July 2010 - Personal Planning

In our last issue, we described Professor Meir Statman’s first lesson of successful investing that he shared with us at our Financial Forum earlier this year. He explained that it is critically important to “Know Yourself” as an investor, or “make yourself your ally”—and doing this involves careful planning and thorough personal risk assessment. Of course, the ultimate fundamentals are important, too. As Warren Buffet has said: in the short-run, the market is a voting machine (which involves the emotional element), but in the long run it is a weighing machine (which gets at values and fundamentals that cannot be ignored). This leads to Prof. Statman’s second lesson—to “Utilize Science” or “make science your ally.” While this is accomplished by researching and embracing the capital markets, it is also critical to realize that various kinds of market and financial risks exist. Therefore, Sand Hill relies on well-diversified asset allocation programs to meet each client’s individual needs and objectives. We also maintain sufficient liquidity to handle any short-term needs or surprises, incorporating each client’s time horizon in order to avoid being forced to sell at inopportune times.

Clients’ plans are tested using various techniques customized to each investor’s personal situation. Cash flow analysis is particularly helpful in this regard, but it can be misleading if only assumptions of “straight line” returns are used. They can result in the false security and the appearance of predictable, positive results. Sand Hill uses Monte Carlo simulations, on the other hand, which incorporate historical market volatility and variability of returns over time to test outcomes based on a given set of assumptions — some of those outcomes may be negative and will guide a change in approach. Sand Hill focuses attention on “worst case” scenarios in our projections, which allows us to test upfront for the effects of possible downside results. We do this because the time to consider risk is in advance… not during crisis!

Sand Hill’s risk assessment reasoning and portfolio strategy is documented in the Investment Policy Statement (IPS) that we prepare for each client. This written plan serves as a mutual agreement between us and our clients. The IPS has two major benefits: it helps our clients stick to a strategy and it helps Sand Hill maintain a tight discipline in adhering to the plan. Surprisingly, we see few investment professionals articulating a clear investment plan to help guide their clients and themselves. Indeed, as Prof. Statman pointed out, many firms and their clients fall prey to emotions—even, at times, selling to those emotions. Sand Hill believes that controlling emotional responses to market activity is more than half the battle when it comes to achieving long-term investment success. We work continually with our clients to help them understand the effects of their emotions on their financial decisions.

The “secret ingredient” of asset allocation is rebalancing. Rebalancing is the key! It is the sensible alternative to both strict buy-and-hold strategies and clever market-timing tactics, and makes it possible to buy low and sell high on an ongoing basis without the big gambles. Sand Hill continually rebalances client portfolios through market cycles, when everything seems rosy at the “top” and when everything seems dire at the “bottom”; the goal is to attain the superior long-term, risk-adjusted returns that most investors seek. This is the quiet and powerful benefit of rebalancing!

But even this is easier said than done, especially when times get tough. This is why Prof. Statman’s third lesson emphasized the importance of “Making Your Advisor Your Ally”—and frankly, there is no better ally than a fiduciary. This is the standard that Sand Hill Global Advisors takes most seriously. Our interests are directly aligned with our clients. We have no ulterior motives for what we recommend. We have no proprietary products to sell. We are not affiliated with any other firms, and we have an arms-length agreement with our third party custodians. We only do well if our clients do well. Prof. Statman believes that we should act like our client’s financial physician and accept the equivalent of the Hippocratic Oath: “First, do no harm.” Of course, this does not mean that bad things will never happen, but at least your advisor and your investment plan should not compound trouble when it occurs. As Prof. Statman reminded us, this is not just about maximizing wealth. It is also about maximizing financial well-being.