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May 6, 2009 Dear Client: Q1 2009 Market Update
Index Returns for Period Ending March 31, 2009
The perception that equity markets were in free-fall has abated over the past eight weeks as the S&P 500 Index climbed from 666 on March 6th to 907 on May 4th, a recovery of 36%. The Dow Jones Industrial Average (DJIA), the headline benchmark, recovered from 6547 to 8436 over the same period, a gain of 29%. The decline from September 2008 through February 2009 was shocking so it is not surprising that investors are paying more attention to their finances now. Market losses of the magnitude we just experienced are new to most of us. More than half of our clients started working with us between 2002 and 2007, a period of "investment nirvana". Imagine yourself looking at your portfolio on October 31, 2007. The 1 year, 3 years, 5 years and 10 year returns of all asset classes were positive returns. In five years, U.S. large cap stocks had nearly doubled and foreign stocks nearly tripled. Investment Returns, Then and Now
Never in the thirteen years since starting Grubman Financial have I spoken as intensively with clients as I have during the past six months. Clients have said these discussions have helped them develop a solid investment plan, in the face of relentless advice offered by media, advertising, friends and family. From my side, the discussions have helped me better understand my clients' concerns and thought processes. It is human nature to suffer our losses much more acutely than we appreciate our gains, and thus I was not surprised to hear that clients are paying closer attention to their investment portfolios now. More than a few clients said they had never read one of these cover letters that accompany our quarterly statements. Many clients did not understand the statements, did not know where to look for their investment return. Some clients were unaware of their asset allocation. Many did not know how we come up with asset allocation, or even the meaning of asset allocation. What did surprise me were the number of people who thought my firm was making investment decisions based on what we expected the market to do in the near term. When I explained to one client that I had no idea when the decline would stop, she succinctly asked "what am I paying you for, then?" So, the rest of this letter is a simple answer to a fair question. What Does Grubman Financial Do? We are your financial manager: we help you identify and prioritize long-term financial goals, and take action to achieve those goals. We help you implement some of the actions, for example, purchasing insurance policies, protecting your electronic identity, updating your estate plan when needed, to refinancing your mortgage, budgeting, etc. We prepare tax returns and projections. And, of course, we directly manage your investments, using what is referred to as a "passive" strategy. What is "Passive Management"? Sometimes referred to as "indexing" or "investing in index funds", the financial term for indexing is "passive investing". Passive management is the investment strategy based on the knowledge that asset allocation is the main determinant of investment return. Asset allocation is the proportion of different types of assets within a portfolio. The broad asset classes are stocks, bonds and cash. The asset classes are further divided into sub-classes: foreign vs. domestic, large-company vs. small, non-dividend paying stocks vs. dividend-payers, Treasury bonds vs. corporates, and many other types, each with its own attributes of risk, return and relationship to other asset types. Each asset class and sub-class has a benchmark. A benchmark is a reference point used to measure performance of similar assets. The Dow Jones Industrial Average is a benchmark for U.S. large company stocks. It's a poor benchmark because it's made up of only 30 stocks. The better benchmark for the U.S. stock market is the S&P 500, which is made up of 500 of the largest U.S. industrial companies. All investment classes and sub-classes have their own benchmark: Treasury bonds, corporate bonds, small-cap stocks, gold, emerging market stocks, emerging market bonds. Any way you slice or dice investment assets, there is a benchmark you can (and should) use to compare your investments' performance. Most investors believe that it is possible to consistently beat the benchmarks with superior knowledge. Those investors choose managers who actively research and trade individual securities, with the expectation that their manager will be able to outperform their appropriate benchmark. However, the data show that the vast majority of active money managers underperform their benchmarks. Standard and Poor's publishes a quarterly report comparing passive vs. active managers, called the "SPIVA" scorecard*. The most recent SPIVA scorecard reports that only 28% of active managers beat the S&P 500 benchmark for the 5-year period ending December 31, 2008 and only 15% of active small-cap managers beat their benchmark (the Russell 2000 Index) over the same period. Not only do most active managers fail to deliver better returns than passive managers, but they can also expose investors to excess risk, since the active manager typically holds more concentrated positions than their passive fund peers. Active management increases the cost of management: the average actively managed U.S. large company stock fund charges 1.2% per year. The corresponding passively managed fund costs about 0.1% per year. It may not sound like a lot, but if you expect to earn 8% per year on your portfolio, 1% additional fees each year will make a HUGE difference over the long run. The final nail in the active management coffin is the fact that even if some managers CAN consistently earn more than the benchmark, it's not possible for an investor to know ahead of time which manager it will be. The beauty of passive management is that every benchmark has at least one corresponding mutual fund that an investor can buy. The S&P 500 benchmark has hundreds: the original and best known is Vanguard's 500 Index Fund. Still, an investor can hold an entire portfolio of benchmark funds, with much, much lower expenses than actively managed funds, and a much, much higher probability of achieving investment returns in the top quartile of all investors, individual and professional. Why Pay Grubman Financial for Passive Management? Now that you understand why we utilize passive funds for your investment portfolio, you might wonder, why not do it yourself? There are several reasons:
Our investment management services include:
Associated financial management services include:
We aim to provide all financial management services, financial planning, tax services and investment management, for the same or lower cost than the investment expenses alone charged by the average actively managed mutual fund or privately managed investment account. We expect the return of the passively managed portfolio to consistently perform in the top quartile of professionally managed portfolios. One of our clients asked if there is a "Passive Management for Dummies" book. Well, there is! Please email us if you'd like a complimentary copy.
Regards,
*Standard and Poor's Index Versus Active Scorecard, published quarterly |
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