How to Invest For The Next Decade – Summary

Looking BackWhen considering how to best position an investment portfolio for the next decade, an investor can’t help but think back over the past 20+ years and wonder what possibly could happen next. The decade of the 1990′s was the last stretch of a “once in a lifetime” bull market, starting in the early 80′s and delivering over a tenfold increase in stock values. The 2000′s followed with the bursting of the Tech and Real Estate / Credit bubbles, leading to what has been dubbed the “lost decade” for equity investors in the United States; with all major stock indices posting negative returns for the 2000-2009 decade. As we sit here in 2010, where does this leave us? How should we be thinking about our investments going forward for the next 10 years?You never really know what the future will bring. The best you can do is craft a sound investment strategy aligned with your personal circumstances and providing a high probability of achieving a fair return on your money. We believe the four themes discussed below offer sound guidance for investing over the next decade.Anticipate a regression to the mean – don’t be overly influenced by recent, short-term trends”Regression to the mean” refers to the tendency of asset classes to generate returns below their historical average following periods of above average performance (and vice versa). Probably the most discussed asset potentially primed for a regression to the mean is the bond market. Bonds have enjoyed a very nice 20 year run, with Treasuries outperforming the S&P 500 stock index over the 20 year period 1990-2009. This is an unusual occurrence, happening only two other times in modern market history. Stocks have significantly outperformed Treasury bonds over the ensuing 5 years following both other occurrences.The other currently popular investment is gold. The annual return on gold between 1975 and mid-2007 (the start of the recent financial crisis) was about 5% annually. During the three years since the start of the crisis (July 2007 until September 2010), gold has doubled in value. This is an annualized return of approximately 24%. Going back to gold’s cyclical low around the turn of the century, gold is up nearly 400% in about 10 years.Maintain a focus on risk management – control your portfolio risk and potentially benefit from market volatilityAll speculative investments are risky. By maintaining a focus on managing your investment portfolio’s overall risk, you take a step toward achieving a satisfactory return for the level of risk. We believe two risk management techniques are fundamental; ideally allowing you to gain from the market’s volatility. Invest in a collection of low correlation asset classes Regularly rebalance portfolio to maintain target asset allocation Ground your investment strategy with core principles and a long-term, historical perspectiveWhen plotting an investing approach for the next decade, an investor should consider not only aligning their portfolio with market opportunities, but also remaining true to foundational investing principles. We believe the following concepts apply to any sound investing strategy almost regardless of the market environment.1.) Diversify investments broadly, with emphasis on equities Emphasize stocks over bonds Tilt toward value and small-cap stocks Invest internationally 2.) Use low-cost, passive investment fundsMitigate volatility by investing in alternative asset classes not historically available to most investors Investors today can access asset classes historically only available to institutions and high net worth individuals (as expensive unregistered private investments) due to recent innovations by mutual fund and ETF issuers. In the past, investing consisted of buying domestic stocks and bonds. As times changed, and investing became more sophisticated, the number of available asset classes grew. Stocks and bonds fragment into numerous niche asset classes (large, small, value, growth, etc.) and new asset classes became standard in investors’ portfolios – international equity and real estate to name a few.Now in the past few years, we have seen a large number of funds introduced that provide exposure to commodities and investing strategies which previously were the exclusive domain of private hedge funds.An attractive feature of these funds is their low correlation with traditional stock and bond investments. By incorporating these funds into a portfolio, investors hopefully benefit from lowering overall portfolio volatility and increasing the probability of meeting investment objectives.ConclusionThe next decade promises many rewarding investment opportunities for those with portfolios positioned to capitalize. We believe the four themes discussed provide sound guidance for investing over the next decade: Anticipate a regression to the mean – whether it is the recent superior performance of bonds and gold, or the recent poor performance of stocks in developed international markets, be mindful of the potential for returns to reverse course and converge on historical averages. Maintain a focus on risk management – consider constructing a portfolio of asset classes with exposure to different fundamentals, and rebalance your portfolio to maintain a consistent risk profile. Ground your investment strategy – think about a portfolio with diversification across asset classes and with an emphasis on Value and small-cap equities, implemented using low-fee, passively managed index funds. Explore new sources of diversification using funds offering exposure to real assets and alternative strategies. Just remember, reality has a way of disrupting the best laid plans and past performance is no guarantee of future results. Any speculative investment is risky and can lose money. By adhering to sound investment principles, you tilt the odds in your favor and hopefully earn a fair return on your capital.This article is a synopsis of a white paper. Click here for full report.

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