Atlanta Planning Guys

Our population is aging, the baby boomers are retiring and the only certainties still seem to be death and taxes.  We have seen quite a few boomer clients who have lost their parents in 2010 and, as such, have come into new wealth by way of an inheritance.  A financial windfall is something that family members can, and should, be prepared for.  Here are a few things to consider to ensure that your loved ones financial legacies are carried on for years to come:

Plan Ahead:  There is really no way to plan for winning the lottery (other than buying a ticket).  However, if you expect to inherit money from family, now is the time to plan for the inevitable.  A candid conversation about how assets are titled, what the will states, and who ends up with what, can save a lot of headache down the road.  With the future of estate taxes still very much in the air, taking necessary steps to reduce tax liabilities and increase transparency among beneficiaries can go a long way in saving time and money…and to avoiding the common beneficiary family feud.

Avoid the urge to spend immediately:  Before you go buy that toy you have always wanted, prudence dictates that a meeting with a financial advisor would likely bear fruit.  Taxes, probate and unforeseen debt are just a few of the things that can whittle down your windfall.  The total cost of coming into money may not be realized for months (in some cases a year or two). So the dollar figure that you end up with will likely be a fraction of the initial figures presented in the will.

Impact to Cash Flow:  This new money will surely make an impact on your calculations and expectations when it comes to the amount of fixed income that you should be saving to plan for your retirement.  We generally encourage clients to save as much as possible.  However, if your coffers are full, you may be able to forgo additional savings and enjoy more money in your pocket now.

Rethink Everything:  It sounds trite, but coming into wealth needs to be met with pragmatism and careful planning.  You may feel that this newfound wealth gives you the ability to forgo any formal steps to developing a strategy for this money.  This couldn’t be further from the truth.  Working with an unbiased, third-party, trusted financial expert can help to ensure that you are making rational decisions that are in your best interest, and those of your heirs.

Late this July, President Obama signed the Financial Regulation (FinReg) bill into law, the largest reform of Wall Street since the New Deal. The nearly 900 page piece of legislation is popularly thought to be lawmakers’ knee-jerk reaction to the current financial and economic muck that we find ourselves wading through, blamed by many on the big banks and financial institutions. Whether or not you agree with the catalyst for FinReg’s creation and passage, one thing is for sure – no one knows what it all really means.

While we won’t know for sure exactly how FinReg will effect individual and small business owners for some time, we’ve attempted to summarize some of the provisions in the bill that are the most likely to effect us – the little guy. Of course, we have several months, if not years, for regulators and agencies to sort all of this out, so the future landscape of the banking world is anyone’s guess. But the below can serve as a quick guide for those of us who are still scratching our heads in confusion….as well as my “gut reaction” to each bullet point.

• Establishes an independent Consumer Financial Protection Bureau inside of the Federal Reserve whose purpose is to curb unfair practices in consumer loans and credit cards and weed out predatory practices.  GOOD
• Allows all consumers to get their actual credit score along with the one free credit report per year that they are currently able to receive.  GOOD
• Place a cap on, and make more reasonable, the debit card swipe fees that retailers currently pay to banks for the cost of transferring money. Probably GOOD
• Unemployed homeowners with good credit could be eligible for low-interest loans to help them avoid foreclosure.  GOOD
• The SEC can raise the standards for broker-dealers who give investment advice, holding them to a fiduciary duty similar to that of investment advisors.   REALLY, REALLY GOOD
• Holds credit-rating firms to a higher standard, allowing investors to sue credit-rating firms for “knowing or reckless” failure and establishes a new oversight office within the SEC to monitor these firms and the ratings that they give.  GOOD
• Requires that hedge funds and private equity funds register with the SEC as investment advisers and to provide trade information, allowing regulators to monitor for systematic risk. (Currently neither are SEC regulated)  Probably GOOD
• New rules would be put in place for how all publicly-traded companies pay their top executives, giving shareholders voting rights on CEO pay and severance.   Maybe GOOD

Again, this is just a sampling of the many rules held inside of this massive Wall Street overhaul. How this all plays out remains to be seen, but investors are encouraged to continue to have open dialogue with their financial advisors as reform progresses and a questions or concerns arise.  I am sure I will be blogging about some of these as the picture gets a little clearer…especially the “fiduciary duty” rule (*fingers crossed*).

I’ve always been one to focus my attention on the silver lining of any cloud.  In times of economic struggle, many of us look to tighten our belts to weather the storm.  This is an incredible opportunity to build some healthy spending habits that can be used in good times and bad.  No matter what size or shape your family’s budget, there are always steps that you can take to build healthy spending protocols for the future.  Here are my top 5 recommendations:

#5. Retire the Debt

I’m always amazed at how many people carry at least one credit card with a balance.  While the reasons vary from person to person, there is one common denominator: INTEREST.

You may have noticed that your statements look a bit different these days. Credit card companies are now required to show you how long it will take you to retire your debt making just the minimum payments, and the numbers are staggering.  No balance is too small…or small enough. Retiring a $1000 credit card balance might save you as much as $20-$30 per month, which certainly adds up over time.  If you have multiple balances, pick the one with the highest interest rate and devote all your free cash to knocking it down.

#4. Cut back on the little things

Coffees and lattés are quite the staple in our society these days.  It’s an easy example for me to use for several reasons:  1) you can make your own coffee and 2) regular consumption means that the costs really add up fast.  A $3 latte every morning comes to a whopping $1095/year.  Look at your spending and try to identify a few items that can be mitigated by doing it yourself, significantly decreasing consumption or going without (which, in the case of a latté, can also trim your waistline!).

#3. Shop your Services/Needs

Whether it’s your lawn, maid service or your auto/homeowners Insurance, there are savings to be found.  In economic times like these, you are likely to find some real deals from businesses hungry to make you a client. Many service providers may not come outright and offer discounts, but will be more than happy to work with you after you inquire—it never hurts to ask! A few friendly phone calls could net you more money in your pocket every month.

#2. Curb your Impulse Buying

We all have them, large & small.  Smaller impulse buys tend to come in larger numbers and therefore can be just as damaging as the big toys we crave.  There are a few strategies here.  For the big-ticket items (set your own standards), try to save the money to buy the item instead of buying it that very moment.  Banking is inexpensive…and you can probably start a “toy” savings account for little money at any bank.  Start depositing funds in there until you have amassed a sum to purchase that new phone/laptop/power drill.  On the ‘smaller’ side of impulse buying, practice asking yourself the following questions: “Do I REALLY need this?”  “Will I be able to get it next week?” “When will I use this?”

Another great way to curb smaller impulse buys is to pay with cash.  We don’t associate as much financial burden with swiping cards.  Once you have to open the wallet and pull out cash to put that new toy in our cart…it somehow becomes less important.  To that end, don’t carry too much cash…problem solved!

#1. Develop your Budget

How can we know if we are spending too much if there is nothing to which we can compare our spending?  One of the first exercises we go through for all of our financial planning clients is filling out a monthly cash flow spreadsheet.  We ask that they document every dollar coming in/out of their coffers.  This is a tremendous exercise and one that can truly empower you to make better decisions related to your spending.  Take a weekend and get everything in order.  There are countless software programs to assist you…or just build your own.  Once you have your budget in place, review it periodically to find areas of concern and celebrate your victories. 

**Important to Note – if you do come in under budget, don’t run out and spend those extra nickels “just because.” We all have the unexpected or emergency expenses that arise – better to have a cushion for those than to have to panic and/or add more debt.**

Health Insurance has certainly been a hot button for many Americans in recent months.  Premiums continue to climb and so many questions remain unanswered regarding the recently passed health care reform—the effects of which may not be seen for years to come.

This week, we’d like to identify some of the most common mistakes, oversights and/or misconceptions that we have observed with our individual and small business clients—items that, when not corrected, can end up costing policy holders a lot more than just a few dollars.

#5. Splitting Coverage

With the increase in dual income households, many consumers don’t take the time to research how their dependents will be covered under each of their employer plans.  If both spouses work, consideration must be given to who is insured through which plan.  Often times, we find that families choose to have their dependents covered under the benefits plan of the higher paid spouse, which is about as dependable a method as flipping a coin. As financial planners, we urge individuals to take the time to research and evaluate each plan, selecting the one that will suit each member of your family, which could mean splitting coverage.  You could be costing your family hundreds of dollars per month by having all your coverage with the same carrier. 

#4. Don’t put too much focus on the Deductible

Like the number of cup holders in a new car, the deductible often gets all the attention when comparing plan options, when statistically, this is the least likely benefit to be utilized every year.  Lowering your deductible to levels where you feel “comfortable” can often inflate your premium substantially. Consider that the probability of meeting your annual deductible is actually less than 20%.  While the deductible is certainly one important factor, the key to remember is health insurance is designed to protect you from catastrophic loss.  Adding $500 or even $1000 to your deductible will seem a small price to pay in the event of a true medical emergency.

Attention must also be given to your level of coinsurance, which applies once the deductible is met.  It is a percentage of balances due above the deductible (90/10, 80/20, 70/30).  If the coinsurance is 80%, you will have to pay 20% of the remaining balance.  Your coinsurance will have a maximum that you will be required to pay, in most cases, called the stop loss.

Example of Deductible and Coinsurance:

Your plan- $2,000 deductible; 70/30 Coinsurance; $2,000 stop loss

Major Medical Claim of $10,000

You Pay- $2,000 for your deductible (remaining balance $8,000)

30% of $8,000= $2,400 (you pay $2,000 of that balance due to stop loss)

**Be sure to carefully weigh these options and don’t be afraid to increase your exposure to reap some favorable premium savings

#3.  Drug Benefits- Check the formulary

Most every plan out there offers some benefits for prescriptions. We recommend that individuals take note of how their specific insurance plans covers the following three forms of prescription medications, and speak with your physician with each new prescription to ensure that you are prescribed the most cost effective treatment available:

•  Generic- Covers all generic drugs and offers the lowest “co-pay” amount
       o  Always inquire with your doctor if a generic version exists for your medication
• Brand Formulary- These are branded drugs that have been approved for distribution on the insurance companies list (ask your insurance company for a copy).  Filling a prescription with Brand drugs will cost you more money than generics.
       o  Brand Formulary lists are different with every insurance company.  If you’re taking brand drugs, be sure they are listed on the formulary at the insurance carrier.  If not, you need to ask for one that is.
• Non-Formulary Drugs- These are typically drugs new to the market.  They will cost you 3-4 times more than generics and typically 2-3 times more than Brand name.
       o  Careful consideration should be practiced when electing to use a non-formulary drug.  Be sure to discuss this with your physician.

#2.  Co-pays drive rates

The days of a $10 or $20 co-pay are going the way of the Dodo Bird.  Choosing a plan with a slightly higher co-pay can often save you 10-15% in premium.  If your household premium is $500/month, you’ll end up spending up to $600 more per year to save a few dollars IF you go to the doctor.

• A good rule to live by is that a premium dollar is spent money!

Example:  Go from a $20 co-pay plan to a $40 co-pay plan saves you $400 in premium.  You would have to make 21 trips to the doctor in a year before you used up your savings.

#1.  Know your Network!

Whether you have an HMO, POS or PPO, you have a network of doctors.  I’ll grant you that the PPO will offer benefits for ‘out of network’ claims.  However, the price is usually substantially higher than staying in the network.  Tread cautiously when doing your research on who is in network and who is out.  In some cases, a doctor can be in the network but the particular facility he is in that day is not.  When you get a referral to a specialist, don’t take your doctor’s word that the referral is in network.  Check and double check.  Most carriers offer online portals to see who is in network.  Follow that up with a phone call to the physician. Even triple check when you go in for your appointment.

This mistake can cost you hundreds, if not thousands, of dollars when it comes time for insurance to pay the bill.

When I meet with a prospective client for the first time one of my first questions of them is about retirement.  I am curious to know how they anticipate living off their nest egg.  It’s important not to “coach” them at this point.  I want them to tell me what they are thinking, not what they think I want to hear.  The five responses below are some common misconceptions about retirement. 

#5.  Buy bonds and live off the interest

Unless you are extremely wealthy, this won’t work.  The two main reasons:

1.  Interest rates fluctuate and may not generate enough income (e.g. as of today (7/16/2010), the 30 year note yields less than 4%).
2.  The amount of interest that the bonds generate cannot keep pace with increasing withdrawals.  In other words, income needed in retirement generally increases with inflation while the interest on bonds is fixed.  

While bonds can and should play a key role in any retirement portfolio, we do not recommend exceeding a  40% allocation to fixed income holdings as the equity portion of any retirement account is likely to be the major source of asset growth and inflation protection.

  #4.  Increasing fixed income allocation as you get older

The “Rule of 120” is a bad rule.  It should go the way of the rotary phone.  This rule holds that an investor’s fixed income allocation should match 120 minus their age.  For example, a 70 year old should have 50% of their portfolio in fixed income investments (120 minus 70 equals 50).  The thinking is that as one gets older, portfolio losses are more destructive to their financial freedom.  Generally, fixed income is considered to be safer and less likely to incur losses.

In reality, fixed income investments can have sharp declines.  Also, people are living much longer than before.  A retiree, aged 65, has a high probability of living to age 95.  For that reason, one must look at a retirement portfolio with a long term view….even if the investor is “older.”

The “Sustainable Withdrawal Ratio” is something that we ingrain into our client’s heads.  It is part of every financial plan we create and part of every quarterly review we perform.

William Bengen, in his landmark article in the 1994 issue of The Journal of Financial Planning, demonstrated that portfolios with 60% in fixed income had a much higher rate of failure than portfolios with 40% in fixed income.  For this reason, we target a stock / bond ratio of AT LEAST 60/40 and no more aggressive than 75 / 25.  Our recommendation would be the same whether the client was 80 or 60 years old.

#3.  Increasing distributions due to good investment returns

Thinking that good results will continue indefinitely, or conveniently forgetting lessons learned in the bad years, can really lead to some trouble.  For many, a major purchase (almost always a luxury purchase) is sure to follow a “nice year in the market.”   How many investors bought a bigger house, an investment property, a boat, or another “toy” because 2003 through September 2007 saw such great market returns?

The 18 months that followed are powerful reminders that portfolios will ebb and flow.  Good years only serve to offset the down years that are sure to follow.

#2.  Assuming you will spend less

Now that you aren’t going to work each day, you will probably spend MORE.  There are several studies out there that show spending increases for the first several years of retirement.  After all, now you have the time to do all of the things you love and travel to all of those “one day” destinations.

#1.  Under-estimating how much you need

One of the big insurance companies has a commercial that has each investor carrying around their “number”.   It’s the amount of money they will need to have saved in order to retire confidently.  It’s one of my favorite commercials.

Most people are shocked to find that you need a nest egg 22 times as big as your first withdrawal.  For example, to make an initial withdrawal of $44,000 and have those withdrawals last for 30 years, an investor would need 1 million dollars.  This is consistent with the “Sustainable Withdrawal Ratio” of 4.4%. 

A good advisor can add more value in this situation (retirement distribution planning), than any other area of financial planning.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.

Price, yield and availability of securities are subject to change. Certain call or special redemtion features may exist which could impact yield.

When we meet with a client for the first time, the conversation quickly drifts to their employer’s retirement plan.  The most common of these is the participant-directed Traditional 401(k), a qualified retirement savings plan that allows employees to regularly contribute to the account while deferring current income taxes on the saved money and the earnings until withdrawal. Employees can select from a variety of investment options and direct their own account, and reallocate, as desired.

Many of the blunders described here would also apply to other types of retirement plans (e.g. SIMPLE IRA, 403(b), SEP IRA, etc).

#5.  Chasing “winners”

It is a natural tendency to think that the best performing investments last year will also be the best performing investments in the coming year.  There are several studies that show investment “in-flows” to be at their peak when there has been stellar recent performance.  I guess we don’t want to “miss the boat.”

What many investors fail to realize is that the situation that caused the strong performance may no longer exist.  A great example of this would be government bonds in 2008.  With the “flight to safety” and the lowering of interest rates, Government bonds were among the best performing asset classes in 2008.  These circumstances were not likely to be repeated in 2009…and they did not.

#4.  Too little diversification

Another one of our many counter-productive tendencies as investors is to over-simplify our investment process.  Despite what you may read from the “experts,” putting your retirement savings SOLELY in one major index (such as the S&P 500) is not likely to be the best course of action.

Many investments have performed far better than this index over long periods of time.  The most likely candidates would be those that invest in stocks of smaller companies or even international or emerging markets.
There have been years (think 2008) where investments that tracked the S&P 500 would have been among the worst performing asset classes.  If you were close to retirement (or even IN retirement), a decline of this magnitude could derail an otherwise well thought out retirement plan.  It is easy to see the advantage of diversifying across asset classes and owning some fixed income investments in times like these.

#3.  Too conservative

Retirement accounts are tax deferred.  For that reason, they will be among the last assets an investor should tap into during retirement.  Even if the retirement account is the only sizable personal asset, the portfolio is going to need to last for the remainder of the investor’s life.  William Bengen, in his landmark article in the Journal of Financial Planning, October 1994, demonstrated that being too conservative actually HURTS portfolio performance in retirement. 

In most circumstances, we would recommend an allocation of about 75% to equities and 25% to fixed income.  We would never, ever, recommend going more conservative than 50/50.

Another key:  Participants are likely to be adding to the portfolio with each paycheck.  Dollar cost averaging into a volatile portfolio can produce some fantastic results.

#2.  Contribution percentage is too high

I know.  Seems counter-intuitive.  Let me explain.  If your company matches contributions, it is important that you don’t hit the maximum contribution too early in the year, which for a 401(k) in 2010, with several exceptions, it is $16,500.  I wrote about this in a prior entry, but bottom line – you only receive a match when you are contributing.  The match is based off of your contribution AND your income.  Maxing out too early leaves money on the table…since all income earned after your contributions have stopped goes unmatched.

#1. Contribution percentage too low

For some people, the sound of finger nails on a chalk board makes them cringe.  For me, it’s meeting someone who doesn’t contribute enough to their retirement plan to take full advantage of the employer match.  Except in the MOST EXTRAORDINARY of circumstances, this is the biggest mistake in all of personal financial planning.  Free money is being left on the table.  Stop and think about the math:

• Employer matches 3%
• Paycheck is $1000 per week
• Employee pre-tax contribution would be $30
• Employer matches $30
• $60 goes into retirement account
• Take home pay reduced by about $22 (this is an estimate – since it is pre-tax, deferring $30 will reduce after-tax pay by a smaller amount.  The exact amount would depend on how much you earn.)

Clearly, you can see that I would be a proponent of giving up $22 in cash now to get $60 later.

From time to time, our clients come to us with plans to make a big recreational purchase or inheritance checks that they want to deposit into their accounts. Understanding the impact that distributions/contributions can have on a portfolio’s overall performance is critical. Most statements that investors get in the mail only detail recent transactions. By contrast, our Chappell Mayfield Investment Dashboard provides a complete historical account of all money flowing in and out of all accounts.

In all likelihood, contributions will occur almost exclusively during the ‘accumulation’ phase of a client’s financial history. This is the period leading up to retirement when money is being poured into the portfolio to accumulate and grow. At Chappell Mayfield, we encourage our clients to systematically contribute money into their accounts on a regular basis (monthly, quarterly, annually). This concept, referred to as Dollar Cost Averaging, tends to spread out risk and reduce the emotional trauma of investing in volatile markets. Doing so allows investors to buy more of an investment when prices are down, and less when prices are high. This investment technique holds investors feet to the proverbial fire and also forces them to save, which consumers tend NOT to do very well.

Occasionally though, large chunks of money come pouring into a client’s portfolio as a result of a bonus, inheritance or rollover, etc.  Wary investors wrack their brains about when the exact right time to invest this money may be. We see things differently. We know that time in the market tends to overrule timing the market. We will almost always encourage our clients to immediately allocate extra money toward their portfolio.

Consider the stark difference between the performance of money invested in March 2009 versus the same funds deployed in March 2010.  I touched on the ‘cost of waiting’ in an earlier blog.  For this particular time period, by getting the money invested early rather than anxiously waiting, an investor would have participated in a huge market run-up.  Having an accurate record for when money was deployed can provide much needed perspective when it comes time to view performance.

Distributions, almost exclusively reserved for retirement, must be tracked with even greater vigor. The importance of tracking not just the timing, but also the total amount taken from your portfolio, is of the utmost importance. Clients tend to look at the balance on their statement and forget about any/all funds that were withdrawn for spending. For example:

John’s portfolio started at $1,000,000 three years ago.  His balance today is $1,000,500.  On the surface, it is easy to see why he might be a bit disappointed if the market has been up for those years. However, the fact that he has withdrawn $250,000 adds much needed perspective to the numbers and overall performance of his account.

Tracking withdrawals carefully also helps clients to keep a lid on what might be unnecessary spending and ensures that they are carefully watching their portfolio to make certain that they can maintain their usual quality of life in retirement.

Additionally, Chappell Mayfield’s approach to sustainable withdrawals means that withdrawals are taken each year despite upward or downward fluctuations in the market.  Holding true to a withdrawal pattern in good markets and in bad is critical.

Table is for illustrative purposes only

In keeping with the mindset that an Investment Dashboard should be a turnkey tool, providing all the relevant information pertinent to making sound decisions for a client’s portfolio, it only makes sense to include a page that clearly illustrates the Asset Allocation for all the client’s holdings.  The concept of diversification goes back to the old proverb “don’t put all your eggs in one basket.”  There is nowhere that this concept has more bearing than in your investment portfolio.

Diversification is the central tenet of asset allocation, proposing that by combining multiple assets with varying correlations (moving independently of each other), one can reduce overall volatility and risk.  To determine the appropriate allocation for each of our clients, we take into account factors specific to the investor’s unique financial situation as well as financial market and economic factors that could affect a particular sector, asset class or type.
In the end, sustainable withdrawals are the goal.  It is realistic to think that an investor can live well into his/her 80’s nowadays.  Advances in modern medicine have made it increasingly difficult to have enough money to last until you die.  The longer money is needed, the more care that should be taken to hedge investments against inflation.  For any investor, we recommend a strategic allocation with the following parameters:

• 10-15% allocated to Alternative Investments – these are ‘non-traditional’ investments that have little to no correlation to the equity or bond markets.  Alternatives tend to provide much needed protection during Bear markets.
• Of the remaining Balance (after Alternatives)-60-75% allocated to Equities – effectively, you end up with an approximate total allocation to equities of 55-70% exposure. Equities will be spread among numerous styles and market caps (Large Cap, Mid Cap, Small Cap, Foreign, Emerging Markets, etc.).
• Of the remaining Balance (after Alternatives)-25-40% allocated to Bonds – this puts your effective Bond exposure somewhere between 20-35%. These funds are allocated to various bond holdings (Corporates, High Yield, Treasuries, Municipals, etc.).

(Above is a hypothetical example for illustrative purposes only)

Historically, this allocation gives the client a greater probability of sustaining their ability to withdraw money over time and steadily increase their withdrawals to keep pace with inflation.  It should be noted that we employ this strategy across our entire client base. You should expect a similar allocation regardless of your age.  Being too safe can drastically affect the long-term sustainability of wealth in the same manner that being too risky can bring about too much volatility when taking withdrawals.

By graphically showing our clients the asset allocation each quarter, we can easily ensure that they understand how their different positions work together to mitigate risk.  An investor’s asset allocation will fluctuate over time due to market movements and individual investment performance.  The Dashboard gives us a breakdown of the current allocation and allows us to quickly determine how weights may have shifted.  Reallocations within the portfolio are sometimes necessary to maintain the proper mix established for a client based on their risk tolerance and ever-changing financial picture.

Evaluating a portfolio’s holdings is tricky business.  In our previous discussion, we focused our attention on performance versus benchmarks and peers.  Knowing that a manager performed better than their benchmark and/or peers is an indicator of a good investment, but should never be used as a sole deciding factor.  Another common way for investors to determine an investments’ attractiveness is to look at its risk, or volatility, levels.  One method that is used in evaluating the volatility of an investment is to measure upside/downside capture versus the benchmark.

Upside/downside capture ratios measure the difference in the return of an investment against the performance of the underlying benchmark—that is to say, “how much did the investment participate in a bull market vs. its benchmark and how much did the investment participate in a bear market period vs. its benchmark.”  Numbers higher than 100 indicate higher volatility.  Ideally, investors should look for higher numbers for UP capture and lower numbers for DOWN, indicating that the manager outperforms the benchmark in bull markets, but performs “less poorly” than the benchmark in bear markets.

The two columns right of the gray area on the Dashboard below show each investment’s upside/downside capture ratio for each investment.

• First Column: In the last 12 quarters, when the benchmark has gone UP, to what extent has this investment participated in the UP market?
• Second Column: In the last 12 quarters, when the benchmark has gone DOWN, to what extent has this investment participated in the DOWN market?

The last two columns of the Dashboard give our current opinion on the outlook for each investment, including the previous quarter’s recommendation.  This summarizes our conclusion, based on the quantitative factors highlighted in the CMA Investment Dashboard (performance and volatility) as well as some qualitative factors that must also be taken into consideration when making investment recommendations (manager tenure, macro-economic trends, industry/sector news, etc.)  As always, they are color-coded for easy reading.

Green: we recommend keeping this investment. Yellow: this investment is now on our “watch list”—we will monitor closely, but too early to recommend a change.  Red: this is the “sell” signal.  When clients see red in this column, they know we are recommending a change and expect dialogue to support the move. They can also expect us to be ready with a replacement that we feel will work better for them, based on their situation.

Put simply, these two columns reflect the immense amount of thought, analysis and time that goes into each of our investment decisions, and are one way for our clients to hold us accountable for the recommendations that we make.

In our initial Chappell Mayfield Investment Dashboard™ post several weeks ago, we gave a broad overview of the proprietary tool that we, as financial planners, created to help our clients understand and evaluate their investment portfolio’s performance.  We would now like to go one step further by explaining each of the key components of the “Dashboard,” in an effort to show how each plays a crucial role in investment evaluation.

Dissecting the Dashboard: Part 1- Performance

Standardized performance gives us a quantitative view of how well a particular investment has stacked up against its benchmark, and makes it easy for one to compare similar investments. This critical piece to the Dashboard focuses on performance over the preceding quarter, 1, 5 and 10 year time periods. Performance is color coded to allow for a quick assessment of how any investment stacked up for the given timeframe. Green indicates outperformance versus the benchmark, Yellow indicates even performance against the benchmark and Red indicates underperformance versus the benchmark.

Performance versus the benchmark tells only part of the story.  Next, we must consider performance relative to other investments of similar scope and mission. Performance Relative to Peers compares the investment or manager to others with similar objectives by ranking them on a scale of 1 to 100 over the preceding 3- and 5-year timeframe.  Green indicates top quartile performance versus peers (1-25 rank), Yellow denotes performance in the next quartile down versus peers (26-50 rank) and Red is for performance in the bottom half versus peers (51-100 rank).

There is much to be learned by combining these two performance measures.  Studies have shown that many top performing managers spend at least some time in the bottom half of their peers.  A manager that is moderate or even conservative may never appear in the top quartile.  Then again, they may never appear in the bottom either.  These independent measures and facts are all taken into consideration with our overall assessment of performance.  A “home run” scenario would be to own the manager during a rise from the bottom quartile to the top.

A common mistake that many investors make is comparing the performance of a particular investment to the wrong benchmark or peer. Many investors associate market performance with the S & P 500 Index or Dow Jones Industrial Average and will use these when comparing their performance. These are common indices that are tracked on many investor websites and financial television programs. The mistake occurs when an investor holds up a particular investment against these benchmarks when not appropriate, as thousands of these investments have objectives completely unrelated, or uncorrelated, to either of these major indices. The Chappell Mayfield Investment Dashboard™ clearly notates which benchmark to use when gauging the performance of each portfolio holding to ensure a more relevant indication of relative performance.