Tuesday, November 3, 2009

It's All about the Losing Years...

If 2008 taught us anything at all, it's numbers don't lie and losing money is never fun. The uphill battle to regain losses is always challenging. Losing 30% requires a 43% gain to get back to even. So while 2009 is have been fabulous in it's own right, a 20% gain has not made many investors whole as of yet. It's certainly a great start, but only a step in the right direction.

Hedge funds, college endowments and basically, absolute return portfolios, may have the right idea. Their #1 rule: Don't lose money. Rule #2: Don't forget rule #1! They try very hard to minimize risk and manage the downside. In a good period of time, we can all make money. It's the bad periods that concern them.

Having recently read "How Harvard & Yale Beat the Market" by Matthew Tuttle, I was truly impressed how both Universities manage endowment money and how successful they have been over the years. Some of their investments are not available to the average investor, but how they construct a portfolio to minimize risk certainly can be duplicated. Non-correlated assets with Portfolio Managers that add alpha is the key.

"A manager who limited losses last year goes a huge way to helping investors accumulate wealth over time and meet their long term goals" say Don Phillips of Morningstar Inc. "It's the kind of victory that often goes unnoticed."

The typical mutual fund will have a fair amount of volatility as it moves with the general direction of the market. An absolute return portfolio will try to minimize volatility and seek positive year returns year-after-year.

Let's compare two hypothetical investments of $100,000 and use a 5 year time frame. If Fund A (a typical growth mutual fund) has annualized returns of -4%, +12%, +8%, -12% and +14% and Fund B (absolute return product) has returns of +6%, +8%, +6%, +6% and +4%, who has better annualized returns?

Fund A = 3.6% annualized returns with an ending balance of $116,493.

Fund B = 6% annualized returns with an ending balance of $133,775.

While Fund B never has double digit growth in any one year, it manages to avoid losses and increase overall returns through good risk management.

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