Money Management Benefits &
Frequently Asked Questions (FAQ):

Q. Why should I use a professional money manager?

The obvious answer to this question is "to help you reach your financial goals". It may be that you have set some money aside for your children or grandchildren's college education that you would like to see grow over time. It could be that you are trying to build your estate so that the assets will support you and your spouse in your retirement years. If you are already retired, you may be looking for income or growth or a combination of both, but you recognize the need to manage market risk professionally.

Whatever you are seeking to achieve financially, it follows that you are far more likely to achieve your goals if you have a well thought out plan and a comprehensive strategy for money management. This is where the average investor falls woefully short. Knowledge does make a difference and this is where a professional money manager can help you. Money management requires a number of disciplines in order to successfully enhance wealth and minimize risk. Far too many investors are lured into the excitement of trading only to find out later how ill prepared they were to manage their own money.

Investors can spare themselves some very expensive lessons by having a skilled and experienced money manager guide them through difficult market environments. It is not enough to look for great investment opportunities with no thought to risk management. Both are required to succeed. Professional money management is about giving yourself a higher probability of success in reaching your financial goals. With the right money manager you can quickly realize the value of a financial counselor helping you achieve your financial goals.

Q. Why do so many investors fail at managing money for themselves?

Understanding economic cycles is crucial in strategically allocating assets toward the right set of investments. The economic cycle is never a constant, due to different shifts in the Federal Reserve's monetary policies. Because the economy is contracting or expanding in various economic stages, investments can be dramatically influenced, requiring changes in the allocation mix. Understanding which investment classes do best or worst in various economic cycles is vital in meeting the larger challenges of money management and this is where many investors miss the mark. They simply are not very good at interpreting economic data and incorporating it into their investment strategies.

Discipline is another critical component of smart money management. Strategy must dictate investment decisions rather than emotions. If you find that fear is the motivating factor that causes you to sell or prevents you from buying, performance is likely to be jeopardized. All too often investors refuse to use a stop loss strategy, holding on to their losing positions for too long and then selling when they can take the pain no longer. Likewise, buying when greed overwhelms you is generally a poor time to be taking positions in the market. Investing requires a certain type of temperament, and most investors are just not emotionally equipped to reason well in very stressful financial situations. This makes them less objective and prone to poor decisions at critical times.

Often they may lack experience, never having managed a serious amount of money before. Lack of experience is especially dangerous in transitional periods where the economy is shifting from one stage to another and creating an exceptionally volatile market. Time is also an important element of successful money management. A good money manager must devote a constant watch over the assets in his stewardship. Many individual inverstors have many different focuses. They are usually too busy to manage money well, because of their committments to business, travel, family, etc., thus making them unable to follow the markets as closely as needed.

Many investors fail at money management because they fail to minimize losses! Failure to keep losses small puts an investor deep in a hole which may take years to recover, if ever. When you lose money, you wind up having less capital to work with. Therefore, to make back what you lost you have to earn a substantially higher percentage return than what you lost. It is no sin to be wrong about the market. The sin comes when you "stay wrong" about the market. How you accept and deal with losses as they develop is a big component of successful money management. Some investors just can't accept the fact that they could be wrong about a certain trade, and hoping the trade will work out, they hold on and hold on when they should let go. Keep in mind that failure to manage risk can destroy a portfolio.

Q. What risk is involved with using a professional money manager?

Risk comes in many different forms. There is business risk, or the risk that a company, like Enron, could become bankrupt. There is market risk, as we have seen in the great bear market of 2000-2002. There is volatility risk, when the market whipsaws back and forth during transitional periods. There is also the risk that if you hire the wrong professional money manager you may not get the kind of results you're expecting.

It is important to understand that a professional money manager can't eliminate all risk inherent in investing. Taking a risk in order to realize a profit is what investing is about. However, risk can be minimized and managed. In the case of business risk, diversification can be used to minimize risk. This is one reason why mutual funds are so popular. Even if a fund is holding an Enron in the portfolio, risk is reduced when it holds a variety of different companies in its mix.

Market risk can also be minimized. There are three principal methods to minimize market risk. Asset allocation, hedging and market timing in various forms and strategies can reduce market risk significantly. Every investor should understand the risk-adjusting methods or strategies a money manager utilizes. Each strategy has advantages and disadvantages. It is the investor's responsibility to understand the pros and cons of a money manager's style, and whether they feel comfortable with the approach.

A vast majority of money managers do NOT manage market risk, preferring a buy-and-hold approach to investing. Most mutual fund money managers take this approach. While the portfolio may be extremely diversified in its stock portfolio mix, it is of no comfort to know that in a major economic contraction or recession, the majority of stocks are all likely to fall at the same time. This is why the majority of mutual funds often fall as dramatically as the markets. The other side of this argument is you are likely to catch the upswings in the market as well.

However, in a really bad bear market, as we have seen in 2000-2002, it may take many years before large losses are recovered, if at all. In reality, very few investors can stomach a buy-and-hold approach when times get really unstable, as we have seen in the great bear market of 2000-2002. When an OTC fund loses 70 to 80% of its value, the pain of losing this much money is nearly impossible to endure with a buy-and-hold approach that some professional money managers subscribe to.

One of the most popular approaches that many financial planners use to manage risk is asset allocation. Asset allocation is really asset class diversification with a percentage in stocks, bonds, international equities, real estate, gold and money market funds in various mixes. You are reducing risk by not subjecting yourself to just one asset class. If stocks are falling, bonds, international equities, real estate or gold may be advancing. This will reduce full risk exposure to just the stock market but this approach will also subject you to the risk inherit in any given asset class and certainly lower your overall return.

For example, if half of the portfolio is going down and the other half is going up, risk is reduced but reward may also be restricted where both asset classes offset each another. Some money managers will change the percentages held in the various asset mix, depending on market conditions allocating more to equities in favorable economic conditions or reducing equity exposure in poor market environments. This is an active approach to asset allocation rather than a constant percentage mix that doesn't change. Understanding how a money manager handles asset allocation changes is an important factor in evaluating a money managers style.

Hedging is another strategy money managers use to offset risk. Rather than selling key equity positions that might cause a tax problem in an uncertain market environment, or short-term early fund withdrawal penalties, etc., a money manager may try to reduce market risk exposure by taking a percentage of the portfolio and short stocks. A similar strategy is to buy a mutual fund that shorts the market or use options to offset the market risk exposure for the long positions. Having approximately 50% in long positions in strong stocks and 50% in short positions in weak stocks is an example of a hedged position.

Some managers will remain in a hedge position in a difficult market environment and cover the short positions in an improving market environment, while other managers may remain fully hedged at all times. There is obvious risk here, highly dependent on the skill a money manager has in hedging positions. This strategy may minimize downside risk but it can also minimize upside performance. It is possible that long positions can fall while short positions climb, creating losses on both sides of the hedge. Furthermore, a money manager may have an excellent track record for a given market environment but if the market's behavior changes dramatically, a hedged strategy may prove to be ineffective.

Market timing is another strategy used by some money managers to risk-adjust a portfolio. In a difficult and risky market, rather than continue to hold long positions, this strategy will sell the long positions and seek the safety of a money market fund or a short-term bond fund in an attempt to ride out the market storm. In the event of a substantial fall it is imperative that the assets be parked out of harm's way, ready to take advantage of the upswing in the market when the next up cycle begins.

Market timing as a strategy involves certain risks. It works bests when the market is in a prolonged trend, either up or down but may subject the investor to whipsaw trades in a transitional period when the market is unable to establish a trend in either direction. Several bad trades back-to-back can result in substantial losses. There is no perfect market timing system that will work in all types of markets. There is no guarantee that it will reduce risk and may subject the investors to under performing the market averages.

Despite these risks, market timing is popular as investors seek to reduce risk, especially in prolonged bear markets that can wreak substantial damage to an investor's portfolio, ruining even the best of well thought out financial plans. Keep in mind that there is a variety of skill level among money managers who employ this strategy. While a money manager may have an excellent track record at reducing risk by way of market timing, there is no guarantee that this strategy will work in every market environment. The hope is that it may serve as insurance against the really bad market environments.

Q. How should an investor use a professional money manager?

It is critical that you get to know your money manager and the custodian that will serve your account. Remember the more the money manager knows about your circumstances the better he will be able to advise you. It is important that you make it clear what your expectations are so that there are no misunderstandings that could develop later in the relationship. If your expectations are unrealistic, a good money manager will let you know right up front how he feels about your goals and his ability to assist you in achieving them. This is especially important in the early stages of a money management relationship.

It is essential that you understand the money manager's style and make sure you are comfortable with his strategies. Make sure you understand the strengths and weaknesses of the strategies employed. If a money manager's strategy is making you uncomfortable, talk with him and express your feelings. Remember this is a partnership. If risk is making you uncomfortable discuss this with your advisor to determine if a change should be made to further reduce risk.

Keep in mind the markets are dynamic and changing constantly. It is important to make sure that your portfolio is well postured to take advantage of any positive changes that may develop. In a major down cycle restructuring the portfolio to be more defensive should be considered. This certainly needs to be discussed with your advisor. It is vital that you disclose to your money manager any new financial changes that may affect your ability to take risk.

It is the investor's responsibility to manage his money manager(s). Review your statements often and make sure you understand how to read the financial statements that have been provided by the custodian or the money manager. It is good to often review these statements with your money manager so that you stay on top of things and allow the money manager to inform you of changing market environments, new products and any custodian changes. Remember, your money manager works for you and he will answer the questions that you have. Don't wait for the money manager to call you if you have a question. It is your money and it is your stewardship to make sure it is being managed properly to achieve your goals.

Last, it is important that you allow time to work for you. If a single dive into the sea does not bring to you the pearl, do not conclude that the sea is without pearls. Countless are the pearls hidden in the sea but it takes time to discover them and accumulate them. Some economic cycles can take between three and five years to realize the best parts of the economic cycle. Constantly jumping around, chasing the hottest money manager may cost you big if you don't give a manager time for his strategies to work for you.