By Christopher M. Lee, CFP®
As some of you may have noticed (either in your mailbox or email box), we made several changes to your account(s) over the past several weeks. We did get some phone calls asking about the changes, which gave me an idea about what to write about in this newsletter; how we manage your hard earned money here at New England Capital. First of all, please know that we do not take lightly the trust and confidence that you have placed with us to help you reach your life goals. We take what we do very seriously – our greatest joy is seeing you accomplish those life goals.
So how do we put together our “models” that we manage? What’s our reasoning? Why do we make changes in your accounts? In taxable accounts, do we consider taxes before we sell? I will try to answer those questions for you below. We have six “model portfolios” that range from Aggressive to Conservative (based on your life goals, age, income, your individual risk tolerance, and other factors). We help choose those models with you based on 1) the life goal you are saving for and 2) the answers in the risk questionnaire that you filled out. Based on that data (with some discretion) is what models we have chosen with you and the overall asset allocation (the mix between stocks, bonds, alternatives, and cash). Please note (as per the Engagement Agreement and application(s) that you signed when you opened your account(s)) that we have discretion on your accounts, meaning that we can make changes to your investments (buys and sells) as we deem necessary.
The best analogy to use for how we assemble the models is from our countries national pastime, baseball. I apologize for the sports analogy, but it seems to fit the best. We see ourselves as the manager of the team. Our job is to assemble an all-star lineup for you. We also decide who gets to bat where in the lineup (some positions in the lineup are more important than others). Sometimes we will release and swap a batter if they are not being productive enough (compared to their peers at that position). That was one of the changes you saw recently. We were not satisfied with the RS Natural Resources Mutual Fund compared to other Natural Resource funds and we replaced it with the iShares Natural Resources Fund which is an ETF or Exchange Traded Fund. Performance is not the only reason we make changes to our funds. One of our jobs as managers of the team is to have conference calls and have in-person meetings with the portfolio managers (the batters on the team). If we do not like the way the manager (or batter) is going, we may make a change. That is why a long term staple of your portfolio (Pimco Total Return) was removed from all of the portfolios. This fund accounted for a part of the fixed income part of the portfolio. In our opinion, the fund had too large a position in government bonds (treasuries) based on the current economic outlook (i.e., interest rates, economic and political).
Since we are the managers of your team, we are also looking ahead to future innings. Not only are we managing your money for today, but we are looking ahead at economic trends in the market. Please note that we are not “market timers” meaning that we will not put your accounts in cash if we think the market is going to crash and then get you back in when the market bottoms out. I feel confident in our abilities to manage money, but we are not psychics. When you try to time the market you need to be right twice, when to get out and when to get back in again. Inevitably, there will be another Dot.com bust or credit default swap that will temporarily bring the market down; we just don’t know what it is yet. So how do we protect against that? Sometimes a good defense can make a good offense. Our investment committee (that meets quarterly with other advisors associated with New England Capital) not only looks for growth in “up” markets, but is constantly looking for more ways to protect your money in down markets. We believe that downside protection is extremely important. Why is that? To put it simply, when your portfolio is down 10%, you now need to make 11.1% to get back to breakeven. When your portfolio is down 20%, you now need to make 25% to get back to breakeven, and when you are down 30%, you need to make 43% to get back to even. So, if we want to participate in the gains of an “up” market, our models will in most cases, trail the S&P 500 (500 largest US companies). That is because (while we are still invested), we are looking to protect on the downside. It is a “when” not an “if” for the next 10% market drop or 20% drop for that matter. We know that it is coming, we just don’t when.
I talked about the batters that we have hired (mutual funds and ETF’s), now I will talk about where in the lineup they go. If we feel that we have a batter that is about to heat up, we may put him/her into the fourth spot of the lineup (which is usually the power hitter or “cleanup hitter”). We may choose to overweight an asset class. For example, last year two of our largest asset class positions in several of the portfolios were Large Cap Growth and Large Cap Value companies, which did well.
That works the other way as well, if we feel less confident about an asset class (but still feel it is important to own), we can weight it less in the portfolio, which is what we recently did with the Natural Resource sector. We also try to find asset classes that have a negative correlation with the market. In English, that means that we want pieces of the portfolio to “zig” when other things “zag”, so just because we reduce the position doesn’t mean it is not important.
Another thing that we take into account (for our non-retirement taxable accounts) is taxes. We try to be as tax efficient as possible BUT we do not let the tail (taxes) wag the dog (portfolio). For example, if we have a position that earned 40% in one year, do we not sell anything to avoid taxes? The answer is no, due to the rebalancing that we do to the portfolios once or twice a year, as needed. If we do nothing, and the fund that earned 40% goes down 20% the next year, the tax problem may take care of itself, but so will your gains.
There are many, many pieces that go into managing your money and your portfolio and I only touched on a fraction of what we do. I wrote this article as I want you to have some insight on some of the things that we do, as the more you understand, the more comfortable you will hopefully feel. We are constantly looking ahead to the next inning – so leave the worrying to us – that is what you are paying us for. In the meantime, spring will be here before you know it and it’ll be time to let me root, root, root for the home team, if they don’t win it’s a shame!