Quarterly Newsletter – January 2006

In the financial markets 2005 was a pretty standard year. The S&P 500 was up 4.89%. The Lehman Long Bond Index did 2.43%. As your asset class performance report shows, your portfolio did substantially better. This was due to the performance of the value stocks, the small stocks, both US and international, and of REITs. As has been the case ever since the S&P topped out in March of 2000, diversification is paying off in spades.

But what will happen next? What will do well next? We are asked these questions frequently. We may have opinions on these matters. But we do not act on them. Why not? After all, we read the financial press continuously, and we do have some special training and background in investing and economics. How could we not value our own opinions? Surely claiming that we do not must just be some kind of coy trick.

Not so. We invite you to purchase the issue of Barron’s, the weekly financial publication, that contains their 2006 interviews with various Wall Street sages. This will be published in a week or so. Read the advice and try to make sense of it. Some will say – buy this, because it has done well lately. Others will say – buy that, because it has done badly lately. Some will say the dollar is going to rise. Others that it is going to fall. Whatever the advice, each will be recommending a portfolio that is “overweight” in the asset class he or she thinks will do better than some others.

This is the curse of having opinions. One feels compelled to act on them. The result is an unbalanced portfolio, a portfolio that requires constant watching and often much worrying. And what do you do if the recommendations work out? Buy more? Sell what you have? What? And what if they don’t work out? Sell? Buy more? When? It is an endless nightmare.

And we do mean endless. A market timer, or an investor who acts on his opinions, has to be right not just once, but over and over again. In any short time period there is always one asset class that does the best. Portfolios concentrated in that asset class will outperform diversified portfolios. But the worm will turn. It always does. Overperformance and joy will be replaced with underperformance and regret, unless the soon to be underperforming asset class is sold and replaced with the next overperformer. How often can one be right in making this switch? We believe it is just not possible.
The thing we are continuously aware of is how volatile, and how very unpredictable, the capital markets are. Consider what has happened since March 2003. There has been a major bull market. It has been a kind of sneak bull market, because the headline grabbing S&P 500 has done the worst of any of the major equity asset classes. The S&P has not yet made back all the losses it suffered starting in 2000. But international stocks and the US small stocks are way ahead, as is your portfolio.

Who predicted this bull market? Not us. Who predicted that these particular asset classes would be the new winners? Again, not us. Barron’s will have people predicting that it will continue, and people who will say that it must end. One of them will be right but again we do not value these opinions.

There will come a time when the markets will go down. It will be accompanied by scary headlines, and by pundits who will claim to have predicted it all along. They will advise that selling is the only right and prudent thing to do. To follow that advice would just be another kind of market prediction. We won’t do it.

When we review your financial plan and situation, we talk with you about both portfolio risk and also the spending level we think you can prudently afford to follow, given the details of your budget situation and the assets you have accumulated. Market fluctuations influence that spending level. It is in the budget that we think adjustments to market activity should happen, not in the composition of your portfolio.

We are sure we have said all this in previous letters, but it is just so very important. We cannot predict markets and neither can you. When they are rising and you feel like increasing your risk by buying more stock – resist the feeling. When they are falling and you feel like cutting back your stock holdings – resist the feeling. The source of safety in your financial situation comes from budget discipline and portfolio diversification, not from a futile attempt to predict what cannot be predicted.

Here is another way to say the same thing. Over the long term, the investor who comes out ahead is the one who can stand the heat. Markets are volatile and are not for the faint of heart. But we are all faint of heart when it comes to our financial future. No one wants to risk everything on one spin of the wheel. Valuing your opinions above all others and also having self-respect must mean acting on your opinions, and acting on your opinions in the markets must mean having a non-diversified portfolio. Don’t give up the self-respect. Just give up valuing your (financial market) opinions. We think our method is better than having opinions.

On another note, you can now view your monthly Schwab statements via the web. Go to www.schwaballiance.com, register if you have not already done so, log in on Start Page: Account Overview and choose the eDocuments sub-tab. You may view your current and some previous statements on this page. If you would like to stop the paper statements, click on “Turn off mail delivery of your Statements” and make your choices. You can choose to receive emails that alert you that your new statements are ready. For security reasons, none of the data contained in your statements is sent in the email.

Happy New Year.

Give us a call any time.

Jim & Dean