 months. These instruments are relatively stable because of their short maturities and high quality.
Investing Internationally
International stock and bond mutual funds provide a way for you to invest in foreign securities markets. Investing internationally offers diversification and the opportunity for higher returns.
Investments in foreign markets also come with risks not found in U.S. markets. U.S. investors usually buy foreign securities in the other country’s currency, making the investments subject to changes in the currency exchange rate. Fluctuations in currency exchange rates can have a significant effect on an investor’s return. If your fund’s investment in a British stock increased by 10% during a six-month period while the value of the British pound declined 10% during the same period, you would break even on the investment. Some international funds try to offset this effect by performing “hedging transactions.”
Investing in foreign markets may involve additional costs due to the unique operational requirements of an overseas fund, and may involve volatile political and economic situations – especially in emerging markets.
EXCHANGE RATE FLUCTUATIONS AND FOREIGN INVESTING
“Don’t put all of your eggs in one basket” is a rule that has stood the test of time. This rule has also proven itself in the business of investing where we call it “diversification.” Diversification is the strategy of investing in a number of different kinds of securities in order to reduce the overall level of risk of a portfolio.
Diversification in Foreign Markets
Diversification is crucial to minimizing the risk of investing, and investing in foreign stocks significantly increases diversification. For example, foreign stocks represent over half of the value of world stocks, and to ignore this sector of the world stock market would significantly reduce the diversification of a portfolio. Adding foreign securities to an investment portfolio reduces the overall level of risk of a portfolio.
Exchange Rate Fluctuation
The major factor that distinguishes domestic from foreign investing is what is called exchange rate fluctuation. For a U.S. investor, exchange rate fluctuation is the change in the value of the U.S. dollar relative to the value of the currency of another country.
We do not have to go far to experience the impact of exchange rate fluctuation. If you travel to Canada, you know that the buying power of a U.S. dollar fluctuates over time. The cost of a motel room, gasoline, meals, and gifts (in U.S. Dollars) may drop off from one visit to the next. Canadians, on the other hand, see the opposite side of the coin; goods and services in the U.S. cost them more.
The Foreign Investment Process
To understand why exchange rate fluctuations play an important role in foreign investing, you need to understand the investment process as it applies to foreign securities and how this process differs from domestic investing. To invest in General Motors stock, one simply purchases GM shares paying with U.S. dollars. But to purchase shares of Toyota, one cannot simply purchase shares with U.S. dollars on the Japanese Stock Exchange. One must first exchange U.S. dollars for Japanese currency (the yen), then purchase the shares. And, when these shares are sold and payment is received in yen, the yen must be converted back into U.S. dollars.
The ultimate conversion of yen back into dollars after the sale is where the exchange rate fluctuation impacts investment return. If the yen can be converted into dollars at the same rate as the original transaction, then the impact of the exchange rate fluctuation is neutral. If the yen can be converted at a better rate, then the exchange rate fluctuation impact is positive. But if the yen must be converted at a lower rate, then the exchange rate fluctuation impact is negative and reduces the return on the investment.
A Further Complication
Two factors determine the outcome of an investment in a foreign security. One is the exchange value fluctuation of the currency that we have discussed above. The second is the market value of the security in the local market. These factors can complement each other or counteract each other, and the size and direction of these forces determine the ultimate performance for the investor in the foreign shares. If a foreign security rises in price while, at the same time, the exchange value fluctuation of the dollar is positive, then these two factors complement each other to produce a positive return. If the foreign security declines in price while, at the same time, the exchange value fluctuation of the dollar is positive, then the two factors counteract each other and the return on the investment will depend on weighting of each of the factors.
Protection Against Exchange Rate Fluctuation
It is possible for an investor to protect against exchange rate fluctuation by means of sophisticated trading techniques commonly referred to as “hedging.” In this process, a contract is purchased which guarantees that the yen obtained from the sale of Toyota shares can be exchanged for U.S. dollars at the same rate that the yen was originally purchased. This guarantee effectively eliminates the risk of exchange rate fluctuation. However, this hedging process incurs fees and commissions, and so reduces the ultimate return on the investment.
The Value of Foreign Investing
While exchange rate fluctuation complicates the process of foreign investing, studies have consistently shown that the addition of foreign securities to an investment portfolio reduces the overall level of risk of that portfolio.
One of our objectives in managing your investment portfolio is to control risk by diversifying among a number of different types of investments. The uncertainties that characterize the securities markets can best be met by ensuring that your portfolio contains a number of different investments, each with distinct characteristics. The old saying of “not putting all of your eggs in one basket” is a familiar way of describing a proven portfolio management strategy.
To control risk, portfolios have traditionally been invested in three investments: stocks, bonds, and short-term money market securities. Each of these investments (or asset categories) has distinctive characteristics that normally will respond differently to changes in economic trends. Among these categories, stocks historically have provided the highest return, but they have also provided the greatest degree of volatility. Bonds historically have provided a lower return (about half that of stocks), but their volatility is significantly lower than stocks and fluctuations in bond values often moderate the effects on a portfolio of wide swings in stock market values. Short-term money market securities historically have provided the lowest return but also experienced the lowest level of volatility. These three asset categories represent the traditional building blocks of any investment portfolio.
In addition to these traditional investment categories, however, there are other investments that are available for use in building a portfolio. These investments that are not included among the three “traditional” investments described above are known as “alternative investments.” The securities industry is continuously inventing new types of alternative investments and offering them to the investing public.
One of the services we provide as your Financial Advisor is that of monitoring the development of these alternative investments to determine whether or not they should be considered for use in your portfolio. We want to be sure that you are taking advantage of any instrument that could help meet your investment objectives but, before using them, we also want to be convinced that the new instrument adds value. Because of the large number of alternative investments that are continuously being developed, we spend a large amount of time in this research before making any recommendations.
While we are always looking for alternative investments that will add value to your portfolio, very few under close examination prove to be worth considering. This is true because the motivation behind the development of a new investment is not primarily to provide an attractive investment for the investor. Rather the motivation is one of shifting risk from the issuer or reducing their costs and/or generating profits for the developer of the instrument.
One of the alternative investments that met our strict criteria was the treasury inflation-protected security or “TIPS.” This alternative instrument provides guaranteed protection against inflation as well as extremely high credit quality, and its features led us to add this security to those that we use in constructing portfolios.
We continually look for ways to add diversification to your portfolio, and you can be assured that we carefully analyze alternative investments as they become available. Those that meet our strict criteria will be considered for use in your portfolio.
It is our practice to ask you to provide us with a copy of your tax return each year. We do this because, to us, your tax return is a goldmine which we can mine for information that will allow us to better serve you.
Following are just some of the questions we can answer when we review your tax return:
- Should we purchase tax-free bonds for you or should we purchase taxable bonds? The answer to this question depends exclusively on the tax rate you are paying on the next dollar of income you receive (your marginal tax rate). And we calculate your future marginal tax rate using information we obtain from your tax return.
- Do our records accurately reflect your financial situation? By reviewing your tax return, we can determine if we have overlooked any assets.
- Are you subject to the special tax that was enacted by Congress in 1969 and which has gradually encompassed more and more tax filers? If you are subject to this tax, which is known as the Alternative Minimum Tax or AMT, we want to take whatever action is possible to minimize the impact of this tax.
- Has our fee been handled in the way which gives you maximum tax savings and results in a reduction in the cost of our service to you? We coordinate with your tax preparer to determine whether the fees should be paid from taxable or tax-deferred accounts. We report to your tax preparer the amount of fees that you paid so that he can be sure to deduct it, when applicable, and provide you with that added tax savings.
- Do we have in our records a complete list of all of the sources of income that you receive? In preparing your retirement projections, we want to make sure that we have taken every source of income into account.
- What type of IRA contributions can you make – nondeductible traditional, deductible traditional, Roth?
Given this list of crucial information that we can mine from your tax return, you can appreciate how important it is for us to have access to your tax information in order to provide the best outcome for you.
You can be assured that your tax returns will be handled with a maximum regard for the confidentiality of the information contained in the returns. We carefully control access to these returns, and they are shredded when they are no longer needed.
DO YOU HAVE ENOUGH LIABILITY PROTECTION?
With the accumulation of assets, it becomes prudent to protect them from possible liability claims as well as from the legal costs of defending yourself against such claims. In most cases, Automobile and Homeowners Insurance policies will provide coverage for settlement and defense expenses up to the limits provided by the policy. It should be noted, however, that these policies generally will have limitations or exclusions which may leave you without any coverage. An important issue is, how much coverage is enough? Unfortunately, there is no magic formula that will tell us how much a jury may award in the case of serious injuries, pain and suffering, or loss of life.
Limits of Coverage From Your Automobile and Homeowners Insurance
The State of Michigan requires that owners of each automobile provide insurance coverage of at least $20,000 for bodily injury per person and $40,000 per occurrence, plus $10,000 for property damage per occurrence. (The minimum amount of coverage will vary state by state.) These limits are not adequate in today’s litigious society. A more appropriate limit for automobile liability coverage would be $500,000 bodily injury per person and $500,000 per occurrence, plus $100,000 property damage per occurrence.
In addition, your Homeowners policy should have a limit of at least $300,000 per occurrence. Even with these limits however, legal settlements above these amounts will have to be paid by you from your current assets or future income if no other insurance coverage exists.
Umbrella Liability Coverage Provides Additional Protection
It is important that you have sufficient protection to shelter your assets, and this protection is available through what is called an “Umbrella liability policy.” This policy provides an additional layer of protection beyond that provided by your Automobile and Homeowners policies. It also provides coverage against most of the exclusions or limitations not covered by the other policies.
It is also important that if you have secondary homes, snowmobiles, watercraft, or other recreational vehicles that they have property liability coverage and that they be included under the Umbrella. If you own any form of aircraft or are a licensed pilot, this should be reviewed with your insurance agent.
Some Basic Facts About Umbrella Policies
The basic Umbrella liability policy is issued for $1,000,000. Additional protection is available in multiples of $1,000,000.
These policies are inexpensive with the cost for the first $1,000,000, starting at about $150 per year, depending upon the state in which you live. The premium depends on the number of residences, automobiles, recreational vehicles, drivers, and the drivers’ ages.
How Much Protection Should You Have?
This is a difficult question to answer.
There is always the chance that you could be the subject of a very large liability lawsuit. While the odds of this happening are very small, the possibility still exists, and the only way to protect against this possibility is to purchase an Umbrella liability policy. Insurance industry standards suggest limits of one and one-half to two times your net worth.
We believe, given the very low cost of Umbrella coverage, that everyone should have Umbrella liability protection of at least $1,000,000. For a cost of a few hundred dollars a year, you are protected from liability lawsuits equal to your Automobile or Homeowners liability coverage plus the limit of your Umbrella policy.
Should You Have Additional Coverage Beyond $1,000,000?
Your decision to purchase coverage beyond $1,000,000 should be based on the cost of coverage, the amount of your assets and your concern over the risk of potential liability.
In order to determine the cost of additional coverage, you should request a quote from your insurance agent for 1, 2, 3, 4 and 5 million dollars. This will give you the cost information you need to make an informed decision about coverage.
In considering your insurance costs, you should also give consideration to increasing the deductibles on your Automobile and Homeowners policies. The cost savings from the higher deductible could then be applied towards increasing the amount of coverage under the Umbrella.
Conclusion
We believe you should have minimum Umbrella coverage of at least $1,000,000. Coverage beyond this $1,000,000 protection should be based on the cost of coverage, the amount of your assets, and your concern over the risk of potential liability.
A PATH TO INVESTMENT PEACE OF MIND
Are you confident that your investment portfolio is designed to achieve your financial goals? At Gardey Financial Advisors, our clients have the peace of mind that comes with knowing that their portfolios have been specifically designed to meet their financial goals.
Gardey Financial Advisors
Gardey Financial Advisors is an independent investment management and financial planning firm located in Saginaw and founded in 1985. We presently manage client assets in excess of two hundred ten million dollars and have a staff of seventeen, including financial advisors with over 144 years of combined professional investment experience. Our fee is not generated by commissions but rather is based on the size of the portfolio. This arrangement ensures that our recommendations are always made solely in your best interest. We are not stock brokers.
Our Service
If you were to become a client, your account would be managed by an experienced team composed of a Portfolio Manager and Portfolio Administrator who are responsible for the management of your investment portfolio. Both will be available for consultation at any time to assist you without additional fees being incurred. We begin by working with you to define your financial goals and objectives. We then prepare an investment strategy designed to meet your current income needs and future capital requirements. And we will continue to meet with you regularly to evaluate results and discuss appropriate investment strategies.
Added Value
In addition to investment counseling, the consulting aspect of our service extends to retirement planning, estate planning, tax minimization, and insurance analysis for you and for members of your family. With some of our clients, we have already begun to counsel the third generation on family wealth management and related issues. We will also work closely with other family advisors such as attorneys and accountants. Our willingness to assist with a variety of financial matters that are not strictly investment management functions is a convenience that many of our clients find most helpful, such as purchase of a second home or purchase versus leasing of an automobile. This service is included as part of our standard fee.
Who We Help
Our Investment Management Service is structured for clients with combined investment assets of $500,000 or more (including retirement plan assets). The service is designed so that it will be timely, attentive, and tailored to your needs.
