Does activity like “sector-hopping” equal control?

by brendon on May 18, 2011

Investors and advisers in Kansas City and Overland Park want control and success when implementing investment advice and strategies. The illusion of control is often created by advisers in the traditional financial service industry by making unnecessary changes in the amount you have invested in a particular asset-class or segment of the market.   This is an example of “active-management” investing.

Chasing returns in hot sectors of the market is referred to as “sector-hopping”; a common practice for advisers, fund managers and individual investors; it increases costs, risk of loss to your investments and lowers the probability of a successful investing experience.   (NOTE:  having an e-Trade, TD Ameritrade or Scott account makes this possible for the individual investor.  It also compensates these companies whether your investment gains or losses value.)

Instead of chasing hot markets—have you considered the benefit of owning all of the markets?

Being a better investor means recognizing the difference between GOOD ACTIVITIES and BAD ACTIVITIES.

As an example, recognize the BAD ACTIVITIES this recent WSJ article highlights:  “Investors Take a Defensive Turn-Formerly High-Octane Energy Stocks Out, Health Care In as the Outlook Shifts” “Out are hot ‘growth’ stocks in the technology and energy sectors.  In are the steadier, less volatile shares of utilities, health-care and telecommunications companies.” Most people reading this would believe changing their investment strategy based upon economic conditions, forecasts or predictions about the future will lead to an increased rate of return to their investments.  While it could, it also increases risk of loss that you’ve simultaneously added into in your strategy.

Making changes like this is an expression of “active-management” investing.  Many of you have experienced this working with large broker dealer firms like Edward Jones, Merrill Lynch, Wells Fargo, etc.   This is a recipe for future frustration, fear and confusion.  It’s also a way to compensate the registered representative of the broker dealer for buying and selling again.

Clients of Wealth Renovators have investment portfolios with over 12,000 holdings in 19 distinct asset-classes and 45 countries. There’s no such thing as panic and “active-management” strategies when a particular segment, sector, asset-class or market experiences notable gains or losses.   The financial science of investing is translated into solutions that capture market rates of return with structured asset-class investments.  Based on asset-class performance data, our clients know the scientific measure of volatility and expected rate of return for their investments.   This is how we implement “passive-management” strategies.

A super attribute of this strategy is that losses in one asset-class are typically offset in another class because the “price-movement” is going the other direction.  Another super attribute is that transactional costs are low because the money manager isn’t “hyper-actively” trading, i.e. “sector-hopping”.   Low internal turnover ratios equate to greater tax-efficiency;  meaning lower tax bill due to Uncle Sam.

Another step you can take toward being a better investor is knowing answers to the right questions.  You don’t have to know everything.  Here are a couple.

1)  What percentage of your investment accounts are in the following asset-classes:

TIPS, Short Term Govt. Bonds, Intermediate Term Bonds, One Year Fixed income, Five Year Global Income, International Large Cap, International Small Value, International Value, Emerging Markets Value, Emerging Markets Small Cap, Emerging Markets, International Small, US Large, US Small, US Small Value, US Large Value, Us Micro Cap?

2)  What’s the expected rate of return and measure of volatility for your current investment mix?

Don’t mistake activity for control. It’s not necessary to react with “active-management” strategies when you see news like the above Wall Street Journal article.

Getting better investment results starts with a belief that markets are your ally and not your adversary; that capturing rates of return can be done with broadly diversified investment portfolios; and that knowing answers to the right questions will help improve your investing results.

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