This past month my wife, Amelia, and I returned from a trip to Hong Kong and Beijing, where we visited family in Hong Kong and our son and daughter-in-law in Beijing. The motivating factor for the trip, however, was that Amelia’s sister Joyce, who had been fighting cancer for several years, had taken a turn for the worse. Joyce had been moved to hospice care (called a cancer rehabilitation center in Hong Kong) and was receiving round-the-clock care. She was surrounded by loving family members who had come back to visit and assist her. As I pondered life and death, the words shared by Steve Jobs at the 2005 Stanford Commencement came to mind:

“When I was 17, I read a quote that went something like: ‘If you live each day as if it was your last, someday you’ll most certainly be right.’ It made an impression on me, and since then, for the past 33 years, I have looked in the mirror every morning and asked myself: ‘If today were the last day of my life, would I want to do what I am about to do today?’ And whenever the answer has been ‘No’ for too many days in a row, I know I need to change something.

“Remembering that I’ll be dead soon is the most important tool I’ve ever encountered to help me make the big choices in life. Because almost everything — all external expectations, all pride, all fear of embarrassment or failure – these things just fall away in the face of death, leaving only what is truly important. Remembering that you are going to die is the best way I know to avoid the trap of thinking you have something to lose. You are already naked. There is no reason not to follow your heart.”

He closed with these words of counsel for the 2005 graduates of Stanford that apply to each of us, “Your time is limited, so don’t waste it living someone else’s life. Don’t be trapped by dogma — which is living with the results of other people’s thinking. Don’t let the noise of others’ opinions drown out your own inner voice. And most important, have the courage to follow your heart and intuition. They somehow already know what you truly want to become. Everything else is secondary.”

This week Amelia and I return to Hong Kong to honor Joyce in a celebration of life (she passed away a couple of days after we returned home). The goodness of her life and the faithfulness of her family cause me to ponder my own life. Should I change anything, am I following my heart? As a teenager I learned that laws matter and that they have a purpose. Likewise, I have come to the realization that there are natural laws and they do matter. Death will come to each of us, and for most of us we will have little control over when it comes, but we can control what we make of each day. As I have pondered Steve Job’s challenge, I am grateful to be excited to be doing what I do; I am grateful to work with exceptional people; and I am grateful for the privilege of serving you.

Wishing you Happy Holidays and a Prosperous New Year!

In line with the Halloween season, the recent volatility in the stock market has certainly created its own host of thrills and chills.  If only investing were as easy as trick-or-treating. Wouldn’t it be great if we could ring a doorbell to receive a dividend or net capital gain? Unfortunately, money management is never that easy. But for those investors wandering alone in the dark with nothing more than a glow stick, we offer a few lessons taught to us by our young costumed friends.

First, seek out those with a track record.  Children learn which houses provide the best candy through years of experience and word of mouth. Some houses are just more popular than others. It’s not uncommon to see all the children lined up to get their king-sized Nestlé Crunch bars and bag of Skittles, while the porch of the next-door neighbor sits empty because they are passing out apples, pennies, or toothbrushes.

Use investments that have solid, long-term results. At Prudent Investors Network, we typically exclude investing in assets whose manager has not been in place for at least five years.  In addition, we focus on the five- and ten-year return and not their one-year and year-to-date performance. Five- and ten-year returns will include various market cycles and provide important insight into how the product performs during an upturn and, more importantly, a downturn.

It is not uncommon in our research to see some of the same names appear year after year–in part because of their long-term record.  For the average investor, you can use the resources of Morningstar.com to view the three-year, five-year, and ten-year track record. Of course, past performance is not indicative of future results.

Second, do an accounting of your investments. After a night of trick-or-treating, I still have memories of dumping my orange bucket on the floor and sorting my Tootsie Rolls, lollipops, and Smarties into little piles. Set aside a specific time at least once each year to review your investments and whether they are still appropriate to your financial goals.  Make changes to your investments, when needed, in the context of your long-term investment objectives.  Avoid checking the market every day because it can generate emotional responses that distract you from the proper decision making needed to keep your finances in order.

As we draw close to the parties, costumes, and candy of October, let us remember these simple Halloween lessons.  May you have a safe and happy Halloween!

On the other hand, most of us realize that the odds are set to favor of the casino – if you roll the dice enough times, the casino is guaranteed to win, which means you are guaranteed to lose. Historically, the equities markets have shown roughly an average 9% bias to positive earnings (i.e., 9% annual growth since 1925). Of course, if you put all your money on a single stock, you may win big, or you may lose your shirt. But, if you “spread your risk” (diversify effectively), and if you are patient, you are more likely to be rewarded with positive returns on your portfolio. Notice that I emphasized the word, effectively. Managing downside risk is crucial. A big loss is devastating to an investment plan.  At PIN, we like to say that losses are far more harmful than gains are beneficial.

Let’s illustrate that point. Let’s say you make an investment. In the first year (as happened in the 2008 bear market) you lose 50%. Fortunately, however, the next year the market takes you back up 50%. How have you done? Well, you are still down 25%! Why? It’s easiest to understand when we talk in terms of dollars. Had you begun with $100,000 and lost 50%, you would have only $50,000 left at the end of the year. But then you enjoy a 50% gain.

Unfortunately, you began the second year with only $50,000, so 50% of $50,000 is only $25,000. At the end of the second year, that 50% gain only takes you back up to $75,000. And, that’s true whether you experience the loss first and the gain second, or the gain first and the loss second – in either case you’ll end up with $75,000. Here’s the truth:  to offset a 50% loss you must double your money – that’s a 100% gain! How often do the markets double?

That brings us to the point of this article:  We believe effective management of the risk of loss in an investment portfolio trumps all other factors in earning a higher long-term rate of return (not to mention the preservation of your capital). Let’s illustrate that point graphically.

Now study the green line of the PIN Portfolio Account.  Like the S&P 500 Index, it peaked in late 2007, but lost only 17% before turning back up in January 2009. From its low point (December 31, 2008), it required only a 20% gain to break even with its prior high. It had already achieved that by the end of November 2009 and, as of the end of August 2011 it was 4% above its 2007 high. By avoiding the worst of the 2008 losses, it ended up with a 4% gain (since the 2007 high) versus the S&P’s 15% loss over the same period.⁴

This was not an isolated event. In the late 2001 through late 2002 period, the PIN Conservative Portfolio dropped 6% versus the S&P’s loss of 28%. The PIN Conservative Portfolio became profitable (i.e., crossed above the black line on the chart) by the end of April 2003, whereas it took the S&P another eight months to offset its losses.⁴

Finally, notice the long-term effect of consistently avoiding major losses. Since November 30, 2001 (to the present), the PIN Conservative Portfolio has enjoyed cumulative earnings of 79% while the S&P 500 has gained only 29% (in nearly a decade).⁴

How is this accomplished? Primarily through use of sophisticated analytical tools that enable truly effective diversification of an investment portfolio. There is a huge gulf between mere talk of diversification and possessing tools that test a portfolio’s diversification and its risk of loss before losses occur.

In conclusion, management of investment risk and avoidance of loss is vastly more important to the protection of your principal and the achievement of desirable long-term investment returns than any other factor. Prudent investment management is the antithesis of striving for high returns by speculating and exposing your assets to high risk of loss.

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¹  The Citigroup 6-Month Certificate of Deposit index is an unmanaged index of certificates of deposits maturing in six months. Citi reports returns net of expenses. The impact of taxes is not included. It is not possible to invest directly in an index.
²   The Standard & Poor’s 500 Index (S&P 500) is not a fund, it is a broad index of 500 leading U.S. stocks representing the overall market. Calculations assume dividends and capital gains are reinvested and do not include any expenses, including transaction and/or custodial charges, management fees, nor the impact of taxes. Expenses would have the effect of decreasing historical performance results. It is not possible to invest directly in an index.
³  The PIN Conservative Portfolio began November 30, 2001. The charts track the actual results of PIN’s first client in its “Conservative” Portfolio Model from November 30, 2001 through June 30, 2003; from July 1, 2003 to the present, it represents the average performance of all clients in the PIN Conservative Portfolio.  PIN’s performance includes dividends and is net of all fees, including management fees. Individual results will vary depending on factors such as date invested and cash added to or withdrawn from the account.
⁴  It should be noted that past performance does not guarantee of future results. There are risks inherent with all investments and there is no assurance objectives will be achieved.