10 STEPS TO A GREAT INVESTMENT PORTFOLIO

10 STEPS TO A GREAT INVESTMENT PORTFOLIO

T he best portfolio is the one that accomplishes your long-term financial goals with as little risk as possible. We have outlined the 10 steps that we follow at Surevest when building and managing investment portfolios. 1 HAVE AN OVERALL STRATEGY Each portfolio should have one overall manager who understands the big picture and oversees all of the individual components. Mutual funds, annuities, individual stocks, bonds, ETFs, MLPs, REITs, etc. need to be combined in such a way that they are working together to achieve your specific goals. The portfolio manager needs to understand any overlap among investments and how each investment will react to outside shocks such as interest rate hikes. This manager should know when your portfolio becomes out of balance with the planned allocation. This allocation also needs periodic adjustments based on changing market conditions. At Surevest, we monitor all client portfolios on a daily basis to assure they are performing within your expected risk and reward parameters. 2 INCORPORATE MULTIPLE MANAGERS It s very difficult if not impossible for one person to be the best investor in every asset class and every geographical area of the world. You leave yourself vulnerable to the poor decisions, biases, or just an investment style that can become out of favor over extended periods of time if you rely on a single manager. Yesterday s top manager can be tomorrow s dinosaur. By utilizing multiple managers with different philosophies, you give yourself the potential to reduce risk and capture greater overall returns. At Surevest, we oversee the overall portfolio construction and directly manage the majority of your money. However, we also use an average 4 to 5 outside managers for specific segments of the portfolio. We only employ best-of-breed managers whom we feel have the ability to outperform their benchmark and contribute positively to the overall returns of our portfolios. We consistently monitor and communicate with these managers to assure they are staying true to their mandates. 3 KEEP FEES LOW A great portfolio draws on the wisdom and expertise of multiple managers. Many argue the merits of using passive low cost index funds vs. active money managers in an investment portfolio. There are certain areas like domestic large cap stocks where market pricing is very efficient. This makes it extremely difficult for active management (e.g. mutual fund managers) to outperform their benchmark. The opposite can be found in areas like frontier or emerging markets, where opportunities still exist for active managers to significantly outperform, even after accounting for their fees. Your active vs. passive decision doesn t have to be all or nothing. Instead, it makes sense to selectively incorporate active managers in areas where they can add value and utilize passive low cost ETFs for SUREVEST WEALTH MANAGEMENT 10 STEPS TO A GREAT INVESTMENT PORTFOLIO 2

more efficient areas. At Surevest, we utilize low cost ETFs from well-known indexers such as Vanguard or Wisdomtree. For example, we may buy an ETF that tracks the energy index if we feel that entire segment of the market is undervalued and we want broad-based exposure. On the other hand, we would use individual stocks if we thought the asset class as a whole was fairly valued but we could still find a few companies that were undervalued. This is where individual stock selection can pay off. Mutual funds are normally only used in specialized areas (e.g. emerging markets or alternatives) where markets are less accessible and less transparent. We use no load, load waived, or institutional class funds to avoid commissions and keep expenses low. 4 DIVERSIFY GLOBALLY AND BY ASSET CLASS Don t fall in love with any one asset class. Whether its stocks, real estate, gold, or bonds, there are many points in time when one asset class is doing well while the rest of the market is doing lousy. It is impossible to consistently move in and out of the market or specific asset class at the right time. Our experience has shown more money being lost trying to time market corrections that do not happen than is lost in actual corrections. Therefore, it is important to stay diversified in order to help minimize risk. This approach also generally provides a more consistent stream of income and the opportunity for greater overall returns. Many investors are prone to falling in love with their home market. The U.S. only represents 50% of the investable universe and an even smaller percentage of the world economy. Many foreign markets performed quite well from 2000-2010 while U.S. markets were flat. Your own portfolio should reflect today s global economy to give yourself a broader chance for success and consistency. (See Appendix B Portfolio Construction for sample asset classes and allocation considerations) Your own portfolio should reflect today s global economy to give yourself a broader chance for success and consistency. 5 BE PREPARED FOR MARKET MELTDOWNS Markets experience 5 15% declines quite often. This is just part of investing. These movements are normal and even necessary for a healthy market. However, drops like we witnessed in 2008 of nearly 50% can be catastrophic for investors near retirement or during retirement. We believe that every portfolio should have a risk budget utilized to buy protection for these large unforeseen declines. Buying index put options with a small percentage of your portfolio can act as portfolio insurance. These put options have the potential to become highly profitable when markets crash, thereby cushioning the downturn of the rest of your portfolio. These options can also give investors a source of funds to invest when assets are cheap (e.g. right after a crash). Options involve risk so this strategy is best incorporated with the guidance of a professional. At Surevest, we normally allocate between 1% and 2% as portfolio insurance. We also invest a portion of your portfolio in SUREVEST WEALTH MANAGEMENT 10 STEPS TO A GREAT INVESTMENT PORTFOLIO 3

asset classes that have the potential to profit even in a declining market. Our goal is not to protect against normal market declines but the large unforeseen drops that can derail your financial plan. We also recommend that investors always have cash and cash equivalents readily accessible and isolated from market volatility to accommodate short-term financial needs. 6 BUY WHAT S ON SALE Warren Buffet was criticized as being out of touch for steering clear of Internet stocks in the late 90s. Mr. Buffet didn t look too smart for a few years, but he was ultimately proven right. The same can be said for real estate, precious metals, and other hot opportunities, which people tend to chase at the tops of markets. A strict eye should always be kept on the valuations for each area of your portfolio. Investors are well served by reducing positions once they exceed historical valuations and redeploying those funds into areas that have recently underperformed. This leads to the desirable practice of buying low and selling high. Avoiding overpriced assets is a key component of managing risk. Emotionally, the hardest time to sell is when your stock is going up and everyone is buying. At Surevest, we adhere to a strict sell discipline to avoid the froth that ultimately occurs in every market. 7 DON T USE INDEXES TO MEASURE PERFORMANCE Far too often, people try to compare their investments to an arbitrary benchmark like the S&P 500. Technically, you beat that benchmark if the index drops 50%, but you only lose 45%. Unfortunately, that is little consolation if you run out of money and have to go back to work. We suggest investors switch their mindsets to an absolute return strategy. Absolute return means that you are trying to achieve the same return in all market conditions. Naturally, it is impossible not to have some variance of returns but you want to get as close as possible each year. To level out the inevitable ups and downs, we suggest targeted rates of return should be measured over rolling five-year periods. Investors should also know the maximum drawdown that they are comfortable with and that their portfolio can recover from while they are taking withdrawals. At Surevest, each portfolio is based on the client s financial plan and designed to take as little risk as possible in order to achieve our client s objective. 8 KEEP YOUR EMOTIONS IN CHECK Avoiding overpriced assets is a key component of managing risk. Markets move up and down. People are naturally inclined to take more risk after having recent success, which is typically at or near the top of the market. People instinctively want to sell and protect what they have left after a market decline. This means that normal human emotions and intuition will lead investors to buy high and sell low. This is further SUREVEST WEALTH MANAGEMENT 10 STEPS TO A GREAT INVESTMENT PORTFOLIO 4

compounded by the fact that many good years in the stock market are accompanied by significant intra-year declines. For example, in 2010 the S&P ended the year up 13% but many investors bailed out mid- year when the market had a 16% pullback. (See Appendix B Volatility and Investor Emotions) One of the reasons investors are likely to panic during market declines is they do not have a good understanding of the There has never been a investments they own. A second reason that many investors panic market decline that we is they do not have a disciplined long-term strategy that gives them have not recovered from. confidence to stay the course. There has never been a market decline that we have not recovered from. That is not likely to change in the future for investors who own a portfolio of high quality assets which are appropriate for their planned time horizon. At Surevest, we do extensive research on each investment so that we can have conviction in our investment decisions. This provides the comfort to stay the course when markets become volatile. 9 HAVE A SELL DISCIPLINE Forever isn t always the best holding period. There will always be investments that do not work as intended, no matter how much research you do. Selling tends to be difficult for many investors. There are two reasons to sell: 1) You were really right and the asset has increased in value to a point where it is fully valued or overvalued. Think of that one bedroom condo that doubled in value over just a few years. It is likely time to sell if the current trend cannot continue. 2) You were wrong. There will be times when you or your money manager had it wrong. Investments do not always go according to plan, but the key is to cut your losses before they become catastrophic. There is no shame in taking a loss. It is better to sell when you are wrong before you are proven really wrong. Think about Enron or the thousands of other stocks people watched go to zero. They may have bought at $100 and did not want to sell at $70 because they did not want to admit a mistake. Instead, they watched their investment become worthless. Knowing when to sell is a crucial component of great portfolio management. You should always ask yourself, If I had the cash today instead of this investment, would I still buy it at today s price? If the answer is no, then it is time to sell. At Surevest, we incorporate a strict sell discipline. We sell a stock when the original reasons that we purchased the stock have materially changed and the stock no longer has a clear future catalyst. Secondarily, we sell a stock or asset class once it passes the point that we have determined to be the fair market value. SUREVEST WEALTH MANAGEMENT 10 STEPS TO A GREAT INVESTMENT PORTFOLIO 5

10 INVEST A SMALL AMOUNT IN COMPANIES OF THE FUTURE A moderate risk portfolio should not be invested in all moderate risk investments. It should have some low risk investments, some moderate, and a small percentage should be invested in companies that could be home runs. Investing a small percentage of your portfolio in stocks that have the potential to be the next Coca-Cola, Amazon, or Starbucks gives you the opportunity to exceed your own expectations in creating wealth. This is hard to do with just a portfolio of index funds. At best, you will do slightly worse than the benchmark over the long run due to the fees. At Surevest, once we have allocated enough assets to achieve short and midterm goals for our clients, we incorporate stocks that we believe have the potential to exceed greatly index type returns. Small investments in high quality, early stage companies can reap great rewards. This is an area where research has the greatest potential to add value. This component of the portfolio should be risk managed in terms of both position size and sell discipline. The 10 step approach described in this paper enables you to protect and grow your wealth over long periods of time. Through years of research and experience we have found that the best strategy for accumulating and protecting wealth does not try to guess the market s next move, but instead prepares for the widest variety of potential outcomes. There are many investment strategies which work for a period of time and then blow up. There are also strategies that look great in the rearview mirror but are unlikely to work as well going forward. The 10 step approach described in this paper is one that you can stick with for the rest of your life. We hope it provides you with peace of mind and a prosperous future. For more information about investment portfolios, contact Surevest Wealth Management 480.272.7116 or visit www.svwealth.com. SUREVEST WEALTH MANAGEMENT 10 STEPS TO A GREAT INVESTMENT PORTFOLIO 6

APPENDIX A: PORTFOLIO CONSTRUCTION Investors should take as little risk as necessary to achieve their objectives. This is accomplished by drawing from a wide universe of asset classes and strategies. Factors that should be considered when evaluating how much to allocate to each asset class are: Income (dividends/yield), Capital appreciation potential, Risk/volatility, and Diversification benefits. The portfolio needs to be rebalanced to maintain the risk/reward objectives of the investor as valuations and correlations change. Investor Objectives Return Objective: Inflation + 4% Risk Tolerance: 70% of S&P 500 SUREVEST WEALTH MANAGEMENT 10 STEPS TO A GREAT INVESTMENT PORTFOLIO 7

APPENDIX B: VOLATILITY AND INVESTOR EMOTIONS As the chart below illustrates, since 1980 the stock market, as measured by the S&P 500, has risen in 26 out of 32 years. However, the market has experienced drawdowns in each of the 33 years depicted. 50% Calendar year returns S&P Intra-year declines Thrill 35% 20% 5% 26 10 17 1 26 15 2 12 27 26 4 7 34 31 27 20 20 26 9 3 14 4 23 13 13 Excitement Relief -10% -25% -40% -10-14 -17-17 -7-8 -9-12 -34-8 -8-7 -23-2 -6-6 -5-9 -3-8 -11-19 -10-12 -13-17 -23-26 -32-14 -8-7 -8-10 -38-28 0-16 -19-9 Optimism Anxiety Fear -55% -47 Panic Sources: S&P, esignal Managing your emotions is an essential component to successful investing. Investors typically feel happy and secure after the market rises and worried and fearful after market declines. Good investing is frequently counter-intuitive. A disciplined, consistent and unemotional investment process helps investors stick with their long-term plan. SUREVEST WEALTH MANAGEMENT 10 STEPS TO A GREAT INVESTMENT PORTFOLIO 8