Inside The Minds - Leading Wall Street Investors - Industry Leaders Reveal The Secrets To Profiting in Turbulent Markets

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I N S I D E T H E M I N D S
Inside The Minds:

Leading
Wall Street
Investors
Industry Leaders Reveal the Secrets to
Profiting in Turbulent Markets
Published by Aspatore Books, Inc.
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Inside the Minds:
Leading Wall Street Investors
Industry Leaders Reveal the Secrets to
CONTENTS
Scott Opsal 11
FAIR VALUE AND UNFAIR ODDS
Victoria Collins 51
EARNINGS COUNT AND RISK HURTS
Howard Weiss 85
NAVIGATING TURBULENT MARKETS:
A CASE FOR DISCIPLINED INVESTING
Sanford B. Axelroth, Robert A. Studin 143

BUILDING AN ALL-WEATHER
PERSONALIZED PORTFOLIO
Gilda Borenstein 167

MANAGING YOUR WEALTH IN
ANY MARKET
Josephine Jiménez 185
WINNING STRATEGIES FOR
INTERNATIONAL INVESTING
Robert G. Morris 201

THE PSYCHOLOGY OF
A SUCCESSFUL INVESTOR
Robert Allen Rikoon 219

INVESTING FOR A SUSTAINABLE
FUTURE
FAIR VALUE
AND UNFAIR ODDS
SCOTT OPSAL
Invista Capital Management, LLC
Executive Vice President
and Chief Investment Officer
11
Inside The Minds
Knowing When to Pull the Trigger
My personal approach to investing follows the classical

lines of realizing when an asset is selling for a price lower
than its fair value. I hesitate to use the words “value
investor,” because some people think value means just low
P/E or low price to book. Value is actually defined as
buying an asset for less than its worth. When I am investing
I first analyze the long-term prospect of an asset, whether it
is stock, bond, or real estate. Investing means
understanding the asset’s worth in a long-term, fair-market
value and then trying to understand if it’s mispriced in the
short run and, if so, why. If an investor can identify a short-
run pricing gap compared to fair value that is temporary or
not justified, he or she should move in and buy that asset. I
probably fit the mold of what is classically thought of as a
value player, someone who looks at the long-term worth of
an asset and buys it at a temporarily discounted price.
The art of investing has a couple of components that are not

financial or mathematical at all. First, investing takes a lot
of creative thinking. Whether you are a value investor, a
growth investor, or a fixed-income specialist, you need to
be a creative thinker. Most of the time, assets are fairly
12
priced; the markets are pretty efficient – that is, markets

price assets at values somewhat close to their fair economic
value. If an asset is fairly or efficiently priced, the investor
can expect to earn a fair rate of return on his investment but
should not expect to earn an exceptional rate of return. If
you think you have found an investment that is mispriced,
you should stop and ask, “What can I see here that other
people don’t see? Why do I think this asset is mispriced?”
And that question is usually not answered by poring over
more financial statements than the other guy or running
more computer models. It’s more about looking at
relationships. Investing is all about making a comparative
decision. Most investors are not deciding whether or not
they should buy stock A. They are asking whether they
should buy A or B, because they have assets to invest and
want to put them to work. So it’s the comparative decision.
Because the market has already determined the price of
each asset, an investor needs to be creative in looking for
situations where two assets that should be influenced by the
same factor are actually priced very differently. That goes
back to the ability to recognize patterns and shifts
differently than other people.
13
Inside The Minds
The second part of the art of investing involves risk

analysis – not in the quantitative sense, but more in
understanding when the odds are in your favor. This is true
for whatever type of investor you are. One of the most
important aspects of making good investments is to know
when the odds are stacked in your favor, and the more
biased, or “unfair,” the odds seem to be tilted in your favor,
the better. In the stock market you have the opportunity to
buy 5,000 or 10,000 different stocks. In the bond market
you have different credits and different durations. In both
markets you have a multitude of economic scenarios, and
you have to make a decision.
For me, the art of investing is identifying a relationship you

think is potentially profitable, and then being able to
understand whether the odds are in your favor and whether
what you have identified is likely to be correct and will to
pay off. It’s not necessarily forecasting, but rather the art of
understanding the likelihood of different potential
outcomes. As an investor you want to believe the outcomes
are stacked in your favor, not 100 percent, but maybe two
thirds for and just one third against. So there’s clearly an art
to understanding the trade-offs and the ups and downs, and
14
saying this prospect has a better chance of paying me off

than the other one I am looking at.
In looking at investors who succeed year in and year out, I

think what differentiates them the most is that they can
consistently identify conditions in which the odds are
highly in their favor; their determination proves correct,
and they are paid off. There’s really no way to run it
through a quantitative model or a screen or anything like
that to decide the odds – it’s strictly a judgment call.
Perhaps the most important aspect of the art of investing is
understanding the odds and pulling the trigger only when
the odds are really on your side.
The Need to Change Strategy in Turbulent Markets
An investor’s style should change in several ways in a

turbulent market. First, a good investor becomes a more
active decision-maker. In a turbulent market, the reason the
market is moving up or down is that something is changing
in the current situation or, more probably, in expectations
for the future. As a result, an investor has more of these
relationships to understand and reconsider in a period of
15
Inside The Minds
great flux. For example, the market could move 10 percent

or more in just a week, forcing the investor to refigure all
those relationships. Now, this does not mean you trade
more often; you’re just offered decisions to make more
often, and that becomes an extra opportunity and an extra
burden.
The second aspect of an investor’s approach that changes is

the evaluation of the fair value of an asset. In turbulent
conditions, it’s not quite as clear whether the long-term
value has or hasn’t changed. For example, in a bear market
for an investor like me to buy an asset I think is mispriced,
I also have had to decide that its long-term value has not
eroded and that the bear market is not correctly pricing the
asset. When you have a turbulent market the turbulence
comes from the uncertainty about the future, which means
there’s uncertainty about what assets are really worth. In
effect, the good investor has to raise his or her standard of
decision making to be able to confidently say, “I really still
believe this company is undervalued or this bond is too
cheap.” In a turbulent market an investor is less certain of
the foundation or fixed point of reference in terms of value.
16
The third important thing in a turbulent market is to be

much more aware of other investors’ sentiment in the
market. When the market is turbulent and you sense
uncertainty, people aren’t able to use their traditional
processes of discounted cash flow or P/E measures or any
other technique they relied upon in the past. If those models
aren’t working because the market is moving too quickly,
they have to rely on something else, and that’s usually
sentiment.
Even though I prefer to invest based on economic decision

making, a successful investor can’t ignore feelings in a
turbulent market, because they probably will be the main
driver in the short run. More to the point, if you’re on the
wrong side of sentiment you can get beaten up fast, even if
you’re right in the long run. Becoming much more aware of
sentiment, the investor factors it more heavily into his or
her decision when the market is moving rapidly in either
direction.
Recently this has occurred on both sides. In the technology

growth stock boom of 1999 and early-2000 – whether or
not you thought those stocks were a good deal – sentiment
was clearly on the upside, and you had to consider that.
17
Inside The Minds
Now, within the past year you have had sentiment on the
downside, and you have had to consider that, as well.
Although it is not really an economic term or a financial
factor to consider, in markets that are volatile and moving
you have to judge sentiment correctly, or all of your other
work could be blown away by that one issue.
Forecasting Market Direction
When a person asks where the market is heading, an

investor sees a probability question: What’s the likelihood
of the market going up or down? Or what forces would
cause it to go up or down? As a fundamental investor, you
look at valuation and earnings as the most important things.
Valuation basically means examining the relationship
between stocks and bonds and the relationship between
stocks and other sectors of the stock market. In general, it’s
important to understand whether stocks or bonds are
correctly priced, because it’s not really a yes-no call; it’s an
either-or call.
The direction of the stock market is quite often influenced

by the opportunity on the other side of the table. For
18
example, when stocks sold off rapidly in the fall of 1987, I

think it was driven by the realization that bonds had a
higher expected long-run return than stocks had, and people
reacted to that. I think the bull market of most of the 1990s
was a reflection of interest rates consistently falling, and
that made stocks an increasingly more attractive option. If
bonds yield only 5 percent or 6 percent, stocks have a very
easy hurdle to beat. One of the critical issues is the
relationship between stocks and alternative assets because,
at the end of the day, that’s really going to drive the
marginal cash flow into the market.
The second thing to watch when forecasting the market is

earnings. When all is said and done, a company’s stock is
priced on earnings. So one of the key questions today is
whether it’s going to be a short or long-lasting trough for
earnings. Furthermore, bull and bear markets are almost
always driven by either interest rates or earning swings.
Events such as a war or political situations usually don’t
have a long-term impact.
Investors don’t really forecast the absolute level of returns;

they just look at where the spreads are today between
assets. On earnings, the forecast is driven on an analysis of
19
Inside The Minds
the growth rate of the economy and a look at the margin of

the companies. It is figuring out for each dollar of sales
whether the company is getting more or less profit on the
bottom line than they used to. Earnings tend to go up and
down much more than revenues, because profit margins
add another layer of volatility to the income statement. So
earnings quite often will change much more than sales
growth changes. In an environment in which margins are
shrinking, that’s a big problem. I recently read that in the
past 12 months, the GDP has grown 3 percent, and
corporate profits are down 45 percent, which tells us it was
the margins – not sales – that got hammered. When I look
at earnings, I am primarily looking at margin swings,
because the economy is too large and too stable for revenue
swings to make a big difference in the market.
As with investing in turbulent markets, another factor an

investor uses to forecast change in a market is sentiment.
Most often, sentiment can be best defined as the direction
of least resistance: If the market could make its own choice,
in which direction would it most like to go? For most of
2001 it preferred to go down, but in the last months of 2001
it preferred to go up.
20
To help you understand the market’s inclination, the thing

to look for is relative strength on news flow. If the market
doesn’t go down when bad news hits, it tells you the
preferred direction is up. On the other hand, if the market
won’t rise anymore on good news, the preferred direction is
down. When calling turns in the market, it’s important to
understand which direction investor sentiment wants the
market to go. It might sound silly that investors would ever
want it to go down, but in fact when people realize stocks
are pricey and the environment is getting worse, they want
to get out. I do think it works in both directions.
Fundamental and Technical Analysis
On the technical side of studying stocks and investments,

there is very little economic analysis. A good investor
watches the relative strength of companies and relative
strengths of industries. It’s more a measure of where these
companies have been and what the market and investors
have decided about these companies, rather than where
they are going. In my opinion technical analysis doesn’t
personally tell me much about the future. But I do know
that quite often swings in the market are self-correcting.
21
Inside The Minds
Groups of companies tend to cycle up and down. When one

group outperforms another, it has become more highly
valued because more of its good news has been taken into
account, and it has a more optimistic outlook. Once a stock
has outperformed long enough, it becomes “priced for
perfection,” meaning the market has attributed a great deal
of good news to the stock. From that point the odds
generally favor the next piece of news or the next
development being bad, and that group is unlikely to
continue to go up indefinitely. Similarly, the groups of
stocks that have underperformed have done so because of a
piece of bad news. The lower it goes, the higher the odds
become that it’s going to rebound and come back.
Beyond the news flow issue, stock prices are always

influenced by their fair economic value. Although stocks
generally do not trade at their fair value, their price action
is certainly influenced by that. A stock that has been
outperforming for some time has likely risen well above
fair value, and that gap is likely to narrow in the future.
Similarly, stock that has underperformed for some time has
likely fallen well below fair value, and going forward that
relationship will act to pull the price back up a bit. As an
investor, when you look at technical analysis, you really
22
see where things have been recently to tell you how much
of the good or bad news has already been priced into the
asset, and how far the stock might have drifted from its fair
value.
On the fundamental side, a good investor can look at three

different components of company analysis. The first thing
is to understand a company’s business, its business
strategy, and its competitive position. This involves
understanding a company’s market share, its competition,
its growth rate in end-user demand, and its ability to defend
its margins, because that’s what really helps you decide
what the long-term value of the asset is. The more a
company grows and the more it’s able to defend its growth
rate, its market share, and its margins, then the more it’s
worth. So the first level of fundamental analysis is really a
business analysis of what this company does, how well it
does it, who is trying to compete with them, and how well
they are doing that.
The second piece of analysis involves valuation. In

valuation analysis, an investor looks at two things. One is
the free cash flow measure, which tells the investor how
much value is left for the stockholders after a company
23
Inside The Minds
takes in its revenue, pays its expenses, and reinvests in its

capital and its equipment. It’s important to compare the free
cash flow to the current stock price. By doing so, an
investor determines the internal rate of return of the stock;
that is, the rate of return the company’s stockholders as a
group will earn from being owners of the business. In
bonds, yield to maturity is the valuation measure that
compares future cash flows (coupons) with current price.
The same measure can be calculated for a stock. By
comparing free cash flow to the current price, we are
measuring the “yield to maturity” of this stock. If I buy the
stock today at this dollar price and I collect these cash
flows as an owner, the internal rate of return is the proper
estimate of what I get from the company.
I also look at relative valuation. For any company I am

considering, I identify a handful of peers in the industry
and examine how they are valued relative to each other.
Investing is a comparative decision question – a person
must decide how interesting a company is compared to the
others. If a relative peer group valuation analysis turns up a
more interesting company than the one you started with, the
investor can switch his focus. At the end of the day
investors basically want to believe they have an asset that
24
has a good rate of return on its own and that there isn’t
another similar asset that is an even better deal. If you can
answer those two questions, you have resolved the
valuation piece.
The third thing to look at in a fundamental company

analysis is timeliness. Considering timeliness is making a
judgment as to whether today is the right day to get into
that asset. For me, that’s a much tougher question to answer
than whether it’s a good investment. A lot of discounted-
price or value investors are so early on an asset that they
can appear to be wrong because they give up too much
going down before the stock turns around. So timeliness is
important.
With timeliness, you look at trends in earnings and

margins, and estimate revisions and earning surprises to get
a true sense of the business momentum of the company.
Momentum is discussed a lot in the stock market, mostly
on a price momentum basis. It’s a chart-reading issue of
how fast and how consistently a stock’s price is rising. I
find little value here, but there is much more value in
watching business, or fundamental, momentum.
25
Inside The Minds
When looking at business momentum, you look at the

margins of business to see if it is doing better than it was in
prior periods, or whether the sales are growing a little
faster. These will also create improving earnings estimates
and rising analyst rankings, which are two other important
measures of business momentum. These are the types of
things that will change an investor’s sentiment, which in
effect is what timeliness is trying to look at. You have to be
able to say not only that you have an asset that is
undervalued today, but you also have a reason to believe
the business is steadily improving and investors are going
to warm up to the asset rather than cool off on it in the short
run. The biggest danger in being a long-term fundamental
investor is being too early and losing too much on the way
down. So timeliness is kind of a check to say this is a good
investment, with a good return built into it, and today is
probably as good a time as any to get into it.
When to Get In, When to Get Out
Deciding when it’s time to get in or out of a position is a

comparative decision. It’s looking at my best idea that I
don’t own versus the least interesting idea that I do own.
26
Sometimes, getting in or out of a position might be driven

by the other stocks you want to buy in place of the one you
already own. Assuming an investor has a stock that popped
up and looks interesting, you like the story; the point of
pulling the trigger depends on the timeliness.
For example, if the news flow going forward is neutral or

positive – and I don’t think it will be negative – that will be
a trigger to get in. Then I’ll also look at the relative strength
– whether the stock has already started to run or not. If a
stock has started to run, I’ll generally get in at a partial
weighting from what I think my total position will be.
Maybe I’ll buy in at a half weighting on the basis that if it
has run a little, it might give some back, and I can pick up a
little more at the bottom. If it looks as though it has
bottomed out and set a price level, then I’ll go ahead and
buy a full position. Building a position in a new stock can
be thought of in much the same way as the dollar cost
averaging approach that people use with a stock or a fund.
If the moon and the stars are lined up perfectly for this
stock, I am going to get in now, but if I think there is a
chance the news flow will turn bad, I’ll leave a little
powder dry and get in a little more later. Most often you’ll
get a chance to buy in at a later date.
27
Inside The Minds
A lot of investors like to do what they can to avoid the risk

of regret. Regret is saying in hindsight that you wish you
had done something different or at a different time. If you
buy a partial position, you obviously leave yourself a
mental out to say, “If it goes down, I have room to buy a
little more at a better price, and if it goes up, at least I got a
partial position before it moved on me.” It’s like golf pros
who, every time they miss a putt, blame a spike mark or a
bump on the green. Investors need the same mental trick to
avoid consistently thinking they may not have called a
stock exactly right. A dollar cost average approach really
minimizes your risk of regret and helps you avoid losing
sleep because you think you did the wrong thing. And
again, you have to balance it with not being too much of a
chicken. That’s a little tool if you’re really not sure the time
is right. I just like to take a partial position and average my
way in over a period of time.
Getting out is about as tough as or tougher than getting in.

Once you’re in, you have not only the analytical capital
invested, but you also have invested your personal capital
of being wrong. As a result, people don’t like to sell.
28
The art of investing is making good decisions when the

odds are in your favor. The best process is to actually
decide at the time you buy a stock what it will take to sell
it; that is, it’s time to sell the stock when the reasons you
bought it no longer exist or are no longer true. If the
condition under which I bought has now happened, I
usually will go ahead and sell it. If you simply wait to
decide on the spot whether to sell, you will be influenced
by too many short-term events: If the stock price is
running, you will say you’ll hold it for one more dollar,
which is not a reasonable, well-thought-out decision to
make. If it’s a loss, you might say it will come back if you
wait long enough. Those are not analytical risk-analysis
calls; those are gut feelings. On a day-to-day basis, people
who watch the market will have more gut-feel decisions
that they want to make than sound, rational decisions they
should make. The best way to make any call is to decide up
front what it will take to sell.
Nevertheless, if I see a stock reach my original sell criteria,

I won’t sell it until I go back and examine my reason to buy
it. If I find out my reason to buy is still true – perhaps the
company is still gaining market share or still has rising
margins with more room to go – then I’ll hold it. You
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Inside The Minds
shouldn’t use your preset sell criteria as an automatic

trigger, but you really need to figure out the day you buy a
stock what you will use to make the sell decision and then
stick with it. If you don’t, you’ll have buyer’s or seller’s
regret almost every day, and you won’t get much done.
Importance of Discipline
Discipline, or having a process and sticking to it, is another

trait almost every successful long-run investor has. Self-
enforced discipline comes from will power and confidence
and involves several levels. First, each investor has to
understand his or her own philosophy and process. Are you
a value player? Are you growth? Are you short- or long-
term? You need to understand yourself and not try to
employ someone else’s process, because the first time
another’s process doesn’t work you’ll blame the other
person’s process and say it was a dumb idea. For those of
you who don’t know your own personal investment beliefs,
there have been many good investment books written over
the years. I encourage my staff to read as many as they can.
I encourage the average investor to read as many as they
can and to figure out which line of thinking they believe
30
feels right to them. Although there are many ways to make

money in stocks, you have to pick one and stick with it.
That’s the first level of discipline.
At the second level of discipline, you use that process on

every position that you take. If you buy a few stocks using
your basic process, and then buy a stock because of a good
tip or something you think is happening in the market, you
place yourself at risk both financially and emotionally. As
soon as you deviate from your process and the stock goes
down, not only do you lose money but you also kick
yourself for knowing better. As soon as your self-
confidence is shaken, your risk goes up of making bad
decisions going forward because you are now gun-shy.
Most good processes have been proved to work over time if
followed consistently and carefully. One thing I have never
seen is a good investor who is able to consistently change
his or her process at the right time and make it work. So the
second level of discipline is to stick to your process for
every decision.
At the third level of discipline, you understand that not

every process will work in every stage of a market cycle or
in every time period. But a good process should at least
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Inside The Minds
allow you to hold your ground in periods when it is

somewhat out of favor. If there’s a wild-growth mania, as
we saw in 1999, a value-based player will not make the
most money he can, but that’s okay. It’s important to
understand it’s okay because every good process has days
when it won’t work, but it has more days when it will work.
A value player who was laughed at in 1999 made a load of

money in 2000. Investors need to realize that part of any
investment discipline is believing no process makes money
in every single market environment, but a good process will
at least keep you moving in the right direction and give you
satisfactory results. If your process just blows you up in a
certain environment, it’s not a good process.
Having a process you believe in is a huge boost of

confidence I think you need to have. A process enables you
to say, “I may be wrong today, but I know why I bought the
stock. I believe on average my process will work, and that’s
all I need to know. I don’t need dwell on it anymore.”
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Take a Swing When It Matters
To make money in stocks, my number one strategy is to

watch for cases where the stock price and the current
thinking about the stock just do not match what I know is
going on with the economy and what I think will happen
within the next couple of years. For example, in late 1998 I
believed the initial premise behind the technology boom
was very reasonable and well-founded, but it eventually got
to the point where it didn’t make any sense. What would
have to happen to make that boom continue would not
happen in the economy, so I looked for cases where I
thought the long-term outlook just did not match what the
company was doing then and how the market was pricing
it. That set up high odds of being right, and those are my
favorite strategies to take a shot at.
Those situations don’t happen every day – not even every

month. Part of my favorite approach to stock investing is to
realize you might have three or four – maybe five –
chances in a year to make a call that really matters, to have
high odds of being right and affect a large segment of the
market. So my money-making process is not a tactical day-
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Inside The Minds
to-day look at what is going on and trying to trade on points

and halves of points.
One of the most interesting pieces of good investment

advice I have heard came from Warren Buffet. He said, “I
don’t have to swing at every pitch, there is no called strike
in investing, I can stand there all day with the bat on my
shoulder and wait for that pitch that is right down the
middle that I can knock out of the park.” Every year you
get a few of those pitches that you just have to reach back
and swing hard on. My approach to making money in
stocks is to look for those periodic, but not very frequent,
opportunities where the odds are in your favor and you can
really jump in and do some good for yourself.
The Right Mix for Short Run and Long Run
“Investing” and “short term” are not words that go together.

It’s almost an oxymoron. For the purpose of discussion,
let’s define short term as a year. A good investor assumes
that when someone has a short-run horizon – that is, they
have assets to put to work for the short term – they have a
goal in mind that’s going to come true in a short period. In
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these scenarios it’s all about capital preservation. In a short-

run horizon it would be good to use fixed-income assets
that really take a lot of risk out. On the long run, the key
strategy for investing is to understand the long-run return of
each asset that you’re looking at. For example, today the
fair rate of return on government bonds may be 5 percent or
6 percent, corporate a little bit more, and preferred or high-
yield stocks a little more on top of that. If you analyze the
long-run potential of stocks, you have an asset with an 8
percent or 10 percent return, maybe 11 percent. But
whatever the set of expected returns is at any point in time,
to me, long-term investing is about looking at those
different relative returns.
These are all choices you have to make in deciding what

mix is right for you. In the long run it’s better to prefer
riskier assets, because they have higher returns. So in the
long run I rule out CDs and treasuries, because in the long
run you don’t need to protect against short-term risk. What
you want to do in the long run is to pick out excellent assets
that have high rates of return, and those generally are
stocks, high-yield bonds, corporate bonds, and preferred
stocks – areas where you can make a pretty good spread if
you can take that short-run volatility.
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Inside The Minds
If we are talking about making money in the next six

months without actually cashing out of the market, I just
don’t approach investing in that way at all. I never initiate a
trade thinking it will pay me in three or six months. If the
stock does go up that quickly, wonderful. But investing is
really about identifying a situation in which a stock might
pay me anywhere from three months to a year out, maybe
two years out – I don’t think there is any way to time it
very well. The difference between long term and short term
is that in the short run you will not get paid enough of an
income to make up for the price volatility; but in the long
run you will, because the price volatility tends to wash
itself out.
Know What You Don’t Know; Seek Imbalance
Probably the best single piece of advice I’ve ever received

is that one of the most important things for an investor to
know is what they don’t know. People get in trouble by
assuming they know what’s going to happen. They assume
they understand the situation, but in reality they don’t. The
economy is so broad; the future is obviously unknowable
by definition. There are a lot of things you don’t know, and
36
you have to take that into account when you’re deciding on

the odds of your analysis and forecast coming to pass. Not
knowing or understanding what they don’t know is
probably the number one way people lose money in
investing. The issue is not to know everything; it is to know
as much as you can, and understand what you don’t know
and how that can hurt you, and then make a decision on
that basis.
Another good piece of advice is that you don’t have to have

an opinion every day, and you don’t have to make a call
every day. The current market is a good example: There are
some positive drivers in the economy – you have the Feds
cutting rates; you have the government doing some fiscal
stimulus – and yet earnings are going down, and companies
are not doing very well. It’s hard to for me to sit here today
and say in the next three months one of those sides is going
to win over the other. I am perfectly happy in some periods
to say I really don’t know what’s going to happen. I’ll try
to make profits on individual stock selections and take little
positions at the margins, but today is not the day to take a
big strategic position and find out whether I am right. You
have to understand the difference between when the
situation is there to be had and when you just don’t know
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Inside The Minds
enough. Those are both excellent pieces of advice that help

deal with the tremendous difficulty we all face in investing,
which is that the future is unknowable.
I received a great piece of unusual advice from the person I

trained under and worked with for quite a few years, Ralph
Kosmicke, the founder and president of our firm. He taught
me that in economics the long term is quite often easier to
forecast than the short term, because the economy and
individual companies are driven by the principles of
economics and the laws of supply and demand. The laws of
economics describe what will happen under certain sets of
conditions in an economy or in an industry. These
principles are very reliable and repeat themselves over
time, so when you see a particular economic situation in
place, you can often understand what the outcome will be.
One of the techniques we often use at the firm to forecast

the long term is to look for situations in which supply and
demand are out of balance. For example, we recently
invested in natural gas producers. We analyzed the growth
rate in demand for natural gas, which has been increasing
nicely over the past decade. Because prices were so low,
drilling was low, and it was not very hard as an economist
38
to forecast that the day would come when rising demand

and falling production meant we would not have enough
supply to meet the demand. You know as an economist
what will happen: The prices will go up.
Quite often one of the best investment techniques is to

identify a supply and demand imbalance. In a free market
imbalances don’t last forever – they are corrected. If supply
or demand is too high, it will be corrected. If profits are too
high, they will be competed away. So in economics and in
finance, I can often tell you what’s eventually going to
happen. I just can’t tell you whether it will happen
tomorrow or in two years.
Economic Versus Market Risk: What Matters?
An investor needs to think about two completely different

types of risk. One is market risk, the risk of price volatility.
There are quantitative risk measurement tools, as well as
measures of volatility such as beta. Another kind of risk is
called economic risk. It’s the risk that you misprice your
asset badly enough that you will ultimately earn a rate of
return that is below the return you expected or needed. I
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Inside The Minds
look at risk in these two ways. In the market risk sense,

where you are talking about the beta of your stock or the
volatility of your stock on a short-term basis, typically the
market will pay up for safety. People don’t like volatility,
and low-volatility stocks generally return less than high. In
that case I will have a goal in mind for my portfolio.
If your goal is to be a long-term investor, you can take a

certain amount of market risk before you end up just having
wild swings. You can actually define the level of market
risk you want to take and target that. When we speak about
market risk, the risk-return trade-off is what we have all
learned: Higher risk generally means higher return. The
interesting part of risk analysis involves economic risk.
When considering economic risk, we find the opposite
relationship between risk and return – the opposite of what
we have all learned. With economic risk, we find that
higher returns come with lower risk; the investor who finds
a low economic risk opportunity will actually make more
money and take less risk. Economic risk refers to the
probability that I misvalued this company, and the true rate
of return I will earn is lower than I thought. In essence,
economic risk is the chance that I didn’t actually achieve
the return goal I had when I made the investment.
40
Economic risk can be understood by looking at a simple

example. Let’s say you have a stock that your research and
analysis indicate is worth $100 per share. If you buy it at
$80, you have a $20 spread, which represents your return
potential and your “margin of safety.” Margin of safety is
the measure of economic risk. It defines how much room
you have between what you paid for the asset and what it is
really worth. The safety factor refers to the idea that even if
your analysis and research were slightly off and the stock
was truly worth only $90, instead of your estimate of $100,
you will still earn a profit of $10. Now consider what
happens if you buy the stock for $60. Now your profit
potential has gone up from $20 to $40. In addition, your
margin of safety has gone up. Now you have as much as
$40 of room for your forecast and valuation to fall and still
make a profit on your initial cost. So if you buy the stock at
$60 rather than at $80, you have a higher rate of return and
a lower risk, because your forecast can be wrong by twice
as much and you can still come out ahead.
When I talk about risk with a client, we are usually talking

about market risk – how volatile the investment is, how
likely I am to lose money in the shorter or intermediate
term. But as an investor making decisions, I am actually
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Inside The Minds
looking at least as much at economic risk and asking what

the odds are that I actually paid too much for this stock and
I just don’t know it yet. In that case risk analysis takes on a
whole new meaning, because the price you pay has a big
influence on the risk you have in the stock, and that’s partly
why I am a price-conscious, or price-driven, investor.
Economic risk goes down if you buy a stock at a bigger
discount.
In the long run economic risk is the real risk that counts. If
you encounter price volatility over time, but you have
correctly figured out the economic value of your stock, it
will get there someday, and you will make a profit. It’s
critical for clients to understand market risk, but on a true
investment basis – whether or not I am going to reach my
investment goal – I think economic risk is the more
important question.
Good vs. Great Investors
Great investors have several key traits. First, they have a

sound process they believe in and follow. Most well-
designed processes work on average over time. The great
42
investor is not great because they made 200 percent in one

year, but because they made 20 percent in 10 different
years. Great investing means being right more often than
you are wrong.
The second difference between good and great investors is

their ability to realize the odds are in their favor and their
willingness to step up and act on it. One of the best
investors I can think of is John Templeton, who has made
his money by making calls that, at the time he made them,
were completely out of step with the current reality.
Conditions were terrible, the news flow bad, but he realized
he had an asset he could buy at a big discount that he knew
in the long run would work itself out and go his way. Most
of the good decisions Templeton has made were based on a
process he believed in. He follows a fundamentally price-
conscience approach, but I also think he trusted his process
and realized the odds were in his favor, when virtually
nobody else in the market thought he was right. Because he
followed a sound decision-making process and acted on
what he believed, he made a great deal of money. Great
investors are successful over long periods. The reason they
are so successful is probably not that they are smarter than
other people, but that they have a process they trust, and
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Inside The Minds
they’re good at assessing the odds. Great investors pull the

trigger at the right time. Investors such as Buffet and
Templeton didn’t make 300 day-trades that all worked out;
they probably made maybe 10 or 20 really good decisions
in their career that paid off in really big ways. That takes
process and a lot of confidence, because usually those bets
have to be made when you’re going against the grain.
Golden Rules of Investing
The most important rule of investing is to have a process

that will either work well or at least keep you above water
in most conditions. The second rule is to understand that
markets and stocks cycle up and down.
Inherent in the free market system, or capitalist system, is

that the system will act to remove imbalances in the
market. Over time, when things are really good, the system
will slow it down and bring them back to normal. Whether
the economy is booming or in a recession, understand the
market will cycle back toward its normal state, which for us
is a growth rate of maybe 3 percent, with the GDP maybe
44
little higher. A free market never remains in an excess

position or a deficit position too long.
The third important rule of investing is to be realistic. If

you’re in a recession, being realistic means, first of all, you
don’t know when the bottom is going to happen. The
second thing you have to be realistic about is what your
rate of returns can be in a down market. For example, to be
realistic in a market such as the one we experienced from
the start of 2000 to the start of 2001 means anyone who
made more than 5 percent on their total portfolio did a good
job: They lost money in stocks; they could have made
money in bonds; and real estate had a good return. In a
situation such as the 1990s, when earnings were rising,
margins were rising, interest rates were falling, the
economy was growing, and you had that once-in-every-20-
years extra boost from the Internet and wireless build-out,
your goal needs to be significantly higher.
The fourth crucial aspect of investing is being aware of

taxes. I have done a lot of research on taxable investing,
and I have managed taxable accounts. What I have learned
through research and experience is that the amount of value
you can add by properly managing your taxes, in my
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Inside The Minds
opinion, is just as significant as the amount of money you

can make doing good research and analysis. In a stock
portfolio I think you can add 200 basis points a year (or
more) of return by managing your taxes well, which is
about the same as the return a good investor can earn in
large cap stocks.
The biggest key to managing your taxes involves a process

called harvesting the capital losses. It is important to
understand that market volatility actually is an advantage to
a taxable investor. If you buy a stock today that you like
and it goes down 20 percent, you should seriously consider
taking that loss and reinvesting your money into a similar
asset, maybe staying within the same industry but with a
different company. Harvesting, or capturing, that loss gives
you the flexibility to sell a winner when it’s time to sell and
pay no net capital gains taxes. By managing your taxes, and
particularly by harvesting losses that are available in your
portfolio, this tactic can be a huge windfall on top of your
good research and good investment decisions. A taxable
investor who properly measures their return on an after-tax
basis can make almost as much money on their tax
decisions as they can on their investment decisions. And
certainly all the vehicles, such as 401(k)s and IRAs, that let
46
you compound your returns on a pretax basis are absolutely

part of the strategy. Being tax aware will make you a lot of
extra return. If you just properly manage your taxes and use
all the tax-advantaged vehicles, you can outperform a buy-
and-hold strategy quite nicely.
The Future of Investing
I think the biggest change I expect – and hope – to see is

that people over the next five years come to realize the late
1990s was probably a once-in-20-years event, where
everything came together to produce excess returns. That
confluence of factors has happened infrequently in the past
and almost certainly won’t happen in the next five years.
The biggest change will be in making decisions, planning
your investment strategy and structuring your portfolio
with the concept that a fair market rate of return will
probably be 5 percent to 8 percent for bonds, and maybe 8
percent to 12 percent for stocks. I think being more
realistic, and setting lower and more realistic assumptions
on what your asset mix and expected return should be will
be the biggest change.
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Inside The Minds
Another change in the future of investing involves the

government’s desire to encourage savings, retirement
planning, and educational planning. More programs will be
developed that will encourage savings and give you tax
breaks to save for key life events. One of the more recent
changes has been the development of funds that allow you
to save for your child’s college education on a pre-tax
basis. I think you will see more and more opportunities like
that.
Although it’s really a continuing trend and not a change,

there will more and more opportunities to make tax-
efficient investment choices, and people will have to put
more and more thought into this part of their investment
plan. Instead of just owning stocks in my online account, I
will have to think about taking advantage of a college
educational fund and park the money there. Having these
kinds of options will move the tax decision and the choice
of investment vehicles higher on the decision chain of
where to put your money. All the changes will be related to
properly structuring your portfolio, making sure it has the
right mix with realistic outcomes to maximize your
effective after tax returns.
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Scott D. Opsal, CFA, is executive vice president and chief

investment officer of Invista Capital Management, LLC.
Invista Capital Management, an SEC-registered investment
advisor, has more than $24 billion in total assets under
management. Invista is an affiliate of Principal Capital
Management, an asset management company and member
of the global financial services company Principal
Financial Group based in Des Moines, Iowa. As chief
investment officer, Mr. Opsal oversees Invista’s staff of
more than 60 equity portfolio managers, analysts, and
associates focused on local and international equity
markets.
Mr. Opsal joined The Principal in 1983 as an equity

analyst and has been with Invista since its founding in
1985. Formerly head of Invista’s international equities
team, Mr. Opsal was promoted to chief investment officer
in 1997 and serves on the firm’s board of directors.
Mr. Opsal’s previous responsibilities included security

analysis and portfolio management activities for various
U.S. equity portfolios, managing the firm’s convertible
securities and taxable portfolios, and overseeing Invista’s
index fund and derivatives positions.
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Inside The Minds
Mr. Opsal holds an MBA in finance from the University of

Minnesota and a BSBA in Investments from Drake
University, where he is a visiting instructor in the Finance
Department. He also plays an active role as a founding
board member on several local charitable foundations.
50
EARNINGS COUNT
AND RISK HURTS
VICTORIA COLLINS
The Keller Group Investment
Management, Inc.
Executive Vice President and Principal
51
Inside The Minds
Surviving Uncertainty
When I thought about what I wanted to share with you in

this chapter, this title and another, “Investing in Uncertain
Times,” came to mind. But the lessons investors have
learned so clearly since the market peaked in early 2000
can be summarized in the truths, “earnings count” and “risk
hurts.” And the fact is we’re always managing money in
uncertain times. When the stock markets are soaring, as
they were in 1997 through 1999, it was uncertain just how
high stocks would go and when the bubble would burst.
The measure we typically use to evaluate stocks, the price
to earnings ratio, had become more of a “price to fantasy
ratio.”
The years 2000 and 2001 were also uncertain. How long
would the recession last? When would earnings again be
part of corporate news releases? When would the economy
show signs of growth, rather than of contraction? From
what I’ve seen in the more than two decades I’ve been
managing money, the markets are like a pendulum. They
swing too far one way, then reverse course and ultimately
swing too far in the other direction. Somewhere between
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irrational exuberance at one extreme and irrational panic at

the other lies a great deal of uncertainty.
The good news is that we can develop strategies to cope

with uncertainty, because there are certain truths about
investing that we’ve learned – and sometimes the hard way:
R Volatility is here to stay.

R Timing the market is harder than it seems.
R Diversification reduces risk and is critical to long-term
returns.
Probably no words are bandied about in the investment

community more than diversification and asset allocation.
Being diversified across different asset classes and types of
investments is the tried and true premise that works for
successful investors under any market conditions, no matter
what part of the business cycle we’re in. At any time, there
is one asset class that is outperforming all others, but no
one knows just which asset class that will be or how long
its outperformance will last. So the only way to reduce the
potential for loss is to spread your risk by diversifying your
investments. It’s just that simple. But it is not that easy. We
can develop many strategies for a well-designed mix of
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Inside The Minds
stocks, bonds, and cash, but the key place to start any
discussion on investing is with you – the investor.
Does Your Advisor Add Value?
When clients come into my office, they bring two financial

portfolios. One includes their brokerage statements, tax
returns, bank information, balance sheet, cash flow
statement, insurance policies – documents we can lay out
on the table and see, touch, and quantify. The other
financial file is just as important, but far less visible. It
can’t be opened for review or spread out on the table. This
portfolio holds the clients’ hopes, fears, dreams, past
experiences, style of managing, what they would like their
money to accomplish for them. Unless we can integrate
those two portfolios, no investment model or financial plan,
no matter how well-designed, will work.
When the markets are going up, it’s easy to for an advisor
to look good. But when the markets perform as they did in
2000 and 2001, that’s when we advisors really get tested.
Not only are our skills and abilities on trial, but also, and
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maybe more important, how well we communicate with our

clients about what’s happening in the markets.
As a client, you should expect your advisor to keep you

posted on the markets and the economy and how these
forces are affecting your investments. Your advisor should
check with you from time to time to confirm your
objectives. This open dialogue is important and helps
ensure that your wishes are being carried out.
When I think about risk, it’s interesting to note that during

1998 and 1999, I saw a significant increase in how
comfortable clients said they felt with risk. What risk was
and how to determine how much one should take never
came up unless I brought it up. It’s also interesting that
most client questions during the 1990s were about how we
select stocks – our buy criteria. Rarely did a question come
up about sell strategy. In fact, clients often questioned and
were critical when we sold to take profits and reduce
overweight positions in stocks that were performing well.
Risk and buy/sell strategies are two very important

conversations to have with any manager you use. And
whether you work with someone or mange your
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Inside The Minds
investments on your own, the place to start is with a

Personal Investment Policy.
Your Personal Investment Policy (also called Investment

Policy Statement) is critical because it provides the
guidelines for how the account or accounts are to be
managed, helps set realistic performance expectations, and
makes sure both you and your manager start out on the
same page. Our firm uses a questionnaire to probe for the
real level of comfort with risk – not just what the client
says. Our objective form asks clients to select the mix of
stocks to bonds they think most suits their long- and short-
term goals. But a Personal Investment Policy goes even
further. It identifies not only the mix of stocks to bonds, but
also the strategies that will be used, the broad categories –
equities or bonds versus metal funds, for example.
Most important for you is that a Personal Investment Policy

states how performance will be measured and against
which benchmarks. Comparing your portfolio’s
performance against the Dow when you have mostly
NASDAQ-type tech stocks is no more appropriate than
comparing large cap U.S. stocks against international small
cap. Different asset classes will perform differently during
56
the same time periods. One client reminded me that the

municipal bond portfolio he was managing was
outperforming the stock portfolio we were managing. True,
but one would not have expected apples to taste, feel, and
look the same as oranges. One of the reasons to be sure you
are measuring against the appropriate benchmark is that it
helps to keep your expectations for performance realistic.
Managing Your Expectations
What’s wrong with this picture? You say you want a low-
risk portfolio with returns of not less than 15 percent
annually. You want it to be tax efficient, with the majority
of returns coming to you as long-term capital gains. What’s
more, the portfolio should be liquid, so you can cash out or
change investments at any time without suffering a penalty.
Low risk, high returns, tax advantaged, and very liquid: Is
this a realistic expectation? As with many things in life,
there’s a choice. Generally to achieve the best returns,
you’ll need to be in equities, which will fluctuate in value,
some more, some less, depending on the industry sector
and stocks within that sector.
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Inside The Minds
How clear you are in expressing your goals and level of

comfort with risk is just one part of the equation. Your
advisor may be hearing what you say and able to
implement a good plan to meet your goals. But all too
often, I find that planners and advisors enter a situation
with a preconceived notion of what the client should do. I
believe top-notch financial professionals understand their
work must be client-centered, client-driven. What they
think is best must be brought to the table as a resource, but
they must remain flexible and open to their clients’ needs.
I recognize investment management is not just about

numbers – it is about emotions and goals, about what
clients want to accomplish with their money. If we truly
understand our clients, and they have confidence that we
care deeply about their well-being, they will be less likely
to pull the trigger and exit the market at the worst possible
moment.
Most people would guess that clients always go to their

advisor with financial goals. However, I would say that
only one third of the people who come into my office have
written goals and understand the steps to reaching those
goals. The other two thirds can use help articulating their
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goals. An open-ended conversation might be, “What would

an ideal retirement situation look like to you? Where would
you live? Would you travel a lot? Would you play golf?
Would you want to spend money on charities? From this I
get a sense of how much cash flow will be required for
them to support their desired lifestyle. This type of
questioning and analysis goes beyond the client’s initial
comment, “I want to retire in 10 years.”
My personal goal, as their advisor, is to provide them with

the best investment portfolio possible to help them reach
their goals, as I understand their goals. If someone says, “I
want to get 30 percent returns,” I help them conclude that
that is an unrealistic expectation by showing them the
historically-based range of returns, which is 10 percent to
12 percent in equities. Managing expectations is one of the
most important aspects of my job.
The Savvy Investor
Generally, savvy investors have certain traits in common

and have learned how to handle markets in all their variety:
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Inside The Minds
A great investor understands risk.
A great investor has a plan, is disciplined, does not get

caught up in either irrational exuberance on the upside or
irrational panic on the downside. A great investor does not
allow his or her decisions to be ruled by emotions. By
clearly understanding the potential for loss, they can
allocate their funds among long-term, mid-term, and short-
term money. With longer horizons before the funds are
needed, a higher portion can be allocated to equities. With
short-term money, the options are far fewer and are
primarily money markets, short Treasuries, and low-
duration bond funds.
There are no risk-free investments. Often clients move to

what they perceive as low risk only to incur a higher risk
than anticipated. Moving from stocks to bonds as the
recession ends and recovery begins is an example. Buying
stocks at the beginning of 2002 might actually subject a
long-term investor to less risk than buying bonds at the
same period.
Risk is also subjective. One client who started his own

business nine years ago understands and is comfortable
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with risk. When he asks if this is the right time to shift the
40 percent in bonds of his 60/40 portfolio to equities, and I
determine that he has a long-term perspective, I might
answer that it looks like a good time to invest despite the
choppy markets ahead. On the other hand, another
individual posing the same question might receive a very
different answer. Based on my knowledge of his situation
and level of comfort with risk, I might suggest he mitigate
risk by investing 10 percent a month over the next four
months.
Understanding risk is essential to developing an investment

strategy that works and produces repeatable performance
over time, but it’s only part of the equation. As individuals,
we need to be aware of the times we are irrational in our
thinking about investing.
Wise investors understand how emotions influence

investment decisions.
The field of behavioral finance gives us some good insights

into the most common mistakes people make and how to
avoid them. While there are many, the two that might
sound most familiar are:
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Inside The Minds
Hindsight bias.
In retrospect, it always seems as if we should have known

just when the market would tumble or soar. Hindsight is
always 20/20, and while it seems so obvious as we look
back on the market’s action, the fact is it is not obvious at
the time in reference. Looking back on a particular time is
very different from experiencing it in the first place. At the
time of experience we are bombarded by a whole variety of
data, which we evaluate to make our decision: Should I
buy? Should I sell? At the moment of retrospect, though, all
of that extraneous data is gone, and the only thing left is
what happened. Thus we are struck by how obvious that
seems.
When clients express that they (or we) should have seen the
recession or the uptick coming, I respond that we all
operate with the best information we have at any moment.
The decisions we made were probably the right ones at that
point, given what we knew. A good example of hindsight
bias is most people’s response to the picture of Bill Gates
and the Microsoft crew in 1978 that comes up from time to
time on the Internet. They looked like a bunch of young
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hippies, and if someone had asked if you’d invest in their

company, you most likely would have said, “No way!”
Anchoring.
I hear this type of thinking from clients often. Let’s say you
buy a stock at 80, and it declines to 50, and you think, “I’m
so frustrated, I know it’s coming back. When it hits 80
again, I’m selling.” Or that hesitation about selling: You’ve
probably experienced times when the stock you just sold
rallies right after you’ve sold it. Now suppose you’ve been
watching a stock, and it goes up and continues upward until
you finally decide to buy. We know what happens next. In
anchoring, we tend to get stuck on a number or set of
numbers, even though many other factors influencing the
stock have changed.
It’s clear that as individuals sometimes our emotional

responses get in the way of our logic when it comes to
making investment decisions.
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Inside The Minds
Confident investors deal with information overload.
While it is important to stay current, gathering too much

information can lead to information overload – and the
analysis paralysis that follows. It is important to filter out
unnecessary information and focus on what is most relevant
for you. Define your investment strategy and be consistent
in implementing it. If you listen to financial news
statements or surf the Net extensively, you’ll have a new
stock idea every 10 minutes. Don’t allow yourself to
become distracted.
Suppose you do all of the analysis on a stock or investment

to make a buy or sell decision, and then you begin to
second-guess yourself. Being successful takes more than
analysis. It also takes intuition and steadfastness, rational
thought, and the ability to put emotions aside.
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What It Takes to Be a Great Investor
Diversify across asset classes and industry sectors.
A well-diversified portfolio includes large-company, mid-

size, and small-company stocks. Both value and growth
styles are reflected, as well as U.S. and foreign stocks.
Generally, you will overweight large cap U.S. investments,
as they tend to have a lower-risk profit than do mid- or
small-cap stocks. Research shows quite clearly that an
equal weighting between value and growth styles of
investing produces better returns over a longer period than
does each style alone.
Once you have your diversification model set up, it is

important to stay the course. There will be times when you
will feel you’ve erred as one style (value or growth) or one
asset class (large cap or small cap) outshines the other. The
temptation is to add funds to the outperforming investment,
or at the very least to let your winners run and sell your
losers. Rather than doing either of these, the strategy that
produces the best returns is to rebalance your portfolio
yearly. Reducing your winners to add to your losers on an
annual basis produces very good results over the long term.
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Inside The Minds
Besides rebalancing, you’ll want to stay invested. It’s

difficult, if not impossible, to time the market. So whatever
portion you decide to put into equities should stay unless
something changes in your personal situation requiring that
you have less volatility and more income. Statistics show
that over time that it is more effective to stay the course.
Since most returns come in a relatively few days each year,
staying invested shows better returns than if you move in
and out of the market and happen to miss the select few
days of great market performance.
Go for GARP.
Picking the right stock is not an easy process. You’ll have

better success if you have clearly thought through the
criteria you’ll use for buying, as well as for selling. You
need to have some drug stocks, some financial stocks, some
technology stocks, and some consumer cyclicals. You need
a broad range of stocks, as is offered in the S&P 500. This
gives you some industry underweights and overweights
because we think we can add value to our stock picks. So in
terms of choosing stocks, we look at trends: What are the
drivers in the industry doing? What is their earnings
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growth? We also do a fundamental analysis by looking at

cash flow and employing the PEG ratio.
The PEG ratio is price divided by earnings, divided by

growth. You want to buy stocks that have a PEG ratio of
less than two. If a stock has a P/E ratio of 20 and is
growing at 20 percent per year, it has a PEG ratio of one.
Suppose now that the P/E ratio is 40, and its earnings are
only growing 10 percent per year. It will have a PEG ratio
of 4. That stock is too highly priced. I believe earnings
growth drives the stock selection process.
GARP, or growth at a reasonable price, is another factor to

consider in selecting stocks. For example, even though I
like a stock, I may not buy it until it comes within an
attractive price range. Again, establishing criteria you’ll use
to buy and sell is critical and will protect you from taking
actions that are emotion-driven.
When making sector bets, we start with diversification, and

our portfolios are fundamentally driven, which means we
look at the management, the quality of the product, the
valuation, and the free cash flow. These are very important
in analyzing stocks.
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Inside The Minds
You can enhance the performance (but also take more risk)
of your portfolio by making some sector bets. This means
overweight in certain industry sectors or stocks, based on
trends you observe. For example, a long-term trend that is
having an impact is the aging of America and the world.
Products like health services, biotechnology, and
pharmaceuticals will gain prominence as the world ages.
Financial services will do well in a recovering market, as
will technology. If you are searching for trends after
September 11, 2001, you could invest in stocks of security-
related businesses, but you want to be careful about buying
on stories. An effective strategy here is to identify an
industry you think will benefit from a trend and then buy
the best stock in that industry.
Develop your criteria for buying stocks.
From what I’ve observed over the years, investors who are
very successful set their buy and sell criteria and stick with
them. Those less successful buy on the “story” and are
more likely to “fall in love” with their picks, which
influences their sell decisions.
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We have multiple criteria for selecting our stocks. One of

the first things we look for in the companies we buy is first-
class management. We believe great companies are created
by great managers with great vision. Great managers with
great vision create great companies. We want managers
who have a record of doing what they say they are going to
do. We’ll then analyze management’s vision and try to
understand their business model. Furthermore, we like to
see management owning shares in their own company.
We also have qualitative criteria: The companies we select

must have a sustainable competitive advantage. We want a
brand name, established product quality, and pricing power.
We want a dominant market or a growing market share in a
growing market. A company that is increasing its share in a
growing market is the best of both worlds. A company
must also have products or services that do not become
obsolete quickly. We also look for companies that are
successful in international operations. This is important
because being able to expand internationally reduces the
risk of being tied too closely to the U.S. economic cycle.
We seek innovation, use of technology, and diversified
customer and product base. We also want a scalable
business model – companies that can increase their
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Inside The Minds
business and create economies of scale and are not capital

intensive. The franchise model is a good example.
We also use quantitative criteria. We want minimum

annual earnings growth of around 12 percent, and for
stocks characterized as high-growth, like technology
stocks, we expect minimum annual earnings growth of 20
percent. We want high and expanding profit margins, in
addition to strong positive cash flow and strong returns on
capital. The company must invest its capital wisely and
have a lean expense structure. Obviously, companies that
can keep costs low are much better able to compete,
especially in difficult times, and that sharply reduces the
risk of owning their shares.
Finally, we look for companies with strong balance sheets.

Having strong finances and low debt gives a company
staying power to weather difficult economic cycles.
Set a sell strategy.
Knowing in advance what criteria you will use to make

your sell decision is the mark of a great investor. Our sell
strategy is fundamentally-driven, not price-driven. This
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means we sell stocks when they reach their price target or

when the fundamentals of the company or of the sector
deteriorate. Our analysts focus on earnings visibility when
assessing a potential sell candidate. We will sell if a
company misses its earnings objective, lowers its long-term
growth rate, or reaches our price target.
Even though our sell decisions are made on fundamentals

primarily, we also consider price declines. The use of stop-
loss strategies has both advantages and disadvantages. You
can set your stop loss at 10 percent; that is, if you buy a
stock at 100, and it declines to 90, you sell. However,
volatile stocks can go from 90 to 110 in the next heartbeat.
A more realistic approach is to determine the reason for the
decline, rather than sell automatically. If the market itself
drops or the industry sector has declined, don’t sell. But if
the company also missed its earnings numbers, or the
management team has left, or something else is
questionable about the company and it declines 20 percent,
sell it. However, if it drops 20 percent but still looks good
in comparison to others in its industry sector, I would
advise continuing to hold and watching carefully. I advise a
firm 30 percent sell rule, with conscientious reviews at 10
percent and 20 percent.
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Inside The Minds
To lock in gains is another valid reason for selling. At any

point if you have good gains – suppose the stock has
doubled – and you don’t see much more upside potential, I
would advise getting out. You might sell enough to take out
your original investment if you still wish to hold this stock.
If it represents too large a position in your overall portfolio,
you should reduce your exposure to a potential loss in the
future.
Another valid reason for selling, of course, is for tax

management – to lock in losses to offset realized gains or to
lock in gains if you already have realized losses elsewhere
in the portfolio.
Know your benchmark index.
At a cocktail party, a colleague you’ve known for a while is

discussing how well his portfolio is doing. While you don’t
say anything at the moment, you’re mentally calculating
that your own portfolio has underperformed his
substantially. You’re beginning to feel slightly (or very)
inadequate and wonder how he (or his advisor) was able to
select such winning stocks or investments.
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How do you evaluate your own investment performance?
Maybe you’ve been overweighted in technology. Losses

are not fun, but let’s put them in perspective. Suppose
investor A had a –18 percent return last year; Investor B’s
was –11 percent; and Investor C’s was up 5 percent. Which
one had the best performance? C, of course, is the easy
answer, but not the whole answer. Actually, A’s returns are
the best. Before you say, “That’s crazy!” and stop reading,
consider this: A is heavily weighted in tech stocks. He had
a roller-coaster ride up in 1999 but down in 2000 and 2001.
The stocks are in his IRA, where he can afford to ride out
market corrections as he has 15-plus years till retirement.
The appropriate benchmark for Investor A is the
NASDAQ. This benchmark had declines of 39 percent and
21 percent respectively for 2000 and 2001, so A has
actually done well, despite his losses.
Investor B has a broader basket of stocks – mostly mutual

funds investing in large blue chip companies. Sure, she has
tech, but she also has healthy weightings in financials, oil
and gas, drugs, consumer products, and retail and service
companies. The benchmark with holdings most similar to
her portfolio is the well-known S & P 500, which turned in
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Inside The Minds
a –9.11 percent return in 2000 and a –13.04 percent return

in 2001, while her investments returned –11 percent.
Investor C, on the other hand, is pretty pleased with his

performance, up 6 percent. Pleased he should be, but also
surprised that he actually underperformed. With 100
percent in intermediate corporate bond funds, the most
appropriate benchmark is the Lehman Brothers Aggregate
Bond Index, which did double-digit returns in the past two
years.
So before you pat yourself on the back for a great job or

look for the closest window to jump from, be sure to
compare the returns on your investments with the
appropriate index or measure. You may be doing great in a
bond fund now, when you compare yourself to tech stocks,
but over the long run and in a reasonably performing
market, you’ll see that your returns don’t hold a candle to
the potential that growth stocks have.
Knowing the appropriate index will help ensure that your

expectations are in line with reality going forward. It may
seem like the end of the world when the market is in a
serious correction. It isn’t. The stock market will recover.
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The nice thing about bear markets and recessions is that

they ultimately end and are succeeded by recoveries and
bull markets. Chances are the bear markets of 2000 and
2001 bottomed on the low reached September 21 after the
terrorist attack on the World Trade Center. If this proves to
be true, it was your typical bear market, lasting 546 days
and producing a 37 percent loss. The historical bear market
averages are duration of 559 days and a 31 percent loss.
If you have a well-diversified portfolio, you’ll be better

protected against roller coaster rides and severe drops. Like
investor B, you’ll want to include drugs and health care, oil
and gas, financials, and retail – companies you know and
understand, companies with good fundamentals, solid
earnings, and a lot less excitement.
Buy what you know – as a start.
The “buy what you know” dictum would have saved many
an investor from dot-coms with clever names but not much
else going for them.
Once you spot what you think is a good product or service,

the next step is to review the fundamentals. What is the
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Inside The Minds
current growth rate? Is it sustainable? Does this company

have increasing earnings and a competitive market edge?
Do they have a strong management team, a solid business
model, and the ability to implement changes to stay ahead
of the game? And last but not least – is it GARP – growth
at a reasonable price? It may be a great firm with good
growth potential, but if the price per share already reflects
that, you’ll want to wait for a more attractive time to buy.
When I followed the “buy what you know” advice, I was

right once, dead wrong the other time. In 1986, at the end
of a long and tiring day, I shopped for a gift in a new
department store that had just opened. Gracious, helpful
sales clerks and lovely piano music made it a pleasurable
experience. The following day, I reviewed the company
fundamentals and bought Nordstrom. It rose and split, rose
and split, and had some very good years. Another stock I
bought was Chantal, a company that had just gone public.
Every magazine I picked up had an ad on Chantal’s wrinkle
cream. Even Barron’s came out with a positive article on
the stock. Did I study the fundamentals of the company, the
debt structure, the earnings and growth rate, the business
model? No, I figured I’m part of an aging baby boom
generation. If I wanted to get rid of wrinkles, so would
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millions of other women (and men). The stock crashed, and

I still have wrinkles.
Buying what you know or buying the “story” is not enough

to ensure successful investing. But it’s a start. Couple that
with a serious look into what the company is really about,
and you have a good chance of picking winners over time.
Know how to measure your performance, keep your
expectations realistic, and invest for the long term – and be
confident that you’ll weather the storms that are a normal
and natural part of investing in the markets.
It’s the Earnings!
The date is January 1999. The audience is hushed as the

CEO rises to the podium. He looks the part, dressed in
jeans, a black shirt, and a matching dark tie. He has a
youthful appearance despite his 32 years of age. After the
obligatory opening joke, he proceeds to give his state of the
company address and it goes something like this. “It gives
me great pleasure to tell you that we’ve had an extremely
successful year. We lost more money this year than we did
last year, and if we can keep up the good work, I anticipate
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Inside The Minds
this trend to continue into the foreseeable future. As you’ll

see in our business plans for 2001, we’ve developed several
new services that we’ll be offering free to our subscribers.
Our subscribers pay no membership fees, so it’s definitely a
win for them, and the more customers we have, the better
we look on Wall Street. Remember our goal is not to make
money, but to attract money. Market capitalization is what
counts, and we’ve clearly demonstrated our ability to boost
our stock price. I’m here today to pledge that our superior
management team stands ready, willing, and able to take
this firm to the highest pinnacle of success.” The audience
breaks into applause as those with wireless handheld
devices dial into the Internet and check the stock price: up
6.5 points.
Now fast-forward to another shareholders meeting, this one

in January 2002. The CEO rises to the podium, gray hairs
beginning to show, along with a few wrinkles on his still
youthful face. Again the opening joke, and his comments
go something like this: “You all know how difficult it has
been for firms such as ours, but I’m pleased to say that we
implemented some dramatic cost-cutting, resulting in
improved sales, revenue, and, of course, earnings. We
lowered our guidance to analysts and beat expectations by
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1 cent. But due to market conditions, even that good news

didn’t suffice to increase our stock price, which has
declined. Going forward, we expect earnings to remain
slow due to the economic slowdown globally. But our
management team is outstanding; our business model solid;
and our market penetration growing.”
The audience claps politely but not enthusiastically. What a

difference three years can make. Yes, earnings do count –
they always have.
Investing Is Different Now
Quite frankly, I’ve seen more changes in the past three

years than in the 20 previous years put together. The
environment is different for investors, for various reasons.
R Information is everywhere and easy to get. A

grandmother in Nebraska with a computer can have
access to the same analytical information that used to
be available only to the top money managers. Access to
the Internet also levels the playing field between men
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Inside The Minds
and women. Women are now logging on at a greater

rate than men are and have become active investors.
R Transaction costs have declined so that they are almost

negligible. The trend is away from commissions and
toward fee-only money management. The competition
is fierce as large brokerages, banks, and insurance
companies embrace this new business model.
R The media influence investment decisions. You

probably remember, as I do, that TV spot with the truck
driver who owns an island. It is implied that his success
is attributable to his discount brokerage account. What
it shows is that anyone can be an expert. The media’s
message to America is all you need is a mouse and a
pulse to be a stock market success. Sadly, the general
investing public is now realizing it’s not quite that easy.
R Time frames have collapsed. In the past, when I talked

about long-term investing, it was five to 10 years or
longer. Now people think long term is two to three
years. In my mind this phenomenon contributes
substantially to the next point.
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R Volatility – more than ever before – is here, and it’s

here to stay. Investors often act before they think and
before they have all the information they need to make
appropriate decisions.
Simply put, the best advice is to be diversified and not try

to time the market. Have patience, and focus on the long
term. It has been said that investing in the markets is like
riding an up escalator with a yo-yo. The long-term trend is
upward, and the movements of the yo-yo up and down
represent the day-to-day fluctuations. The short-term
volatility we are experiencing in today’s markets is not
meaningful when compared with longer-term trends.
Successful investors take advantage of volatility: They
diversify their portfolios to reduce risk of loss; they set
clear buy and sell criteria; and they stay disciplined and
focused on the long term.
Dr. Victoria Collins is executive vice president and

principal of The Keller Group Investment Management,
Inc., a registered investment advisory firm managing
approximately $1 billion. She has been named for five
consecutive years among the 250 best financial advisors in
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Inside The Minds
the U.S. by Worth magazine and is listed among Mutual

Funds magazine’s 100 Great Financial Planners.
Following undergraduate work at Cornell University, Dr.

Collins received her Ph.D. from the University of
California, Berkeley. With two decades of experience in
financial planning, Dr. Collins is a well-known lecturer,
speaker, and writer. She is the founder of the Financial
Strategies Conference for Women, an annual event in
Orange County, as well as the Investment Conference for
Women in London.
A recognized leader in the field and a winner of the Orange

County Business Journal’s Outstanding Women in Business
Award, Dr. Collins is a member of the Financial Planning
Association (FPA), and serves on The Orange County
Register’s panel of mutual fund experts.
She has been interviewed on major radio and TV shows,

including “Good Morning America,” Bloomberg, CNBC,
MSNBC, and CBS’s news affiliations, and in publications
such as The Wall Street Journal, USA Today, Money,
Business Week, Investors Business Daily, The Los Angeles
Times and The New York Times. Dr. Collins cohosted the
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PBS special, “The Financial Advisors,” writes financial

columns for various publications, and appears as a
commentator on KOCE TV.
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NAVIGATING TURBULENT
MARKETS: A CASE FOR
DISCIPLINED INVESTING
HOWARD WEISS
Bank of America
Senior Vice President
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Inside The Minds
Stick With What Works
A legendary college football coach was once known for his

trademark strategy of “three yards and a cloud of dust.”
Sports writers and fans constantly poke fun at this strategy
as being boring and lacking in imagination. Most investors
would hardly want their portfolio strategy characterized in
this fashion.
This strategy brought The Ohio State University and its

fiery football coach, Woody Hayes, 13 Big Ten Conference
titles, three national championships, and 16 victories
against its archrival Michigan, over 28 years. To be
successful, this strategy required that all players execute
flawlessly on each play. Every player needed to do exactly
what he was expected to do. The strategy also required a
strong, disciplined defense, as it is not easy to come from
behind with this type of offensive game plan. Since the
“three yards and a cloud of dust” era ended in 1978, the
school dramatically opened up its offense and sent more
star players to the pros, but it has posted no national
championships, and over the past dozen years, it has beaten
its archrival only twice.
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What does this have to do with investing? What are the

lessons learned? Over the course of my career, I came to
appreciate the value of a highly disciplined approach that
focuses on managing risk, as well as return. I learned there
are no silver bullets or magical formulas to investing.
While a small few can earn considerable wealth by
concentrating investments in a single stock or industry,
most investors cannot get wealthy by taking such high
risks. Successful investing, like winning football, does not
have to be fancy. Moving three yards at a time and getting
a lot of first downs is okay. It is just as important to
mitigate losses in bear markets as it is to win in bull
markets. The future will require successful investors to
master that.
Accordingly, my personal strategy has been to establish a

specific investment discipline that I stick with in both up
and down markets. While the maturity of the bond portfolio
may change during a market cycle, and while specific
stocks in the portfolio may also change during the cycle,
the overall discipline remains in place.
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Inside The Minds
A Ten-Point Program for Successful Investing
Over the years much science and mathematics have grown

around the practice of investing. On the other hand, there is
also a considerable “art” to successful investing. The trick
is to effectively weave the “art” and “science” together into
an overall, long-term plan that can operate in both up and
down markets. To accomplish that I have generally
followed this 10-point program when advising wealthy
families and individuals:
1. Establish goals.
2. Define risks.
3. Develop asset class strategies.
4. Establish asset allocation targets.
5. Construct the actual investment portfolio, selecting the
appropriate securities, vehicles, and/or managers.
6. Manage your stock portfolio through a disciplined stock
selection approach.
7. Hedge specific portfolio risks.
8. Manage tax position.
9. Evaluate portfolio performance.
10. Rebalance the portfolio.
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1. Establish goals.
The first step in the process is to define your investment

objectives and profile your needs. You will want to
consider the following elements:
R What are your income needs after tax?

R How do you profile your risk tolerance? One way is to
determine the maximum loss you are willing to tolerate
in any one year. This number will affect your asset
allocation structure.
R What is your time horizon? This will be different for
each investment pool. For instance, educational funds
will correspond to your children’s ages and may have a
different time horizon from your personal portfolio or
retirement funds. These funds may therefore be
invested differently, and the asset mix of each would
change as you approach the day you need to begin
withdrawing the funds.
R What is your need for liquidity? This involves planning
for major expenditures and structuring your portfolio to
accommodate your expected cash withdrawal rates.
Pure liquidity should include cash reserves and income,
as well as assets you can sell at no loss.
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Inside The Minds
R How much of your portfolio must be marketable? A

marketable security is one you can convert to cash at
today’s market value, even if you are selling at a loss.
Your need for marketability will affect how much you
can invest in such non-marketable securities as venture
capital, real estate, and hedge funds.
R What is your tax situation? What is your income tax
bracket, and do you have any loss carry-forwards that
can be used? Do you have alternative minimum tax
problems? Answers to these questions will not only
influence your asset structure but would also suggest
year-end selling strategies.
R Finally, what are your growth expectations? Are your
assets and income adequate to meet your needs? To
what degree do your assets need to grow to meet your
lifestyle needs?
2. Define risks.
The first step in handling risk is to understand the various

types of investment risk. Here are some of the major ones:
R Interest rate risk is associated with the rise and fall of

interest rates. Fluctuating rates will have a direct impact
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on the prices of fixed-income securities and can

indirectly affect stock prices in certain economic
sectors.
R Reinvestment risk is associated with the redeployment
of maturing bonds and future cash flows. The
implication is that you may not wish to have too many
bond maturities in any one year.
R Inflation, or purchasing power, risk is associated with
changes in the price levels of goods and services.
Investors will want to achieve returns that exceed the
increase in inflation over the years.
R Credit risk is associated with a company’s uncertainty
in earnings and sometimes its ability to survive.
R Currency risk relates to changes in the exchange rate
between the dollar and foreign currencies. This
sometimes has an impact on the earnings and,
ultimately, the stock prices of multinational companies.
R Event risk is associated with a nonfinancial event
hitting a company. Examples include a governmental
action, such as a Justice Department monopoly suit or a
Food & Drug Administration order.
R Market risk is the risk associated with the rise and fall
of the stock market and its ramifications to the
economy.
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R Common-factor risk is the specific risk inherent with

securities that have similar attributes. Examples include
high or low P/E stocks, small cap stocks, cyclical
stocks, and defensive stocks. During certain business
conditions, stocks with these similar attributes may
move in tandem.
One of the most important skills an investor can have is to

fully understand the range of risks in the marketplace and
the impact each can have on his or her portfolio. This way,
the investor can construct a portfolio that aims to mitigate
those risks that could more seriously prevent attaining the
expected investment returns. Later I will tell you how an
investor can decide just how much risk to take on.
3. Establish asset class strategies.
Academic studies have shown asset allocation is the single

largest determinant of performance. Accordingly, many
will argue that asset allocation decisions are the most
important decisions you will make as an investor. To
illustrate the role of asset allocation, consider the table
below. This table shows the returns of the highest and
lowest asset classes in each of the past 16 years. Different
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asset classes outperform at different times, and over the

past 16 years no single asset class has consistently been the
top performer. Moreover, asset classes that are on top one
year are suddenly found on the bottom the following year,
and vice versa.
Year Highest Performing Lowest Performing

Asset Class (%) Asset Class (%)
1985 Internat’l Stocks 56.2 Fixed Income 22.1
1986 Internat’l Stocks 69.4 Small Cap 5.7
1987 Internat’l Stocks 24.6 Small Cap (8.8)
1988 Internat’l Stocks 28.3 Fixed Income 7.9
1989 Lg Cap Growth 36.4 Internat’l Stocks 10.5
1990 Fixed Income 9.0 Internat’l Stocks (23.5)
1991 Mid Cap 50.1 Internat’l Stocks 12.1
1992 Small Cap 18.4 Internat’l Stocks (12.2)
1993 Internat’l Stocks 32.6 Lg Cap Growth 1.7
1994 Internat’l Stocks 7.8 Mid Cap (3.6)
1996 Lg Cap Growth 24.0 Fixed Income 3.6
1998 Lg Cap Growth 42.2 Small Cap (2.6)
1999 Lg Cap Growth 28.3 Fixed Income (0.8)
2000 Mid Cap 17.5 Lg Cap Growth (22.9)
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Arriving at your asset mix is a multistage process. It begins

with identifying the range of asset classes you feel are
essential to help reach your income and growth objectives
and, at the same time, are consistent with your risk
parameters. Next, you need to clearly understand the
specific return and risk profile of each asset class. You then
determine how to arrange each asset class within your
portfolio. We will consider each phase.
When identifying asset classes, I advise clients to consider

a wide range of traditional asset classes, and for wealthy
clients, I also advise that they consider a range of
alternative investments where appropriate. Here is a brief
listing of the various asset classes.
Cash Equivalents Fixed Income

Commercial paper Domestic taxable bonds
U.S. T-bills & agcy notes Municipal bonds
Auction rate municipals International bonds
Municipal notes High-yield bonds
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Equities Alternative strategies

Large cap stocks Private equities
Small/mid cap stocks Exchange funds
International stocks Real estate
Emerging market stocks Hedge funds
Hedge funds represent a unique type of asset class and have

a range of strategies themselves. Here are some of them.
Diversified Strategies Market Strategies

Fund of funds Equity hedge
Managed futures Short selling
(CTA) index Emerging markets
Hedge fund index Fixed income high-yield
Global markets Arbitrage strategies

Macro Market neutral
Market timing Convertible arbitrage
Discretionary CTA Event-driven
Trend-followers CTA Distressed securities
I advise clients to understand how each asset class

contributes to the performance, as well as the risk, of the
portfolio. Here is a brief synopsis of some of the major
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asset classes I work with and the role they play in a

portfolio:
Cash equivalents represent the liquidity portion of your

portfolio. Generally, this segment contains money market
funds, treasury bills, certificates of deposit, and commercial
paper. Investments are either immediate cash (e.g., money
market funds), or they mature within 12 months.
Fixed income instruments are essentially debt securities of

the U.S. government and agencies, corporations, states, and
municipalities. They provide the greatest part of a
portfolio’s income. While the long-term expected return of
bonds is measurably lower than its equity counterparts, the
long-term volatility of bonds is also much lower. There are
also two special types of fixed income that can play a
useful role in one’s portfolio:
R High-yield bonds are generally debt obligations of

corporations with a credit rating of BB or lower. They
carry a higher yield to compensate for the increased
credit risk. In many ways they act in concert with the
stock market. During good economic times, their yield
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spread to higher quality debt narrows, while during bad

economic times, their yield spread widens.
R Convertible bonds and convertible preferred stocks are
securities issued by corporations and can be converted
into corresponding stock at a predetermined price level.
They are attractive investments during difficult markets
because they provide yield support to a stock while at
the same time enabling the investor to participate on the
upside if the stock rises.
Large-capitalization equities represent stocks of large

publicly traded companies whose market capitalization
exceeds $10 billion. These are generally mature companies
that are actively followed by securities analysts. They form
the cornerstone of any equity component of a portfolio, as
there will be many years when this asset class outperforms
other asset classes. For example, over the past 16 years,
either large cap growth or large cap value ranked among
the top three performing asset classes. The challenge for the
investor is to determine how to play the large cap market
between value and growth investing. I will comment on a
suggested strategy.
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Mid cap equities represent stocks of medium-size publicly

traded companies whose market capitalization ranges
between $1 billion and $10 billion. Most companies are
mature, but some are not, and this segment is moderately
covered by Wall Street analysts. They are somewhat less
liquid than large capitalization stocks. I regularly
recommend this asset class, as it provides access to many
up-and-coming growth companies that have emerged from
the risks of the start-up phase. They perform very well after
a recession and provide decent returns during up markets.
Small cap equities represent stocks of small-size publicly

traded companies whose market capitalization falls below
$1 billion. Generally, these companies are not widely
followed by Wall Street analysts and are less liquid than
large or mid-cap stocks. Over the long term small cap
stocks have provided greater returns than large cap stocks
but with much greater volatility. Like mid-cap stocks, these
stocks tend to do well out of a recession and do reasonably
well during the growth periods of an up market. On the
other hand, they get hit during recessionary times, as you
would expect.
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International equities represent ownership of

internationally domiciled companies that are traded on
stock exchanges of developed countries. I generally
recommend an allocation to this sector, because many of
the world’s major corporations are now non-U.S. and many
foreign economies have shown attractive growth rates over
the years. Also, many U.S. companies have global ties.
From a portfolio standpoint, international equities offer
attractive diversification opportunities due to their low
correlation to domestic equities.
A subset of the international market is emerging markets

equities. This asset class represents ownership of
internationally dominated companies that are traded on
market exchanges of lesser-developed countries. Unless a
particular client is receptive to this asset class, I generally
do not recommend it to my clients because of its higher
risk. In addition to financial and economic risk, these
companies are also subject to considerable political risk.
Private equity is the first of my alternative strategies. This

asset class includes investments in private companies.
Among these investments are venture capital, leveraged
buy-outs, recapitalizations, reorganizations, restructurings,
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privatizations, and spin-offs. Private equity is available

only to “qualified investors” who have a minimum of $5
million in securities they can invest. Private equity
investing, as you might expect, requires a long-term
commitment, as it has limited liquidity. Nevertheless, it can
be a rewarding investment experience, and I recommend it
to some of my clients, especially those who have owned
private companies of their own.
Real estate can also be an important long-term asset for

larger portfolios, as it offers some important benefits. As a
diversification play, it has a low correlation with stocks and
bonds. Commercial real estate with long-term leases will
not only provide a good income source, but also have low
principal volatility and offer a reasonable chance for capital
appreciation over the long term. Most investors expect real
estate to earn a total rate of return between bonds and stock.
There are risks, however, including tenant default, inability
to rent some of the properties, and deteriorating locations.
Hedge funds are the most intriguing asset class. Established

as private investment partnerships, hedge funds operate
under limited regulations and will generally invest in
futures, commodities, options, currencies, and stock market
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indexes, in addition to stocks and bonds. They also

frequently employ leverage and sell securities short. There
are a variety of hedge fund strategies, some of which I
referred to earlier. On the other hand, there are two major
styles:
R Arbitrage, or market neutral, involves investing in

offsetting long and short equity positions in the same
sectors. Market risk is greatly reduced, and leverage
may be employed. Correlation to the general equity
market is low.
R Multistrategy involves investing in the broader market,
including arbitrage, but also including directional
strategies.
Hedge funds also entail a fair amount of risk and

drawbacks. Among those are tax inefficiency, limited
liquidity, limited transparency, short-selling, leverage, and
no registration under the Investment Company Act of 1940.
Finally, hedge funds are generally restricted to accredited
investors and qualified purchasers who have more than $5
million of assets they can invest. I generally recommend
hedge funds to wealthy individuals because of their low
correlation to other asset classes. Moreover, certain hedge
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fund structures can provide positive returns in down

markets. Discussing hedge funds further is beyond the
scope of this chapter, and you should consult your financial
advisor before purchasing these types of investments.
4. Establish asset allocation targets.
Once you identify the specific asset classes to invest in, the
next step is to figure out how to allocate them within the
portfolio. Your investment objectives and risk profile will
provide meaningful inputs to this process, and two
statistical measures should provide an important backdrop:
1) the expected return and; 2) the expected risk, as
measured by the standard deviation. The expected return of
a portfolio is partially based on the expected returns of the
asset classes that make up the portfolio. The expected
return of an asset class is predominately based on historical
results but may also include a component for anticipated
changes in the future. The standard deviation measures the
variability of investment returns. One standard deviation
explains 68 percent of the return, and two standard
deviations generally explain 95 percent of the return. For
example, if an asset class has an expected return of 10
percent and a standard deviation of 9 percent, you would
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expect that 68 percent of the time, the return would fall

between 1 percent and 19 percent. To illustrate the
approximate return and risk measures for the range of asset
classes, consider the table below. Keep in mind these
numbers are for illustration purposes only and can change
daily. Consult your financial advisor for current
comparisons. Also remember past performance is not
always indicative of future results.
Asset Class Expected Standard

Returns Deviation
Cash equivalents 4.0% 2.0%

Municipal bonds 5.5 4.5
High investment grade bonds 7.1 8.0
Convertible securities 10.2 14.0
Large cap stocks 11.0 16.0
Mid cap stocks 12.3 18.0
Small cap stocks 13.7 20.0
International equity 12.2 20.0
Emerging markets 4.2 25.0
Real estate 8.2 6.8
Private equity 15.0 9.0
Hedge funds 12.0 5.0
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I should note that the numbers for hedge funds and private
equity are still based on inconclusive data because of the
inefficiencies of these markets.
The final step in setting asset allocation targets is to arrange

the asset classes into a portfolio in the most efficient way to
obtain the most attractive return/risk trade-off. Before
doing so, there is one additional statistical measure of
importance. This is the “correlation coefficient,” which
measures the sensitivity of returns of one asset class to the
returns of another. A highly positive correlation (near 1.0)
indicates a direct relationship, while a negative correlation
(near -1.0) indicates an inverse relationship between the
asset classes. On the other hand, a correlation factor near
zero means a specific asset class has little sensitivity to the
movement of the other.
Correlation plays a major role in determining a portfolio’s

overall expected return. For example, two asset classes
could each carry a high level of risk, but if they do not
move in tandem, then each can offset the volatility of the
other. Again, as a way of illustration, consider the
following example of the estimated correlation of certain
asset classes in relation to large cap equities, as measured
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by the S&P 500 Index. Once again, this is for illustration

purposes only, and you should consult with your financial
advisor before using such information as input to your
investment decision.
Index Correlation Factor

S&P 500 1.000
Russell Mid Cap 0.934
Russell 2000 (Small Cap) 0.795
MSCI EAFE (International) 0.517
LB Aggregate Bond 0.331
U.S. T-Bill (Cash) -0.019
Hedge Funds 0.507
At this point you are ready to determine your actual

portfolio mix. I regularly advise clients to use some form of
portfolio optimizer to establish a statistical basis for this
decision. A portfolio optimizer is essentially a
computerized program that combines three inputs –
expected returns of each asset class, their standard
deviations, and estimates of their cross-correlation – to
arrive at the “efficient frontier” portfolio. The efficient
frontier represents the theoretical set of portfolios that
provide the highest rate of expected return for each level of
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expected risk. By using these techniques, you can

statistically design portfolios that offer “the most bang for
your buck,” meaning the best return for the level of risk
you take.
Here is a simulation of how I use a portfolio optimizer and

then proceed to advise clients on their asset mix. Again,
this is just an illustration and should not be used as a basis
for your own specific investment decisions. In the first of
two scenarios we start with an all-cash portfolio, and the
client wishes to arrive at the optimal asset mix.
Scenario 1
Current Portfolio
Cash 100%
Expected return 5.20%
Expected risk 2.06%
I generally prefer to show my clients a progression toward

the efficient portfolio. This is important because many of
my clients will want to either exclude certain asset classes
or see the impact of progressively adding new asset classes.
We start this process by first investing in large cap,
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municipal bonds, and private equity (Portfolio A). The

result is a significantly higher expected return, but with a
measurable increase in risk. However, many investors are
willing to accept this type of risk/return trade-off as
illustrated below:
Portfolio A
Cash 5%
Municipal bonds 25%
Large cap equity 55%
Private equity 15%
Total 100%
Expected risk 11.78%
In this next portfolio, we add international and small cap.

The result is a higher expected return at a lower level of
risk because of the lower correlation of these additional
assets.
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Portfolio B
Cash 5%
Municipal bonds 25%
Small cap equity 13%
Private equity 15%
International 13%
Total 100%
In the final portfolio our addition of hedge funds is

expected to measurably reduce risk, while keeping the
return fairly constant. This results in the most “efficient”
portfolio, but the investor needs to be comfortable with
each of the asset classes presented. Certain hedge funds
will tend to reduce overall portfolio volatility because of
their low cross-correlation to other financial assets.
However, some can be quite risky, so again, you need to
consult with your financial advisor.
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Portfolio C
Cash 5%
Municipal bonds 25%
Small cap equity 8%
Private equity 15%
International 8%
Arbitrage 6%
Hedge funds 6%
Total 100%
Here is the second case illustrating the use of a portfolio

optimizer. In this situation the client wants to diversify
away from a heavy concentration in large cap equities in
our effort to reduce the annual volatility in the portfolio.
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Scenario 2
Current Portfolio
Cash 5%
Large Cap Equity 95%
Total 100%
The key objective here is to reduce expected risk while

maintaining the current, attractive expected return. As a
start, we begin to add funds to the mid cap, small cap,
international, and convertible securities sectors. As
illustrated below, this results in a reduced level of risk,
while maintaining the level of expected return. Each of
these four additional asset classes carries attractive long-
term historical returns, but they are not perfectly correlated
to the large cap equity markets.
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Portfolio A
Cash 5%
Convertible securities 10%
Mid cap equity 6%
Small cap equity 9%
International equity 11%
Total 100%
Once again, to further drive down the expected risk level,

you can add a diversified pool of private equity and hedge
fund investments. These asset classes have a low cross-
correlation to each other and to other financial assets.
Accordingly, we can again maintain, or even slightly
exceed, the expected return level, while measurably
reducing the expected risk level, assuming the private
equity and hedge fund investments perform as they have
historically.
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Portfolio B
Cash 5%
Convertible securities 10%
Mid cap equity 6%
Small cap equity 9%
International 11%
Private equity 6%
Arbitrage 5%
Hedge funds 5%
Total 100%
5. Construct the portfolio.
After establishing asset allocation targets, you begin the

challenging task of selecting the appropriate securities,
investment vehicles, and managers for each asset class. For
most asset classes, there are a variety of investment forms.
Some require minimum investments, so the options could
narrow for certain investors who either cannot or will not
commit the necessary funds. I will discuss these forms
within the context of each asset class.
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Cash equivalents are most efficiently managed through

money market mutual funds. However, during a rising rate
environment, you may wish to buy short-term CDs,
Treasury Bills, or tax-free variable rate demand notes, as
they will reflect current interest rates, while money market
mutual funds will have some “older securities” at lower
rates.
Bond portfolios can be managed via mutual funds or in a

separate portfolio of individual securities. Bonds can also
be professionally managed by a money manager. If you use
funds, it is important to understand the average maturity
objective of each one, as well as their taxability and general
credit quality. For a separately managed portfolio, I
generally recommend that clients ladder the maturities to
reduce the reinvestment risk and always be in a position to
take advantage of rising rates.
Large cap stock portfolios can take the form of mutual

funds or a separately managed portfolio. There are many
elements to mutual fund investing in this asset class; here
are some of them:
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R Many funds will follow a specific style – either value,

growth, or a combination. These styles will not always
move together, as I discussed earlier. I generally advise
clients who use mutual funds in this class to diversify
their assets among both growth and value managers. If
you can pick the right funds, and each outperforms its
peers, you should achieve strong long-term
performance.
R Some mutual funds replicate the S&P 500 Index and
are appropriately termed “index funds.” These
investments are sometimes favored by investors
because of their greater performance predictability
(versus the index), lower turnover, and lower tax
liabilities. While I do not regularly recommend these
instruments, if they are appropriate in certain client
situations, I will use them.
R Annual turnover and, consequently, expected tax
liabilities are critical when evaluating mutual funds.
Additionally, it is important to distinguish between
short-term and long-term gains because of the
significant difference in those respective tax rates.
I generally recommend my clients use separate account

management, as they are better able to manage turnover
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and capital gains. I will cover this topic in the section on

tax management.
Mid and small cap stock portfolios can also take the form
of mutual funds, much like their large cap counterparts.
Here again, I recommend either diversifying between value
and growth investing or selecting funds that cover both
disciplines. Where possible, I also suggest separate account
management because of the tax issues. I do not recommend
indexing this segment because there is substantial room for
a portfolio manger to outperform the indices due to less
complete information flow on these types of companies.
International stocks can be managed in separate portfolios,

but it is costly to do so. So the most efficient vehicle is the
mutual fund or, if available, a limited partnership. The
partnership is more effective from a tax standpoint, since
investors can maintain their own cost basis when they buy
into the fund. They do not incur the built-in gains on the
existing portfolio. Losses can also be passed on in many
cases.
Real estate investments generally take the form of limited

partnerships or real estate investment trusts (REITs). The
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REITs act, in many ways, like common stocks, and they

trade on the national exchanges. For the lower dollar
investments a REIT is just fine, while, for the investor who
wants to make a significant commitment to real estate,
certain limited partnerships are attractive.
Hedge fund investments can be accessed in two ways. First,

you can try to buy a hedge fund directly. The issues in
doing this, however, are that most funds have very high
minimums, and they are sometimes closed to new
investors. Also, you may have limited liquidity, and you do
not get manager diversification. The second way to invest
is through a fund of funds. I usually suggest this approach
to clients because you have fewer problems with access;
you receive diversification in styles; liquidity is somewhat
better; and a professional manager conducts extensive due
diligence and regularly monitors the underlying managers.
Private equity investments can take the form of a direct

private investment in a company, purchase of a specific
private equity fund, or purchase of a fund of funds. Here
again, I tend to suggest the fund of funds route because of
access, diversification, and professional oversight.
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6. Manage the stock portfolio.
While asset allocation may be the single most important

determinant of performance, most investors still enjoy the
action of picking individual stocks. Staying consistent with
my approach to asset allocation, I also believe in a
somewhat disciplined approach to stock selection and like
to follow a three-point approach.
First, I do not believe in market timing, so whatever

allocation you designate for large cap equities, for example,
should be invested solely in that asset class. If your
personal investment objectives change, and you wish to
revise your asset mix accordingly, that is perfectly fine;
however, I do not advise clients to try to out-guess or time
the direction of the markets. Refer to the chart on best- and
worst-performing asset classes to see the potential perils.
At the same time, I believe there is considerable risk in

aggressively overweighting or underweighting particular
sectors of the market. I’ll refer to the following table:
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S&P Sector Approximate Tolerance

Weighting Limits
Basic industry 3.1% 2-6%
Capital goods 8.4 5-12
Communications 9.8 6-15
Consumer cyclicals 3.0 2-6
Consumer staples 7.6 5-12
Energy 7.6 5-12
Finance 18.4 12-25
Health care 14.6 10-20
Retailing 6.8 4-10
Technology 17.3 12-25
Transportation 0.7 1-3
Utilities 2.7 1-6
Total 100.0% N/A
The first column shows the approximate S&P 500 Index

weighting for each major sector. While I do not advocate
“closet indexing,” I strongly advise clients to have
exposure in each S&P 500 sector. To manage this exposure
I generally suggest a tolerance limit range for each sector,
based primarily on the size of each sector. These tolerance
limits then serve as the rebalancing point. For example, in
the health care sector, the range is 10 percent to 20 percent.
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If your portfolio weighting in health care falls to 10

percent, you would add to it, perhaps bringing it up to the
14.6 percent market weighting. Your source of funds would
be a sector or sectors that are overweighted. On the other
hand, should health care exceed 20 percent, you would take
funds out of that sector and redeploy them to those sectors
that are underweighted.
If you do not practice market timing and keep sector

weightings tight, your margin of victory needs to come
from stock selection. Accordingly, my objective is to hold
the best companies within each sector. This means not just
holding the hot stocks in the hot industries, but also
investing in solid companies that might be in depressed or
out-of-favor industries. I’ll expand more on this philosophy
as we discuss fundamental analysis below.
To arrive at the actual stocks to buy, I generally practice a

relative value approach, with a twist. Essentially, I look at
three levels of analysis.
At the top level I suggest companies be analyzed on the

basis of those valuation measures pertinent to their industry
and sector. I do not suggest they be absolute valuations but
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instead, be valuations relative to others in a firm’s industry

or relative to its own history. Here are some of these
valuation measures:
R Relative Price Earnings Ratio

R Relative Price to Book Ratio
R Relative Price to Cash Flow
R Relative Return on Equity
By way of example, consider Coke and Pepsi. If you

believe the prospects for Pepsi are a little better or even the
same, and Pepsi sells at a lower P/E ratio than Coke, you
might be inclined to buy Pepsi. Moreover, if you already
hold Coke, you might even sell it to buy Pepsi. For another
example, consider a stock such as IBM. If IBM were
selling at a historically low price earnings ratio while other
technology stocks were not, you might be inclined to buy
IBM, as long as there were no fundamental problems with
the company.
During certain economic environments, it may not be easy

to find attractive valuations. Particularly during a growth
market, higher P/E stocks could perform much better than
lower P/E stocks. Accordingly, if you find a particular
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sector, such as technology, lacks good opportunities, you

should revert to certain earnings growth measures. Two of
the more important ones are earnings momentum and
earnings surprise. Earnings momentum shows the
acceleration of quarterly earnings. The theory is that if a
company’s business is on the upswing and its earnings are
continually rising, the stock price will continue to advance
in almost a direct fashion. The converse is true if a
company’s earnings are falling. Earnings surprise
measures how well a company meets its earnings forecasts.
The theory here is that Wall Street analysts evaluate a stock
on the basis of its expected earnings. If a company
regularly comes in better than expected, then the stock is
likely to pop and be afforded a higher valuation than a
company that regularly disappoints analysts on its earnings.
Finally, there are still certain times when neither traditional
valuation nor earnings growth measures will get you to
companies you like. In these cases qualitative factors
become far more important. Recessionary periods usually
feature high or even negative P/E ratios and negative
earnings growth rates. As a result I tend to look at
companies with some of these characteristics or qualities:
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R Strong management.
R Leading market share. I prefer market leaders,
especially during weak economic times, as these
companies are better able to weather the storm. They
also tend to be the first out of the gate when conditions
improve. Companies that are number two in many
product lines may also be okay.
R Strong brands.
R Financial strength with less debt than others and
relatively strong cash flow.
R Good cost structure, also enabling the firm to handle
poor economic times better, as they do not have to sell
as much to earn money and have better pricing power.
R Innovative product development.
At the end of the day, by continuously employing valuation

and growth measures, as well as important qualitative
factors, investors will be able to find solid companies
across each economic sector. It is just as important to know
what companies to hold in the struggling sectors as it is in
the high-flying ones. This past year has taught us the
business cycle is still alive and well. What is up today may
well be down tomorrow, and no one is going to ring a bell
to tell us when that change will occur.
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Appropriate examples surround the Internet and technology

industries, where stock prices collapsed in mid-2000.
Applying the above discipline takes you immediately to a
consideration of the qualitative factors, since valuations are
still high, and there is no earnings momentum yet. When
this is the case, I tend to favor the strongest companies –
those with strong managements, dominant market shares,
strong capital bases, and well-recognized brands. At the
end of the recovery some of the weaker companies may
actually outperform if they survive; however, I am
generally not willing to take the necessary risk in such
battered industries. Moreover, as an industry recovery
begins, the larger and stronger companies usually lead the
way, so you may have time to pick up some of the
secondary names later on.
As for the Internet and tech industry in general, even

though these industries have significant overcapacity, and
the stocks are way off their highs, the Internet has forever
changed our business and personal lives and the way we
communicate with each other. Consequently, this industry
will not go away. It is just going through a down business
cycle, and investors need to stay the course and keep
participating in it. You may not want to risk capital in the
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weakest companies or in questionable start-ups, but you

should not abandon some of the strong names, such as
Intel, Dell, Cisco, Sun Microsystems, Oracle, and EMC,
among others. If you are hesitant about some of these, you
can always go to IBM.
7. Hedge specific portfolio risk.
Some investors will hold a concentrated position in a single

stock. This may have occurred by selling a business for the
stock of another company or just through sheer
appreciation. In any event, large concentrations do carry the
significant risk of deterioration in the fortunes of a single
company. To deal with this type of risk there are a variety
of techniques available today. I work with many clients to
mitigate such risks and here are some of the techniques I
may advise clients to use:
To provide substantial downside protection, investors can

purchase a put option. This transaction gives the purchaser
the right to sell the underlying stock at a predetermined
price, called the “put stock price,” at some future date. This
option enables the investor to still participate fully in any
appreciation. I advise clients to do this when they want to
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just cover their downside, but want to retain the full upside
appreciation potential. This transaction does cost money in
the form of a put premium paid by the investor to the seller
of the put.
If an investor just wants to protect the current price level of

a stock but wishes to do so at no cost, he or she can enter
into a costless collar transaction. Here the investor
purchases a put option with a strike price at or below the
current stock price and combines it with the sale of a call
option with a strike price above the current stock price. A
call option gives the purchaser the right to buy the stock at
a predetermined price in the future. He pays the seller a
premium for this right. By establishing a collar, minimum
and maximum prices are set around a stock. It can also be
structured in a way that the premium received from the call
option offsets the premium paid for the put option. I advise
clients to consider this transaction when they wish to hedge
a substantial part of their downside risk while retaining
some upside appreciation. Generally, the client believes the
stock is either fully valued or overvalued and is not
concerned about giving up a lot of upside. These
transactions always have a maturity date such as one, two,
or three years.
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If an investor not only wants to hedge a position, but also

would like to monetize that position, there is a transaction
to accomplish that: the variable share prepaid forward
sale. It involves selling your stock forward, subject to a
variable share delivery formula. This transaction enables
the investor to retain limited upside and downside exposure
until maturity, usually between one and five years. The
collared position then enables the investor to monetize the
position by receiving (from the financial institution doing
the transaction) upfront proceeds based on a discount to the
floor price. These funds can then be reinvested in the
market or used for other business purposes. I advise clients
to employ this strategy when they not only wish to hedge
and monetize a position, but also wish to defer the actual
sale, and thus defer payment of capital gains tax.
Another way to diversify away from a concentrated

position is to contribute your stock to an exchange fund.
These vehicles are partnerships where “qualified investors”
can contribute their stock into a fund as a tax-free
exchange. These funds have termination dates and, at that
time, investors can either receive their contributed stock
back or receive a pro-rated share of the portfolio. You
retain your original cost basis but have a diversified
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portfolio. I recommend this approach when clients want to

move out of their stock and diversify but do not wish to
incur a taxable event.
Some investors may hold a diversified portfolio of stocks

but only wish to hedge against an overall market decline.
You can accomplish this by purchasing a put option on a
market index such as the S&P 100. Other indices are also
available for the purpose of similar transactions.
The above hedging transactions are very sophisticated.

Consult your advisor before employing them.
8. Manage tax position.
While I never advise clients to let the “tax tail wag the
dog,” I do advocate efficient tax management of a
portfolio. There are several strategies you can follow to
gain optimal tax efficiency. Here are some of the common
ones:
R Effectively manage short-term versus long-term capital

gains. All things being equal, you should sell the asset
that would result in a long-term versus short-term gain,
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as short-term gains are taxable at the higher ordinary

rates.
R Harvest your losses, using them to offset gains
elsewhere in your investment portfolio or business
ventures.
R Judiciously employ year-end swaps in both your stock
and bond portfolios. As an example in your stock
portfolio, assume you are holding Pepsi at a loss. If you
believe Coke has the same fundamental outlook and
would not mind holding that instead, you could sell the
Pepsi and buy Coke. After 30 days you could even
swap back to Pepsi to avoid the “wash sale” rules.
Essentially, you hold a similar security but get a tax
loss through the swap. Looking at your bond portfolio,
similar opportunities could exist during a period of
rising interest rates and following bond prices. Here
you could sell, for example, a City of Albany bond with
a 10-year maturity and buy a City of New York bond
with a similar maturity. You can essentially hold a
similar bond but can take an immediate tax loss in the
process, assuming the Albany bonds are selling at a
loss.
R Assuming you can meet account minimums, you may
be better off using separate account management with a
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professional money manager, as opposed to buying a

mutual fund. With a separate account, you have a better
chance of regulating turnover and, ultimately, taxes.
R On the other hand, if you are investing in mutual funds,
look for the turnover and tax efficiency of funds. The
SEC now requires funds to publish pre- and after-tax
returns. All things being equal, if two funds have
similar pre-tax returns but different after-tax returns,
choose the one with the higher after-tax returns.
R To the extent you have tax loss carry-forwards, take
advantage of them by taking gains in securities you
wish to sell or trim back.
9. Evaluate portfolio performance.
Investments is a highly competitive game with winners and

losers. This means investors need to establish a process for
evaluating whether they are winning or losing. To
accomplish this, you should evaluate the performance of
each asset class against an appropriate market index, as
well as against similar style managers. For mutual funds the
manager universe could be the Lipper Indices, and for
independent managers it would be an appropriate
professional money manager universe.
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While you might wish to evaluate your performance

monthly or quarterly at least, you should not make
significant changes in a fund or manager just because of
their short-term relative performance. Generally, you
should allow a mutual fund or professional manager at least
three years or a full market cycle before judging their
relative performance.
Below is an example of how you could structure and

monitor your performance objectives. Each of these
benchmarks is available in the Wall Street Journal. Keep in
mind that performance objectives are indeed very critical to
the investment process, as one could logically argue that if
you are unable to beat certain market indices over time, you
would then be better off to invest in index products.
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Asset Class Market Mutual Fund/ Manager

Index Style Index
Lg Cap Equities S&P 500 Index Lipper Lg Cap Core
Lg Cap Value S&P Barra Value Lipper Lg Cap Value
Lg Cap Growth S&P Barra Growth Lipper Lg Cap Growth
Mid Cap Equities Lipper Lg Cap Growth Lipper Mid Cap Growth
Mid Cap Equities Russell Mid Cap Lipper Mid Cap Core
Mid Cap Value Russell Mid Cap Value Lipper Mid Cap Value
Mid Cap Growth Russell Mid Cap Growth Lipper Mid Cap Growth
Sm Cap Equities Russell 2000 Lipper Sm Cap Core
Sm Cap Value Russell 2000 Value Lipper Sm Cap Value
Sm Cap Growth Russell 2000 Growth Lipper Sm Cap Growth
Internat’l Equities MSCI/EAFE* Index Lipper International
Muni Bonds Lehman Muni Index Lipper Muni Debt
Corp Bonds Lehman Credit Index Lipper Corp A Rated
Intermed Bonds Lehman Intermed Lipper Intermed Debt
Govt/Credit Index Investment Grade
*Morgan Stanley Capital Internat’l/Europe, Australia, Far East Index
10. Rebalance the portfolio.
Perhaps the most critical facet of investing is to know when

to sell. Some investment experts tell you to sell when a
company is just beginning to experience poor sales and
earnings, but then it is usually too late. Others apply
disciplines that suggest selling when a stock goes down by
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a certain percentage or dollar amount. On the flip side,

certain experts suggest selling when a stock becomes
overvalued, as measured by its price earnings ratio.
I am not sure there is any sure-fire formula for selling

stocks or any class of investments. Consequently, I advise
clients to employ a continuous top-down process for
reducing overweighted asset classes and stock positions,
and then rebalancing their portfolios. It is a relatively
simple, but disciplined, program. The process begins at the
asset allocation level. Earlier we discussed establishing
asset class targets. In addition to these targets, you should
also set forth upper and lower ranges for each asset class.
When market values exceed or fall short of these ranges,
rebalancing should occur. Consider the following target
allocations and tolerance ranges:
Asset Class Target Allocation % Range %

Cash reserves 5 2-10
Municipal bonds 20 15-30
Convertible securities 10 5-15
Large cap equity 29 20-40
Small cap equity 8 5-15
Private equity 8 5-15
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International equity 8 5-15

Arbitrage 6 3-12
Hedge funds 6 3-12
Total 100 N/A
As an example, should large cap equities exceed 40 percent

of the portfolio, you would cut back to around the target of
29 percent and deploy the funds into those asset classes that
fall below their targets.
The next part of the process is to decide how to liquidate

investments within the overweighted asset class and where
to deploy new funds within the underweighted classes.
Much of this decision will depend on the strategy and
investments within each class. If for example, you have
only one investment vehicle or mutual fund in a specific
asset class, the answer is simple. On the other hand, if you
have multiple vehicles or a portfolio of individual
securities, you need to determine whether to deal with this
through pro-rata action or use a selective process to reduce
and reinvest. I usually advise a selective process in which
you look for overvalued securities first. This way, you are
addressing potential risks. Should valuation methods not
result in the reductions needed, then you can use earnings
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growth and qualitative factors. Then, of course, if these also

do not yield results, you can fall back on the pro-rata
approach. The important point is that heavily overweighted
asset classes should be cut back, and as a result,
overweighed and possibly overvalued sectors and securities
would be scaled back, as well.
What Does the Future Hold?
Throughout the course of financial history, the investment

markets, particularly the U.S. stock market, have been
remarkably resilient. Despite its sudden drops and daily
static, U.S. stocks have proved to be sound investments
over the long term. The U.S. brand of capitalism has
enabled corporations to always find a way to adjust to
changing economic and political circumstances. Unlike
some of their counterparts around the world, U.S.
companies have relative freedom to increase and reduce
workforces, borrow and raise capital from a strong banking
and financial system, merge and divest, and build and close
down plants and facilities where they please.
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While I am quite optimistic about the future investment

climate, I also see some evolving trends that could take
place over the next five years or so. Perhaps the most
important things to watch are the spending and savings
trends of the baby boomers. As we approach the middle of
this decade, baby boomers will be tapping their savings to
fund a steady stream of college educations. And when they
finish doing that, many will be approaching retirement and
will then begin drawing down their 401(k) portfolios.
Should the net savings line go negative, it could have a
dampening effect on the overall level of the markets.
Another important trend taking place involves the role and

importance of asset allocation. While academia has always
preached the importance of asset allocation, the average
investor is only now realizing how critical it is. The
proliferation of investment products and styles over the past
decade has brought the technique and discipline of asset
allocation to the forefront. Even if you are investing in
mutual funds alone, you can now choose from several
thousand.
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Making Money in Any Economy
We realize – sometimes painfully – that successful

investors are those who can make money in good times and
hold on to it during bad times. In closing, here are five rules
for making money and preserving it through up and down
economic times:
Practice a disciplined approach to asset allocation.

Establish initial targets to reflect your objectives and risk
profile; however, make sure you rebalance the portfolio
when targets are exceeded. Be disciplined to sell the
appreciating asset classes and put funds into the out-of-
favor classes. Also, at certain intervals, re-run your asset
allocation model to ensure it still reflects your objectives
and risk profile. You should also re-run it when significant
changes take place in the markets, as a re-run could reveal
new asset classes to consider or changes in your current
mix.
In your individual stock portfolio, be willing to “sell the

winners and buy the losers.” This is not as bad as it sounds.
Selling winners and buying losers is similar to the concept
of buying low and selling high. When your winners begin
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to take on an overweighted position in your portfolio, start

to trim back on them, as I discussed. While you do not have
to sell the entire position, you should at least get your
investment out, so you are “playing with the house’s
money.” At the same time, be willing to buy solid
companies in industries that may not be doing so well at the
time. By continually investing in out-of-favor market
leaders, you can build solid positions over time.
Following this point, I believe we now have an

unprecedented opportunity to invest in Internet and
technology-related stocks for the future. While these related
sectors (Internet, telecommunications, and computer
equipment) may continue to experience overcapacity and
other difficulties over the next year or so, they do represent
an important part of our future world economy. When
technology stocks start moving forward, they generally rise
quickly. You need to buy them when they are down and
out. At the same time, I generally advocate that you stick
with the strong companies that have dominant market
shares.
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Be smart about taxes. Take full advantage of both bond and

stock swap opportunities at year-end. Pick tax-efficient
mutual funds, or use separate account management.
Wealthy investors (with more than $5 million in assets they

can invest) should consider alternative asset classes at
appropriate times. These include real estate, private equity,
and hedge funds. You should engage in these transactions,
however, only with the direct assistance of a qualified
financial advisor.
The key attribute of smart investors is keen mental

discipline. Do not get overexuberant during great times,
and, certainly, do not panic during tough times. If you
believe in your investment discipline, stick to your guns
and practice it all times. If you can win championships with
a “three yards and a cloud of dust” offense, then do it!
A native of Pittsburgh, Pennsylvania, Howard Weiss spent

his undergraduate years at The Ohio State University and
obtained his MBA at the Wharton School of the University
of Pennsylvania in 1974.
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Mr. Weiss began his career in 1974 as an international

banker for Equibank in Pittsburgh. He became comptroller
and operations manager of the bank’s Luxembourg branch
in 1975. Upon returning from Europe in 1976, he served in
a variety of international banking positions, including
manager of International Operations and director of
Correspondent Banking. In 1980 Mr. Weiss joined the
bank’s Trust Department, where he became its chief
investment officer and, later, its overall senior vice
president and manager.
In 1985 Mr. Weiss left Equibank to join Maryland National

Bank in Baltimore as their chief investment officer. After a
succession of bank acquisitions and the formation of a
separate trust company, Mr. Weiss became head of
Personal Asset Management and Fiduciary Services in
1988. When NationsBank later purchased Maryland
National, Mr. Weiss became the manager of Personal Trust
and, later, Private Banking for the Baltimore Market. He
managed an integrated trust, investment management, and
credit business. While in that position, he led an effort to
establish a private banking office for Bank of America
(successor to NationsBank) in Philadelphia, as well as a
Delaware Trust Company in Wilmington. He also
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developed a successful family office business in the

Baltimore and Philadelphia markets.
Mr. Weiss then assumed his current position as a wealth

management consultant in June 2000. In this role he is
Bank of America’s point person on family offices. He
advises the company’s clients on how to establish and run
family offices and also assists wealthy families with asset
allocation, concentrated equity strategies, fiduciary
structures, estate planning, and philanthropic management.
He was recently selected by Worth magazine as one of the
country’s top 250 financial advisors.
Very active in the Baltimore community, Mr. Weiss just

completed a three-year term as chairman of the board of
LifeBridge Health, a multihospital system consisting of
Sinai Hospital, Northwest Hospital Center, and Levindale
Hebrew Geriatric Center & Hospital. He is also a member
of the Board of Governors and chairman of the Education
and Conservation Committee of the National Aquarium in
Baltimore. He serves on the boards of the B&O Railroad
Museum and the Lyric Foundation. He is a trustee and
member of the investment committee of the Morris
Goldseker Foundation of Maryland and serves as treasurer
140
and member of the board of directors of the Association of

Baltimore Area Grantmakers. Mr. Weiss is a member of the
University of Baltimore’s Business Advisory Board and
was selected the University’s Honorary Alumni of the Year
in 2001.
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BUILDING AN ALL-WEATHER
PERSONALIZED PORTFOLIO
SANFORD B. AXELROTH
First Financial Group
Chairman
ROBERT A. STUDIN
First Financial Group
Director of Planning
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It’s Personal
The challenge for financial planners is to identify and

implement an investment process that delivers reasonable
long-term investment results with appropriate risk. This is
particularly true for the client’s core assets – those slated
for retirement, college, wealth building, and other long-
term goals. Therefore, our objective is to structure a
program that will produce the needed long-term investment
results while adhering to the principles of diversification
and portfolio risk management.
Picking a winning portfolio in any economy starts with a

simple idea: It’s personal. Whether a portfolio is a “winner”
should be measured by the goals being funded, not some
general portfolio that’s right for anyone or by a comparison
to a general index. But in real life we find it doesn’t always
work that way. For many investors the world of current
events, television commentators, magazine articles, and
what they hear today compose their “financial game plan.”
And, even for those with a long-term strategy in place, the
temptation to make adjustments based on current events is
too great to ignore. As a result they end up with a generic
investment strategy that can ultimately depend on which
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television program they had the luck (good or bad) to tune

into. And with the myriad of financial news shows
available on cable stations, a new financial strategy can be
developed daily.
Interestingly enough, when it comes to choosing a vacation,

people don't go snow skiing because a travel magazine says
it is the hot destination if they love the beach and hate cold
weather. When it’s time to buy a car, most individuals
make their choice of vehicle based on their wants and
needs, not because sport utility vehicles are the rage. And
certainly just because a new wonder drug has been invented
– unless it applies to our personal situation – most of us
wouldn’t rush out to fill a prescription. Yet, too many
times, when it comes to building an investment portfolio,
many seem to base their decisions on current events – for
example, what the Fed plans to do with interest rates –
rather than their own personal goals.
The message is that the starting point for any investor in

building their successful portfolio is making it personal! If
your financial decisions are based on a personalized long-
term strategy that recognizes your individual financial
needs and goals, the decisions that result will be made with
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that “game plan” in mind. The “experts” and their

projections about which way the market is heading should
be largely irrelevant to your long-term strategy.
So how do you get started building your personalized

portfolio? Goal setting is the first step.
Setting Goals
Yogi Berra said, “If you don’t know where you’re going,
you could end up someplace else.”
The first step for any investor, long before picking the first
investment, is to determine the ultimate use for the assets,
the time horizon, and their personal risk tolerance.
For most, defining these financial goals is a thought-

provoking experience. Many have general objectives in
place such as “retire comfortably,” “fund college for my
children,” or “as much growth as possible.” But to
determine how to properly invest a portfolio, much more
specific information is necessary.
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The initial allocation should be to set aside adequate funds

for emergencies and short-term objectives. An important
part of long-term investing is to have the flexibility to
maintain or sell an investment at an appropriate point. Not
having an adequate emergency reserve could cause an
investor to have to liquidate an investment at an
unfavorable time or incur unnecessary taxes.
Many professionals feel six months of living expenses

should be kept as an emergency fund. These dollars should
be safe and liquid, with no principal fluctuations. Money
markets, short-term CDs, savings accounts, credit unions,
and even checking accounts are appropriate vehicles to
hold these dollars.
Short-term obligations (those of fewer than five years)

should be identified next. This should be done with as
much specificity as possible. For example, “purchasing a
home in the future” is not of much help in setting aside
adequate funds. A better statement would be, “We need
$35,000 for a down payment in three years,” “$12,500 per
year for four years for college for my 15-year-old,”
“$20,000 to buy a car next year,” and “$100,000 to start a
business when my child graduates from college in four
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years” are all examples of clear short-term goals. These

dollars should be in vehicles with relatively small principal
fluctuations because of the inability to recover losses over
time if the investment is “down” when it is needed.
With adequate emergency funds and short-term obligations

defined, the longer-term objectives can then be addressed.
While short-term goal setting is relatively straightforward
and can be done without a lot of assumptions, longer-term
goals require significantly more analysis. For example, if
my 16-year-old will start at “State University” in two years,
I can get a good idea of what is needed. While the cost may
go up slightly in the next two years, and my investment will
certainly earn some return, it will not be materially
different from today.
For my two-year-old, who will start college in 16 years,

however, the analysis is much more difficult. Not only do I
need to consider the potential increase in college tuition
costs, I must also consider the general inflation rate for
housing, transportation, and pizza. This will, of course, be
offset by an assumed earning rate.
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For most people, maintaining a comfortable retirement is

the most important long-term goal. Calculating this
requirement is fairly complicated. The first step is, once
again, defining a net dollar amount that will provide a
“comfortable” retirement. This is usually based on the
current budget with adjustments for items that will not be
paid in retirement (e.g., the mortgage will be paid off) and
items that will increase (e.g., additional travel or gifting).
Factors affecting this analysis include items such as:
R Inflation
R Taxes
R Social Security
R Pensions
R 401(k) and other employer plans
R Mortality tables
R Long-term health care
R Mortgage payments (and its liquidation)
R Medical insurance (and Medicare)
R Current rate of saving
R Increases in current savings
R Other obligations (weddings, etc.)
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Obviously, with the complexities involved in this analysis,

a computer is necessary. Financial planners, of course,
complete this process as part of a comprehensive financial
plan. If an individual prefers to do their own planning,
many investment Internet sites provide retirement, college,
mortgage, and other calculators.
The final step in the goal-setting process is to prioritize the

objectives. For example, it may be necessary to put off
buying the new car or house because college funding is a
higher priority. This can certainly be an emotional portion
of the process. Determining the most important priority can
be difficult, particularly because many times more than one
personality is involved. Compromise is often necessary.
Buying a less expensive car so more can be directed toward
retirement is a typical give-and-take.
What is the purpose of going through the goal setting and

planning process? This analysis provides a road map for
investment decisions regarding risk analysis and portfolio
allocations. For example, knowing that only a 6 percent
average return is required to meet retirement objectives
might lead to a different portfolio than knowing a 15
percent average return is required.
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Notice that we say “might” lead to a different portfolio.

The person needing only the 6 percent portfolio might still
want to invest aggressively. The person needing the 15
percent return may not be able to sleep at night with a
volatile portfolio and may need to revise their objectives or
make other changes in the plan.
Investment Selection
With the goals and cash flow needs determined, we can

design a portfolio that should meet the desired returns with
as little risk as possible. Many studies, the most popular of
which was published by Brinson, Singer, and Beebower,
show the importance of asset allocation. The studies
conclude, over time, asset allocation is the most significant
contributing factor to portfolio performance. Specific
security selection and market timing combined contribute
less than 10 percent to a portfolio’s overall return.
Determining which asset classes to use prompts us to do

our asset allocation using Modern Portfolio Theory. This is
the approach taken by many financial planners. Modern
Portfolio Theory was originated by Harry Markowitz in a
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famous Nobel Prize winning paper published in 1952. It is

a mathematical system for using asset-class data on return-
rate probabilities to determine a range of best-diversified
portfolios of selected asset classes. This provides the
smallest likely volatility and risk for various expected
return rates.
At the most basic level the allocation is between equities

and fixed income. For broad types of investment asset
classes, such as large cap U.S. stocks, long-term
government bonds, or international equity, we can analyze
extensive historical performance data. This historical return
and risk information can be used to assess and compare
various investment plans and develop probabilities for their
long-term future results.
By selecting portfolios with different allocations to stocks

and bonds (and subclasses within each major class), we can
develop a series of portfolios with varying risk and return
expectations. While each of the asset classes will, by
themselves, have risk and return characteristics, the overall
portfolio will behave differently, based on the correlation
of the classes. To obtain the benefit of diversification, the
most important step is to select several asset classes that
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behave fundamentally differently. If in a year one asset

class goes down, others are likely to offset the decline by
going up.
From this information we can develop an efficient frontier

of optimal portfolios. Each portfolio on the efficient
frontier will offer the maximum possible expected return
for a given level of risk.
Market Timing
It would seem that after knowing the needed return from

our goal-setting and having an efficient frontier of
portfolios to choose from, the next step should be simply to
select the specific securities that fit within the portfolio.
However, additional testing needs to be done. The
information provided from Modern Portfolio Theory and
the efficient frontier is relatively static, showing possible
one-year results. That is, it doesn’t truly reflect the
movement of the market. Markets obviously don’t move in
straight lines – returns vary randomly from high to low,
from down to way down to way up, etc. When combined
with additions to or withdrawals from the portfolio, this
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problem is magnified. The result is “timing risk” – the risk

that the pattern, or timing, of the returns actually earned
will work against you. In developing our all-weather
portfolio, we need to consider the effect of this timing risk.
We discuss market timing below and alternatives in the
following section.
It is easy to determine the next hot sector and where the

market is heading. All you have to do is tune into one of the
financial programs on your cable network or visit any one
of the hundreds of Internet financial sites. There you will
find no shortage of “experts” willing to predict the markets,
sectors, individual stocks, interest rates, and many other
economic indicators. Unfortunately, most of these experts
not only don’t agree with each other, but they are usually so
short-term oriented they may reverse their own positions
from day to day.
The idea behind market timing is to buy stock when prices

are low, hold onto your investment until the market peaks,
and subsequently move your stock investments into cash or
bonds until the market hits bottom. Then the process begins
all over again. It sounds simple enough. The problem,
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though, is that all timing theories are based, at least in part,

on second-guessing the stock market.
Different timing theories consider various “indicators” that

may signal that the market is about to head up or down:
margin debt, interest rates, employment data,
manufacturing levels, number of advancing stocks versus
number of declining stocks, and so on. But even with the
most sophisticated methods, hitting the exact highs and
lows of the market is next to impossible.
Studies of stock market history have shown that not being

invested at the “right” times can be costly to an investor.
Consider the following hypothetical example based on the
return of the S&P 500.
On September 30, 1995, Susan invested $10,000 in a stock

index fund based on the S&P 500 Stock Index. By
September 30, 2000, the $10,000 would have grown to
$26,667, an average annual total return of 21.68 percent.
But suppose Susan decided to get out of the market during

that five-year period, and as a result she missed the
market’s 10 best single-day performances. If that were the
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case, her 21.68 percent return would have fallen to 12.52

percent. If Susan missed the market’s best 20 days, that
21.68 percent return would have dropped to 6.48 percent.
Market fluctuations can make almost any investor nervous.

But getting out of stocks when the market takes a downturn
isn’t the answer. Short-term volatility should not drive
long-term investment planning.
Spreading investments among stocks, bonds, and cash in a

strategic asset allocation (discussed above) that takes into
account time horizon, risk tolerance, need for investment
income, and long-term goals can help portfolios produce
more consistent returns, regardless of whether the stock
market is up or down.
Monte Carlo Simulation
The asset allocation technique of Modern Portfolio Theory

we discussed above uses historical investment returns to
select the most efficient portfolio to achieve a needed
return. We then are able to calculate a level, steady, long-
term, expected return for that investment allocation. The
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portfolio’s values are then projected into the future

assuming this return is earned each year.
However, an additional step is needed. We should

determine whether the selected asset allocation gives a high
probability of meeting goals under all reasonable patterns
of market returns. To determine whether a particular
portfolio meets client’s objectives, the allocation should be
“tested.” There are a variety of ways to test portfolios,
including regression analysis and projecting actual returns
over past periods, that are intended to replicate projected
future periods.
For example, assume we have $1,000,000 available to fund

retirement. We will need to withdraw $80,000 per year.
After preparing retirement calculations factoring in
inflation and social and other future cash needs, we
determine that an overall 11 percent rate of return is needed
to provide for all future contingencies. Further assume that
after analyzing our efficient frontier, we determine that an
investment of 100 percent of the assets in a portfolio
imitating the S&P 500, an unmanaged stock index, with a
long-term return of over 11 percent is appropriate.
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Inside The Minds
Let’s assume that in the first several years, $80,000 per

year is withdrawn. With a projected return of 11 percent,
the portfolio should grow at 3 percent per year. Our
investors expect the portfolio will be worth $1,060,900 in
three years. In 10 years it should be worth $1,348,900.
Thus, they expect the principal value to grow and be able to
provide an increasing stream of income for the rest of their
lives.
We can then test this portfolio using historical data.

Assume we feel that market conditions are similar to those
that existed in January 1973. In fact, from January 1, 1973,
through June 30, 2000, the S&P 500 had an average total
return of 13.58 percent, or 2.58 percent greater than the
assumed return. So it appears we were being conservative.
However:
1. From January 1, 1973, through September 30, 1974, the

S&P 500 fell 42.7 percent.
2. After withdrawing 8 percent annually ($20,000 per
quarter), in only 21 months – by September 30, 1974 –
the original $1,000,000 was worth only $478,000.
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3. Between January 1, 1973, and December 31, 1982, the

S&P 500 averaged only 6.63 percent per year and,
adjusted for their withdrawals, returned only 2.69
percent.
4. In less than 13 years, by September 1985, they are
broke.
On the other hand, assume we feel market conditions more

closely resemble those at the beginning of 1982:
1. From January 1, 1983, through September 30, 1984, the

S&P 500 rose 27.9 percent.
2. After withdrawing 8 percent annually ($20,000 per
quarter), by September 30, 1984, their original
$1,000,000 was worth $1,122,700.
3. In only 10 years their portfolio had grown to
$3,927,750 – $1,927,750 more than their original
estimate – because the S&P 500 averaged 16.2 percent.
4. In less than 13 years, by September 1995, they are
worth $5,684,700.
Long-term averages are accurate. The problem is that using

averages disguises the variability of returns that has
occurred from year to year. The pattern, or timing, of
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returns actually realized may determine the success or

failure of the investment plan.
Using historical data to “back-test” a portfolio is not

necessarily the correct answer, either. While market
conditions may resemble a particular period, they are
unlikely to exactly duplicate the results. In addition, back-
testing puts an enormous burden on the planner to pick the
right past period.
As a result no single projection can be correct. The proper

answer is that there is a range of possible returns.
Therefore, our planning goal is to find the asset allocation
that gives a very high probability of meeting goals under all
reasonable patterns of market returns. To accomplish this
objective, we use Monte Carlo Simulation.
Monte Carlo Simulation is a mathematical system for

producing samples of the results for processes that involve
complex occurrences with various probabilities, and for
determining approximate probabilities for the results.
Stanislaw Ulam and others originated this system for
prediction of possible results in developing nuclear
weapons, in which the interaction of all the variables
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cannot be exactly predicted. Now the process is widely

used for prediction and analysis of result probabilities for
uncertain processes, such as projecting future financial
results.
Monte Carlo Simulation allows us to advance the analysis

and comparison of the best portfolios that are developed
through Modern Portfolio Theory from single-year return
rates to prospects and risks for long-term goals.
With Monte Carlo Simulation, each portfolio allocation is

calculated thousands of times for possible results every
year ranging from the best possible returns to the worst
possible returns. The results should resemble a bell curve.
At one extreme there will be a small number of results that
are exceptionally high every year; at the other will be a
small number of results that are extremely bad every year.
The greatest number of occurrences will be between the
two extremes. While no one can say exactly what return
rates will be in any future year, we can calculate future
investment-result probabilities. We can also calculate the
likelihood that future results will be within particular
ranges and the likelihood that future results will beat or fall
short of future goals.
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Our objective is to determine in how many scenarios our

selected portfolio meets our needs – and in how many it
does not. With this information, the investor can make the
final determination of which portfolio best meets their
needs.
As an example of the entire process coming together let’s

go back to our hypothetical investor needing an 11 percent
straight-line return to meet their long-term objectives.
Assume, from our Modern Portfolio Theory and the
efficient frontier, we determine the “ideal” portfolio for
meeting this objective is:
R 50% large cap U.S. stocks

R 20% small and mid cap U.S. stocks
R 10% international equity
R 20% fixed income
We then run our Monte Carlo Simulations on the portfolio

and learn that this portfolio, because of variations in return,
meets our objective only 70 percent of the time (based on
the thousands of scenarios run by the computer). If 70
percent is not acceptable, we can move up and down the
efficient frontier, selecting alternative portfolios offering
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more return or less risk until we find the portfolio that

results in the desired percentage of success. From this
analysis we find the portfolio resulting in the greatest
percentage of success (90 percent, for example) consists of:
R 75% large cap U.S. stocks

R 15% small cap U.S. stocks
R 10% international equity
While offering a greater chance for long-term success, the

portfolio will obviously be more volatile than the original
portfolio. The investor can then decide whether to accept
the greater level of risk or, as an alternative, revise their
objectives.
Sanford B. Axelroth, ChFC, CFP, is chairman of First

Financial Group, a nationally recognized financial
advisory firm he founded in 1982. Since May 1994, he has
also served as regional chief executive officer for Lincoln
Financial Advisors’ Corp. Birmingham RPO (Regional
Planning Office). In January 2002 Mr. Axelroth assumed
responsibility as Lincoln’s managing director for the
Southern Division.
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Inside The Minds
Mr. Axelroth (on behalf of the firm) and FFG’s director of

planning, Robert A. Studin, JD, CPA, PFS, CFP, have both
been named for five consecutive years among Worth
magazine’s “Best Financial Advisors” in the nation. Their
firm is one of only 11 in the country that had two principals
named. The firm has gained national exposure for the work
of their planning staff comprising 14 CPAs, 26 CFPs, three
attorneys, and other credentialed professionals.
In July 1998 Mr. Axelroth and Mr. Studin were both named
by Medical Economics in their publication “The 120 Best
Financial Advisors for Doctors.”
Mr. Axelroth is involved in various community and

charitable activities, including being honored for the
Multiple Sclerosis Leadership Award - Class of 1997. He is
a coach in community intramural athletics and is on the
board of the Mountain Brook City Schools Foundation.
Robert A. Studin joined First Financial Group of the South,

Inc., in 1985. He serves as the director of the firm’s
Planning Department. Before joining First Financial
Group, Mr. Studin was a partner with Berk, Patterson, PC,
Certified Public Accountants, and before that worked with
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Arthur Andersen. He received his Bachelor of Science

degree from the University of Alabama in 1975 and his JD
from Cumberland School of Law in 1978.
During his career Mr. Studin has worked with clients in

every financial situation. While he still maintains
responsibility for the overall financial planning process of
the firm, he now specializes in designing solutions for
business owners and clients with estate tax considerations.
The focus is to ensure the distribution of assets to the
intended beneficiaries, efficiently, as intended, with the
minimum estate transfer costs.
Mr. Studin holds the CFP (Certified Financial Planner)

and PFS (Personal Financial Specialist, awarded by the
AICPA) designations and is a CPA and a member of the
Alabama Society of Financial Planning Associations and
the AICPA. He also recently earned his CLU and ChFC
from the American College.
Mr. Studin was named in Worth magazine’s Top Financial

Advisors in 1996, 1997, 1998, 1999, and 2000; Medical
Economics 120 Best Advisors for Doctors in 1998 and
2000; and the Birmingham Business Journal’s Top 40
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Under 40; and he received the Leadership Award from the

MS Foundation in 1997. He has been published and quoted
in various business and financial magazines.
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MANAGING YOUR WEALTH IN

ANY MARKET
GILDA BORENSTEIN
Merrill Lynch
Vice President and Wealth Management Advisor
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Managing Investments Versus Managing Wealth
I keep an image of Babe Ruth from the 1932 World Series

on my wall. He’s pointing over the fence, to the precise
location where he wants to hit the ball. That kind of
determination and focus reminds me of the sense of
accomplishment found in setting a goal and reaching it.
As a wealth management advisor, my clients often ask me

what they should be doing to successfully manage their
wealth and meet their goals. The truth, I tell them, is that
there is no single formula. Investing is work that requires
knowledge, discipline, and objectivity. There is one
fundamental principle that I believe has withstood the test
of time: Plan, stick to your plan, and periodically reevaluate
your plan when conditions change.
It is important to distinguish between managing

investments and managing wealth. While closely related,
these concepts are not interchangeable, and managing
wealth today requires a broader interdisciplinary
understanding. It is not as simple as buying and holding
stocks for the long term. There is a dynamic interplay
among asset management, tax minimization, estate
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planning, retirement, insurance, gifting, cash flow, liability

management, etc., where every decision can have a
profound impact on the realization of other goals. And of
course, market conditions play into the equation, as well.
So, as people’s needs become more complex, I’ve found
that clients are looking for more – not less – financial
advice and planning.
As a financial advisor, my greatest skill has to be that of

being a good listener. A successful financial advisor–client
relationship often rises and falls on the ability to listen.
When clients are encouraged to share their thoughts in a
series of meetings, a financial advisor then understands
their fears around investment risk, their concerns for their
family and loved ones, their goals, their financial dreams,
their plans for the future. Only then can a portfolio be
created that can help take a client from where they are
today to where they want to be, with the least possible risk.
That process of listening is ongoing because circumstances

change, and that may require a specific immediate action or
even larger strategies within the financial plan. When
speaking with my clients, I also encourage them to think
beyond themselves, to other generations and to charitable
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Inside The Minds
causes. For me, the interesting thing about wealth

management is that it is an evolving process – not a fixed
point – with the opportunity to provide long-term benefits.
Goals and Risk Tolerance Shape Investing Style
In the preliminary conversations with my clients, I ask

them to define their goals. More often than not, they say, “I
want to have a lot of money and retire early.” But if your
only goal is to make a lot of money, you’ll never be
satisfied. What’s a lot of money? If you cannot quantify
your goals – and be really precise about what you want and
what you need – no amount of advice, or money for that
matter, can help you attain them.
I press my clients to focus on quantifying specific goals,

such as, “I’m going to retire when I’m 65, and I need to
live on $200,000 (after-tax and inflation-indexed) a year
until I’m 85.” We talk about the legacy my clients would
like to leave, the amount of money they would like to pass
on to their children, and the money they need to set aside to
prepare for the long-term care they will probably need in
the future.
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Once we have a clear sense of their goals, I ask my clients

to itemize all their assets and liabilities, so I know and
understand their total net worth. Even if my clients choose
not to have all their investments with Merrill Lynch, it’s
imperative that I understand the specifics of their traditional
and alternative investments, nontraditional holdings, tax
obligations, and other liabilities; otherwise, I cannot give
them fully informed guidance.
And I keep asking questions. One of the most important

things I do as a financial advisor is to determine each
person’s tolerance for risk. I ask my clients: How much
money can you risk before it affects your lifestyle? What
percentage can you afford to lose and still live in the same
house, wear the same clothes, have the same vacations, go
to the same restaurants? How risky are your other
investments? How liquid are they? This is an important
consideration, because if a risky investment goes south and
most of your money is in stocks, you know you can pull out
and have your money in three business days. But if a
majority of your money is in your business or your house,
you will not have such easy access to cash.
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Keep in mind that wherever you fall in the spectrum of

investment risk, from conservative to aggressive, you have
to consider your short- and long-term goals and adjust your
portfolio according to your time horizon. When you are
younger and have more time before you will need the
money you’ve invested, you can afford to take a more risky
position that might produce higher gains. As you get older,
though, you want to keep and transfer the wealth you’ve
accumulated over the years.
Taken as a whole, this process results in a customized

assessment that drives our next steps as we determine the
appropriate asset allocation for my client’s portfolio and
eventually guides our choice of specific investment
vehicles within it.
Portfolio Strategy: Asset Allocation and Diversification
While developing and maintaining a wealth management

plan is based essentially on a client’s values and goals, in
certain ways, investing is a science. From the information
that comes from conversation – a client’s current
investment style, risk tolerance, and time horizon – there is
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a way to determine how portfolio assets should be allocated

among various asset classes of stocks, fixed income
investments, and cash equivalents.
Identifying the appropriate asset allocation for each

investor is paramount in the investing process, because a
portfolio’s long-term performance is determined primarily
by the distribution of dollars among the different asset
classes. Historically, studies from Ibbottson Associates
show stocks outperform bonds, and bonds outperform cash,
over long periods of time. Recent studies have shown a
portfolio’s asset allocation policy is the primary driver of
portfolio performance. Over a period of time, asset
allocation typically explains more than 90 percent of the
variation in the portfolio’s returns. This far exceeds the
effects of both market timing and security selection,
demonstrating that the asset allocation decision is the most
important determinant of portfolio performance.
At Merrill Lynch we divide a client’s investing priorities

into five areas, from the most conservative, Capital
Preservation, through Income, Income/Growth, and
Growth, to the most volatile, Aggressive Growth. For
instance, if, based on our conversations, we’ve determined
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that you are an Aggressive Growth investor, as much as 80

percent of your portfolio could contain equities. A more
risk-averse investor, focused on income or capital
preservation, may have only about 15 percent of their
portfolio invested in equities, while 85 percent would be in
fixed income, cash, or cash equivalents.
Diversification within each asset class additionally helps

manage market volatility, as sectors and industries react
differently to market events. Within equities, for example, a
skilled financial advisor will look at the style and size of
companies, such as large-cap growth, as well as different
equity sectors, such as financials, industrials, utilities,
consumer staples, consumer cyclicals, technology, energy,
transportation, and consumer services. An investor whose
priority is income might be more heavily invested in
financials, utilities, and other stocks that pay dividends.
Heavily weighting the utility sector would be less
appropriate for an investor looking for aggressive growth.
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Implementing the Plan
Determining appropriate asset allocation is only the

framework on which investors should build their portfolio.
Building, maintaining, and transferring wealth requires that
I work with my clients to consider all the financial
implications of their personal issues and decisions. At
every turn it is important to take into consideration tax
implications, liquidity and income requirements and, of
course, proper asset allocation, and to understand the
impact each decision will have on other goals. Only then
will I recommend an appropriate suite of services and
investments that suits my client’s immediate and long-term
needs.
At this point, what I’ve helped develop is only a blueprint.

Getting there depends on discipline and focus – sticking to
the plan. If you say you’re going to fund your IRA every
year, you have to do it. If you say you’re going to put
money in a 529 college savings plan every year, you have
to do it. If you intend to make gifts every year during your
lifetime, you have to do it. The market will do what the
market will do, and you have to remain focused on your
long-term plan.
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Inside The Minds
One portfolio strategy that really brings together everything

discussed – the interrelationship between goals, both
personal and financial, and managing wealth – is called
strategic gifting. It’s important to me that people use their
money not just for themselves, but to make a contribution
to a greater good.
Historically, Americans give to those causes they feel

passionate about, even in times of economic uncertainty,
when people are afraid they will not be able to reach their
long-term financial goals. We saw more than $800 million
donated to September 11 relief funds in the last quarter of
2001. People want to teach their children the value of
philanthropy and pass on that legacy of “giving back.”
Many of my clients have charitable giving as one of their
goals, and I work with them to incorporate philanthropy
into their wealth management plans.
For example, a charitable remainder trust enables

philanthropic giving, as well as providing significant tax
benefits and a regular income stream during the donor’s
lifetime. The trust is usually funded through the gifting of
securities designated for a specific charity. I will offer this
as a possible solution to a client with a highly appreciated,
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concentrated stock position that has been held for more

than one year. A charitable remainder trust funded with
stock would, in most cases, create an income tax deduction
of a charitable gift for the client in the year in which the
trust is created. Because the stock is gifted, rather than sold,
there would be no capital gains taxes, as long as the
organization is a 501(c)(3), or charitable organization.
Once funded, the trust generally begins to distribute income

in an amount that is predetermined by the donor. Either the
amount is fixed, or it may change from year to year. At the
end of the term, typically when the donor dies or upon the
death of the surviving spouse, the remaining assets, if any,
are then transferred to the charity, and the charitable
remainder trust is dissolved.
Often a client wants to make use of the charitable trust

without taking the money away from heirs at death. This is
possible by employing wealth replacement strategies, such
as irrevocable life insurance trusts. For a client, the benefits
of giving strategies such as these are enormous. The client
has the emotional satisfaction of helping a worthy cause
with a sizeable donation. In addition, the assets are gifted
out of their estate and, if the client chooses, replaced with a
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Inside The Minds
wealth replacement trust that passes, free from estate taxes,

to their heirs.
I view strategies like these – that take a holistic approach to

investors and their personal and financial goals – as a
perfect example of the difference between managing
investments and managing wealth.
Monitoring Performance
What makes a successful investor? I believe it’s an investor

who is reaching his or her personal and financial goals.
And what makes a successful financial plan? I believe it’s a
long-term plan, proactively monitored by a knowledgeable
financial advisor. The plan is disciplined and rigorous, but
dynamic and adaptable to change.
Events arise that require clients to rebalance their

portfolios. Changes in lifestyle or circumstance – such as
the loss of a job or the birth, illness, or death of a loved one
– may alter financial needs and priorities. Personal issues
drive financial decisions, but it is important to remember
the effectiveness of a plan is in the long-term commitment.
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Changes to the plan and even to specific investment

choices will obviously have an impact on meeting other
goals.
I try to remind my clients, especially in a volatile market,

that the accumulation and management of wealth is a
lifetime endeavor, so it is critical to focus on goals, rather
than on the day-to-day shifts in the market. I practice
listening to the market and learning from its behavior
history, in addition to considering the recommendations
and analysis of Merrill Lynch research.
Investors who attempt to time the market actually run the

risk of missing periods of exceptional returns. Although
successful market timing may improve portfolio
performance in the short run, it is extremely difficult to
time the market consistently over many years. It can be
detrimental to your long-term growth if unsuccessful
market timing causes you to miss the market’s days of best
performance.
To illustrate how unsuccessful market timing can lead to a

significant opportunity loss, let’s take a look at a
hypothetical $1 investment in stocks invested at year-end
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1980 that would have grown to $18.41 by year-end 2000.

That same $1 investment would have grown to only $4.73,
had it missed the 15 best months of stock returns. By
comparison, $1 invested in Treasury bills over the 20-year
period resulted in an ending value of $3.61. An
unsuccessful market timer missing the 15 best months of
stock returns would have received a return just above that
of Treasury bills.
Attempting to time the market once means that you will

actually have to time it twice to successfully reinstate your
position. This is why it is critical to remain focused on your
goals and not be tempted by temporary swings in the
market. I view the real barometer of successful investing as
my clients meeting their goals. If you remain on-track with
plan components (such as your savings, retirement, and
gifting goals), then you are a successful investor.
The Value of Wealth Management
A good financial advisor–client relationship is founded on

understanding and trust. My clients know that if there is a
real problem with one of their investments or a change in
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circumstances, I would suggest we reexamine their

portfolio. On a bad market day I still receive calls from
clients who are concerned about one of their positions. But
they usually listen to me when I tell them to take a break
from financial news, focus on something else for the
moment, and remember their wealth management plans are
long-term.
Go back for a moment to Babe Ruth: Although he

accumulated 714 home runs over 21 years, a record that
lasted for more than 40 years, even Babe Ruth didn’t hit a
home run every time. He had great years, good years, and
even a few not-so-good years. But he consistently
maintained his discipline, stayed true to his goals, and was
supremely successful.
When my children ask me what I do for a living, I tell them

I help make people’s dreams a reality. I work with clients
and go over their goals and their net worth, and then I help
them develop a plan that will allow them to reach those
goals. When the goals are achieved, I feel a true sense of
accomplishment in being able to take care of people in an
area that is essential to their lives.
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When I work with a client and their attorney or other

advisors on a strategy such as a charitable remainder trust
or a charitable family foundation, and I see the positive
impact it has on their net worth, the charity, and even their
children’s value system, I feel proud. And I’m proud of and
happy for my clients when I watch them invest objectively,
stick to their plan, and reach their goals.
Gilda Borenstein brings over two decades of Wall Street

experience to her clients and has been selected as one of
Worth magazine’s “250 Best Financial Advisors for 2001.”
She frequently appears on national television and is often
quoted in financial publications, such as American Banker,
Money, and Research.
After completing her coursework for a master’s degree

program in journalism at New York University, Mrs.
Borenstein was one of the original trainers and poll
monitors at The New York Times/CBS News poll. She then
worked for columnist Jack Anderson in Washington, D.C.,
where she covered the White House and Congress.
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She began her financial career in 1977 as a reporter for

Commodity News Services, a division of Knight Ridder. She
covered the cotton and orange juice markets and later
became the financial futures specialist, reporting on the
Federal Reserve Bank and the Interbank currency markets.
In 1979 Mrs. Borenstein joined Merrill Lynch as a futures

analyst. She later left Merrill Lynch to become a charter
member and floor broker of the New York Futures
Exchange. She returned to Merrill Lynch as a part of the
Latin American division, where she went on to be a part of
the team that created Merrill Lynch International Bank. In
the late 1980s Mrs. Borenstein served as the bankruptcy
analyst for Steinhart Partners and sat on the bondholders
workout committees, including the one for Public Service of
New Hampshire.
Mrs. Borenstein once again returned to Merrill Lynch in

1990, where she is now vice president and a Chartered
Financial Analyst (CFA). She has been a member of the
New York Society of Security Analysts since 1990. She is
also a Certified Financial Manager (CFM) and a member
of the Chairman’s Club.
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Mrs. Borenstein’s clients have included foreign

governments, multinational corporations, pension plans,
small businesses, and high net worth families and
individuals. She specializes in helping people use
comprehensive financial planning, which includes
retirement, education, and estate planning services, to
realize their financial dreams. She spearheads a team of
Merrill Lynch experts who work with clients’ attorneys and
accountants to provide multidimensional planning and
implementation.
Mrs. Borenstein was the founder and first chair of New

York Youth at Risk, Inc., one of former President Bush’s
“Thousand Points of Light.”
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WINNING STRATEGIES FOR

INTERNATIONAL INVESTING
JOSEPHINE JIMÉNEZ
Montgomery Asset Management, LLC
Senior Portfolio Manager and Principal
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Inside The Minds
Focus on the Future
Predicting trends and anticipating changes are central to my

investment approach. Although one can look at financial
ratios, interview corporate management, and visit plants, an
investment professional must look beyond the obvious.
Potential changes in consumer behavior and geopolitical
events affect markets, so investors must look to the future,
not the present or the past. Investments is all about “picking
the winners.”
When making decisions, I always ask myself: Where’s the

world headed? What are the changes that could potentially
transpire? With questions like that in mind, I also look at
industry supply and demand. For instance, at the moment I
am very curious about the steel industry. With China’s
recent entry into the World Trade Organization, the country
will be opening up its economy in several areas, including
the automobile sector. The bicycle has been the major
mode of transportation in China, but that is bound to
change in the years to come. China has announced that
within two years restrictions surrounding car production
joint ventures will be eased. Then, by mid-2006, China will
be reducing import tariffs to 25 percent for automobiles,
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from the current rate of 80 percent to 100 percent. Armed

with that information I can only conclude this is a very
positive development for global steel demand down the
road. And, as China progresses economically and
experiences an improvement in consumer disposable
income, I believe there will be increased demand for
automobiles. So a consequence of the policy changes I just
mentioned will be an increased demand for flat steel
globally.
My approach is to think ahead of these types of issues and

consider the implications for, say, steel production and the
subsequent demand for oil. The result is that I construct
investment portfolios to capture future trends.
I always consider geopolitical events in my work. For

instance, in Russia, China’s next-door neighbor, I see the
development of another global powerhouse. I look at what
Russia has in terms of China’s emerging demand for
automobiles and the commodities that support increasing
auto usage. Russia has a lot of oil that China will need in
the long term as industrial production accelerates and
demand for automobiles increases. With this reality in
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Inside The Minds
mind, it would be natural to expect the oil sector in Russia

to have a bright future ahead.
Change Strategies in Turbulent Times?
Investment strategies shouldn’t change in turbulent times.

When investors panic for lack of clear vision, I focus
instead on the quality of management and of the financial
statements. I select companies that can withstand further
industry deterioration. When choosing a company I focus
on whether that company can survive in difficult times,
given its management and financial strength. Occasionally,
I will invest in turnaround situations, if I am convinced that
they can turn things around within a reasonable timeframe.
Economies go through cycles: In a down cycle companies

suffer, but if you have the strongest of the best, your
investment portfolio will perform relatively well.
In a down market I scrutinize the balance sheet, which

becomes more and more important. I look at the cash level,
the cash-flow generation ability of the company, the ability
of the company to service debt, its break-even point, and its
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capacity utilization. If demand falls I want to make sure the

company can continue to make money operating during
down cycles. I pay even more attention to the operating
margin of companies because I want to ensure that
companies can make money on their basic line of business.
If they’re not making money on an operating basis, I might
as well hold cash.
Identifying Market Trends
Identifying trends is the culmination of processing a variety

of information. I am the curious type, and when my
curiosity is piqued, I go out on a limb. For example, I went
to Chiapas shortly after the Mexican military fired on
peasants on January 1, 1994. I became curious about why
that happened in Chiapas, instead of in another community
populated by Indians. The year 1993 was a great period for
the Mexican stock market. Telmex had been privatized a
couple of years before. Wall Street was excited about
Mexican companies in general, and then the Chiapas
incident happened. I waited for three weeks for any
information in the press that would describe why that
confrontation happened in Chiapas, but I didn’t get the
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Inside The Minds
information I was waiting for. In my mind, any social

uprising tends to have an economic root. So I went to
Chiapas, armed only with a curious mind and an agenda of
going to the local library to read about the state and
attending church to hear the sermon so I could gauge the
role the church was playing, if any, in the crisis.
As soon as I arrived I went to an old library, dusted off old

books, and learned that the state of Chiapas is very
important economically to Mexico. Actually, I had already
concluded that during the two-hour drive from the airport
to the interior of Chiapas, upon observing how fertile the
land was. Then, based on my readings, I discovered there
are numerous rivers in and around Chiapas that feed several
major hydroelectric facilities in the country and that the
State of Chiapas is an important supplier of energy to the
country because of the presence of gas fields. Because the
land is fertile, it is an important agricultural producer.
Overall, my research indicated Chiapas contributed some
10 percent to the nation’s output, and I concluded that
whoever was behind the Chiapas insurrection was holding a
very strong card.
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I became concerned and predicted more instability ahead. I

was worried about the Mexican peso and sold all of the
domestically-oriented companies held in our portfolios,
focusing instead on export-oriented companies. I was
convinced that the peso was going to weaken. As you may
recall, a presidential candidate was assassinated several
months later, and the peso was devalued later in the year.
That is an example of how to anticipate trends – it helps to

be really out there to feel the situation. If you can’t find the
answer, go out there for yourself. I have done that on
several other occasions. In each case it gave me the
conviction to react a certain way in the portfolio.
Anticipating trends also involves the usual rigor of

financial statement and ratio analysis. I look also at the
price chart. I look at relative valuation compared to other
companies in the same industry, in the same country, and
on a global basis. I rely on my team’s earnings estimates to
determine which companies within a given industry offer
the best investment return potential.
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Inside The Minds
Diversifying the Portfolio
When diversifying the portfolio, I am mindful of the

benchmark used to measure relative performance. I look at
the constituents of the MSCI Emerging Markets Free Index
as a starting point. I look at the neutral position in those,
then determine, based on relative valuation and the trends I
anticipate, which companies or sectors within the country I
should emphasize in the portfolio. While I’m not ruled by
indices, I have to be aware of what’s in the index I am
being measured against. I then decide which countries and
sectors to overweight against the benchmark. I select the
stocks based on the valuation input from my team of
analysts.
I also spend a lot of time meeting with companies in the

emerging markets when I travel. It may seem odd, but what
helps me in making decisions is reading through the
classified ads, for that gives important investment insight. I
always look at real estate prices, rental rates for apartments,
special promotions, and the prices of new and used cars. I
go to supermarkets and watch what people take from the
shelves. I study relative prices for goods when I am at the
supermarket in these various countries, from dry goods to
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meat and vegetables. By the time I look over the details of

these companies’ financial reports, I am able to put those
numbers into an interesting perspective.
Successful Investing in Emerging Markets
The most important characteristics of a successful investor

are originality and independence. A successful investor has
to be original and not be swayed by the masses, especially
in times of panic. One has to remain cool and stick to the
fundamentals of what led to that investment decision in the
first place, unless there have been developments that would
justify a change in opinion.
Again, success in investing depends on the ability to predict

trends. My style is to analyze global events (both social and
political) and industry conditions, and then search for the
most undervalued companies in the most attractive sectors
of each of the local economies. I combine country,
industry, and stock analysis when making investment
decisions.
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It is important to look at the quality of the balance sheet

and just be cool when there is panic out there. You have to
believe in what you have invested in and stick by it. I say
that because if you change your mind so often, then you
were never really sure to begin with. I think it would be
tough to make money that way.
I would tell any investor to take a long-term perspective

and not to panic. In our disclosure and reports, we inform
the investor of the long-term opportunity in the asset
classes. Consider the facts about emerging markets. First,
the majority of world’s population lives in emerging
markets – so the market potential is huge. Also, the
population is young compared to the developed economies
of the U.S., Japan, and Europe. These younger populations
will demand more goods and services in the future. That’s
where the growth will be in the long term.
Emerging markets by nature are in transition and can be

volatile. Therefore, I advise clients to take a long-term view
when investing in this asset class. Granted, not all countries
are perfectly correlated, but generally, as we have seen
since the downturn in this asset class, all the countries have
been affected to some degree or another. If I were to put it
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into an asset allocation perspective, emerging markets

investments are an excellent complement to core portfolio
holdings, for they offer diversification and long-term
growth opportunities. Emerging markets belong in a well-
balanced portfolio to the degree that the investor can accept
the inherent risks in the asset class.
Apart from investing in a diversified emerging markets

portfolio, an investor can consider real estate and
currencies as alternative investments. Real estate can be a
great way to make money in the emerging markets if you
can get long-term financing at attractive interest rates. If the
currency of the country in which you purchased real estate
weakens vis-à-vis your own currency, you can further make
money when you have long-term financing, because you
would end up paying for the property at a lower price.
Also, it makes sense to buy currencies if you think the

currency is going to strengthen. In that way you’ll get more
of your home currency, once you convert the foreign
currency back into your home currency. So if you like the
country, there are other ways to invest, which include
buying either real estate or currencies.
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Inside The Minds
Valuation is Key
Getting in and out of positions depends on stock valuation

and how cheap a stock is compared to fair value. When
adding a new stock to the portfolio, I search for companies
that can deliver at least a 20 percent return. Of course,
given the risk, I would want the return to be much higher,
but that’s my minimum. In terms of expected return, if the
world has entered a global slowdown, and volume sales
have also been weaker, I use certain benchmarks in terms
of expected return in comparison to the ideal. I compare the
stock’s expected upside to short-term interest rates.
As for when to sell, I base it on valuation also. If the

company continues to have excellent prospects over the
long term, however, I may not sell it out of the portfolio
completely, once it has reached my price target. Instead, I
hold less in it versus benchmark. I look at that stock’s
representation in the benchmark – again, going back to that
benchmark we are trying to beat. If the stock is already
fully valued, I set that stock’s weighting to market neutral
or underweight it against the index I am trying to beat.
Generally I use a 12- to 18-month investment timeframe
when evaluating expected returns.
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Confidence in the management is important when

evaluating the future of the company. Financial results are
the scores achieved by management. Current financial
results, compared to expectations, affect share price
performance.
Enterprise value to cash flow, price/earning ratio, price-to-

book ratio, and return on equity are some of the accounting
ratios I consider. It is important to see where they are
currently and determine where they’re likely to be a year or
two from now.
More an Art Than a Science
Investing is a combination of art and science, but in many

ways I look at it more as an art. I can see a picture behind a
set of numbers. You can have just a piece of paper with a
lot of ratios, but I can stare at it and come up with a picture,
or a story. That’s where the art comes in. When people look
at those numbers they can interpret them differently. For
every buyer, there is a seller. The ability to spot trends and
know what the numbers mean can help you make great
decisions.
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Inside The Minds
The science aspect includes computing those ratios and

making forecasts. In the end a portfolio manager has to
select from a number of companies that have the same
ratios; that is where judgment plays a role.
There’s also an art to portfolio construction. It’s really

having the right ingredients – the right percentages invested
in each of the stocks and sectors. When I construct a
portfolio, I set country, industry, and stock weightings in
such a way that there’s a story to it. An investment theme
runs across the portfolio, which is why I say there’s an art
to constructing a portfolio. It’s like creating a recipe: If you
have the best ingredients, it will turn out right.
Golden Rules of Investing
There are three golden rules of investing:
1. Identify the most attractive countries to invest in, taking

into account global events and that country’s social,
political, and economic outlook.
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2. Identify the industries that are likely to have the

brightest prospects in light of the current situation and
potential changes in the future.
3. Invest in the right stocks. Anticipate the decisions likely
to be taken by the management of the companies. The
quality of the balance sheet is critical to the long-term
success of companies. Not only is it important to invest
in the best-managed companies, but it’s also important
to invest in companies that have the wherewithal to
fund growth.
The Future of Investing
The impact of technological changes will continue to affect

the investment landscape. As we’ve seen with CNN, people
throughout the world are more in tune with events that are
taking place on a global basis. Perhaps there will also be
advances in technology that could make trading in these
markets more efficient. In my view, no matter what
happens in technology, the judgment of the portfolio
manager remains the most important factor in determining
investment success.
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Inside The Minds
My style goes back to my teenage years, when my favorite

pastime was predicting songs that would make the “Top
40.” My passion has always been to predict the winners and
find the treasures that lie within.
Josephine Jiménez, CFA, is the senior portfolio manager

and principal responsible for the core and concentrated
emerging markets portfolios. Ms. Jiménez has 20 years of
investment experience. Before joining Montgomery Asset
Management in 1991 to launch the emerging markets
division, she worked as portfolio manager at Emerging
Markets Investors Corporation. From 1981 through 1988
she was an analyst of U.S. equities, first at Massachusetts
Mutual Life Insurance company, and then at Shawmut
Corporation.
Ms. Jimenez received a Master of Science degree from the

Massachusetts Institute of Technology in 1981 and a
Bachelor of Science degree from New York University in
1979. She is a CFA charterholder.
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THE PSYCHOLOGY OF A
SUCCESSFUL INVESTOR
ROBERT G. MORRIS
Lord Abbett
Partner and Director of Equity Investments
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Keep the Courage of Your Convictions
Successful investors have several characteristics or

strengths that drive them to succeed. Certainly, they are
always learning in this business. There’s no evergreen
formula that will allow you to keep coming back to the
same idea time and time again, though there are certain
themes that repeat themselves if you pay attention and are
disciplined. It is important to stay disciplined in the value
style of investing. From my experience, value wins out
over time. Over the course of my career, a number of
“investment manias” seem to recur in the market about
every eight to 10 years. If you’re mindful of sidestepping
the manias, you can do better than the market over long
periods of time. Staying disciplined and understanding
what value investing entails – which is largely about
avoiding the manias – is the underlying principle I have
found works the best.
I don’t think there is a gradation between good investors

and great investors. What separates good investors from
poor investors is being an informed, independent decision-
maker when the force of public opinion and the reinforcing
media are suggesting you are wrong, and everybody is
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standing on the other side of the boat. When you have the
courage of your convictions and you can stand out like that,
you’re in the right place.
Emotions and the Market
I believe it was John Maynard Keynes who suggested the

stock market is like a beauty contest, where you as a judge
may believe that one of the beauties stands out above all
the rest. You may not at all represent the consensus of the
panel of judges. So you have to be careful to avoid letting
your personal biases substitute for justification for what the
market is doing at any point in time. You have to
understand how stock prices are made and how manias
develop because people often believe differently or
perceive things differently than you. How do you deal with
that? How do you square with that? Excess emotion is
generally the biggest pitfall for investors. Understanding
the ebb and flow of emotion in the market is the key issue.
How you deal with that is what we measure all the time:
When are things getting too overheated? When are
downside emotions getting overdone?
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An important element to all of this is being able to stand up

as an informed, independent decision-maker. Cycles recur,
and you have to be mindful of them, willing to understand
there is no absolute equation or formula that explains how
all of this happens. It really is a mosaic that changes over
time.
One of the surest indicators of when a cycle is changing is

when the consensus becomes so one-sided that there is no
tolerance for a contrary point of view. We don’t subscribe
to the idea that being contrarian all the time is how you
achieve fame and fortune in this business. There are times
when the consensus is well-founded and valid for
considerable periods of time. But when it becomes
irrational or unreasonable or the shrillness of the argument
becomes so loud you can feel physical pain as you hear it
for the millionth time – that’s mania.
Technology is the most recent example of a mania market.

There was nothing worth investing in except some brave
new electronic or communications-related technology. This
enthusiasm for technology carried valuations to levels I had
never seen in my career. They were even more extreme
than those we saw during the Nifty 50 market of the early
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1970s, when the stocks of such strong companies as Avon,

Coca-Cola, Disney, and IBM took a long, slow tumble. The
more the mantra was repeated, the shriller it got. The
extremes in the marketplace developed, and of course, it
crashed rather profoundly.
So stand back from the crowd and watch it. When the
crowd becomes a mob and is unwilling to accept any
leadership other than the pathology of the mob itself, get
out of the way because there’s trouble coming.
There’s no precise measurement to lock in on profits. It’s

almost like a piece of music. When you hit the crescendo,
it’s probably time to leave the party. When your ears hurt,
your nerves are on edge, and you can’t stand it anymore,
leave. You suffer for a short time because you left a little
too early. Nobody finds the tops of these things precisely.
In this most recent cycle with technology stocks, the fourth
quarter of 1999 was an object lesson in raw, unvarnished
emotions: Stocks were going up 5 percent and 10 percent a
day – that’s a crescendo, or an early indicator that you’re
coming into a top. A technician would describe it as a stock
chart going exponential. Whatever historical pattern was in
place until that point, the market starts to rise in an
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exponential fashion. The rise is based on extreme emotion,

which is an indication that it’s time to get out – when you
start wondering just how much growth for this company
over how long a period of time it would take to justify
today’s price. Seeing extremes in these quantitative
measures gives you confidence that what you are seeing
and what you are reacting to viscerally is against any wave
that’s going to break on the beach in the not too distant
future. You can look at it quantitatively, but catching that
emotion is important, too.
Needed in a Turbulent Market: Psychological Strength
What always gets people excited is when the fundamentals

for a company have improved and seem to be getting
stronger. Ultimately, this reduces to shorthand – the
earnings per share – and the momentum of those earnings
that are reported and reinforced in the media. When the
excitement breaks loose from reality, a serious price
anomaly can occur, which will correct in the future. That
break with economic reality is emotional and should be
avoided.
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The inverse happens when emotion prevails over reality,

resulting in excess pessimism. This can often happen when
people are selling anything not currently in favor to raise
cash to purchase the favored stock or group of stocks. The
crowd psychology of the moment can create risk or
opportunity, depending on the circumstances. The
successful investor then should constantly watch for signs
of excess emotion in the markets and avoid them.
To be able to anticipate change involves understanding the

economic cycle. There are times in the economic cycle
when industry fundamentals are driven by abnormally
strong demand factors. It’s as if the companies in that
industry have picked up an economic tailwind that pushes
their earnings to surprisingly high levels. When these
conditions moderate, however, the industry fundamentals
slow unexpectedly, causing a sudden shift of expectations
about future earnings. When this happens in conjunction
with an overvaluation, a sharp price decline occurs.
The most serious of market events occurs when a single

group of stocks or a pervasive concept – the Internet, for
example – has prevailed for several years. The excess
emotion in these cases becomes a mania. Several of these
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manias have occurred in my experience, including the Nifty

50 of the early 1970s, the oil mania of the late 1970s, the
great consumer franchise stocks of the late 1980s, and most
notably the technology mania of the late 1990s.
These market environments had several shared

characteristics, the most important of which is that
overvaluation caused excess emotion, fueled in the short
run by very strong earnings growth demonstrated by the
favored subset. There have been several instances in which
the favored group has been technology experiencing an
important change, for example, the vacuum tube to the
transistor. Another important similarity is that each mania
market has ended with the economy entering a recession.
This is important, because the temporary surge for the

favored group is often associated with the boom phase of
the economy. So when the boom breaks, as they all do, the
formerly strong fundamentals of the favored group don’t
just slow down with the economy; they often go bust. The
stocks will go from overloved to unloved, and a serious
price adjustment results.
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A closer look at two of these mania markets – the Nifty 50

of the 1970s and the Internet/technology bubble of the
1990s – shows the pattern clearly. It is very apparent that
the recession of 1973-1974 broke the psychology, and a
substantial price decline followed. As the economy moved
rapidly toward recession, the irrational market structure
could not be supported. Interestingly, the technology mania
market ended when we were sliding toward recession. The
bull market for technology stocks ended in the first quarter
of 2000. We would find out almost a year later that the
economy entered a recession in April 2001.
These patterns recur. Knowing that and being on guard that

a mania type of environment will always break when
recession looms are important for anticipating a change and
getting out of the way, without being able to time it
precisely. Knowing how to recognize growing danger is the
key.
There are other momentum indicators. The breadth of the

market, for example, will often tell you a lot about what’s
going on – i.e., how many stocks are in bullish patterns as
opposed to the number going sideways and down. When 80
percent of the stocks are in a bullish pattern, expect a
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Inside The Minds
sentiment change. When 20 percent are in a bullish pattern

– the polar opposite of excess optimism – that usually
signals a bottom.
When the market goes down, you have a buying

opportunity most of the time. It is not prudent to step up
and buy every time the market dips for a day or two. On the
other hand, as in 1987, when the market dropped 20 percent
in a day and 25 percent in a week, either the world was
coming to an end, or a tremendous buying opportunity had
revealed itself. When this happens the best thing to do is
find some stocks that are irrationally priced and start
buying. Have the courage of your convictions to stand up
and buy that company that was too expensive, but whose
product you really liked.
You have to determine honestly whether you’re

psychologically prepared to do these types of things,
because the greater the scare and the fewer the handles on
the situation, usually the greater the opportunity the market
presents. You have to understand a lot about yourself to be
a very successful investor. There is always a role for
professional money managers in most people’s financial
lives, because I don’t think most people are psychologically
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strong enough to stand outside the crowd when they are not
getting any positive reinforcement from media about the
current situation to make the tough calls.
Identifying Sectors and Good Companies
It is important for investors to look in all sectors all the

time. There are basically two things you should do. First,
try to understand where we are in an economic cycle
because it will inform you as to which sectors might be
picking up tailwinds and which might be running into
headwinds. In the short term you want to emphasize
tailwind situations.
And second, crunch a lot of numbers. When I started in this

business there were guys around who wore green eyeshades
and pocket protectors and still used pencils and erasers to
keep their green paper spreadsheets up-to-date. When I
moved to Wall Street and actually worked on the sell-side
of the business in the early 1980s, the personal computer
was just coming into fashion. It was a remarkable change
from the time when I’d have to think, “If I change this
assumption, how long will it take me to redo my
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Inside The Minds
spreadsheet?” Having evolved from that time, our

databases are now quite good and robust. We can run all
kinds of simulations, and we do regularly, which allow us
to sort through enormous amounts of data to find likely
targets of opportunity that fall out of our analyses. Having
smart algorithms and knowing how to work with the
databases and how to construct reasonable valuation
models will take you in the right direction. It is important to
have a sense of what’s moving from higher risk to lower
risk, based on where you are in the macro environment,
then to be able to sort through all of the companies to see
where valuations will line up in more relatively attractive
configurations.
At the end of the day, visiting companies allows you to

gain an understanding of what you own and the people
behind the businesses. It is amazing how a simple story can
resonate through an organization as a powerful tool in
getting people organized and narrowly focused on gaining
certain objectives. You always go where the ideas are the
simplest. As they say in the NFL, when the team isn’t
performing, take the complexity out of the game. Go back
to basic blocking and tackling. The simpler the story, the
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easier it appears to you as an outsider looking in at the

business.
By going around and talking to management, you can get a

feeling when the company’s confidence is rising; our
instincts should tell us that’s a higher-probability situation
than one where we don’t get that feeling. The only way you
can do that is face-to-face. You can’t get it in an abstract,
from reading a report, or from seeing it in a large-group
presentation. Get the management at home, when their
guard may be down a bit, and draw them into a dialogue in
which they tell you their hopes and fears. We don’t think
there is any substitute for getting to know the management
of the company and meeting as many people as we can
possibly meet – marketing people, financial people, the
CEO – and making sure what the CEO tells you resonates
in the comments of the other people you get to talk to.
CEOs can often be eloquent, but the organization can lag
behind and not really understand the message.
See new products; see new people; and check out the
housekeeping of the headquarters. A place that looks
disorganized could very well be disorganized. I remember
one time visiting a company at a plant site and wandering
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Inside The Minds
out the back door during the presentation, which was a little
boring. Walking into the plant, I noticed the plant was
awfully quiet for a company that was doing as well as the
CEO was telling us in the conference room. I asked a
couple of guys standing outside, having a cigarette, how
business was. They said business was bad, which is exactly
the opposite of the story we were hearing in the meeting.
There is no substitute for letting your eyes and ears tell you
what’s really going on as opposed to what the world is
being told.
If you can’t visit a company, take Peter Lynch’s advice for

individual investors: If you use the product, and you like
the product, the chances are it probably is a pretty good
product; just do some comparison shopping for what you
think you know, and then don’t buy too much of the stock
at once. I am not a big fan of high-priced earning ratios for
companies whose products you like. Being a value-oriented
investor is probably the best way to stay out of trouble. Buy
products of companies you understand and whose products
you like, and make sure you have some discipline in the
price you are willing to pay.
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Know Yourself
The best piece of investment advice I ever received was

learning – at the hands of some very good investors – the
importance of psychology in the market. I learned early
about the research that was going on in this area and have
always been fascinated by it, because I want to understand
what makes people do what they do. It’s important to pay
attention to some of the clues about how human nature
works and how we tend to try to find short cuts. Doing all
of the work necessary to be as well-informed as you should
be to make stock selections is not a trivial exercise, and
people tend to use shortcuts.
The shortest of all the shortcuts is just plain momentum

investing: If it’s going up, I want to own it, and I’ll be able
to figure out when we are at the top before anybody else.
It’s just human nature. Our assessment of our own
capabilities is often much better than we would prove on
any test of those capabilities. Just understanding those
things about yourself, and investors in general, is very
instructive and will help you get through the hard times in
this business.
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Inside The Minds
The advice I find myself most often giving to investors is

that if you have only one investment style represented in
your portfolio, make sure you have value. A value manager
will not always put you at the top of the performance peak
every year, but when you really need him, when the world
is going to change utterly before your eyes, your value
manager, if correctly chosen, will keep you away from
most of the harm.
Remember that the fortunes of most companies ebb and

flow, so do not be averse to taking profits when it seems
reasonable. The enemy of the investor is greed that fosters
a willingness to speculate at inappropriate times. In
investment parlance, this is called the “greater fool theory.”
Assuming someone will buy your most expensive stock at
an even higher price is foolish. If you think a stock is
expensive, it probably looks expensive to others, as well.
The best risk management strategy is to diversify. A

portfolio of stocks in different sectors of the economy is
advisable at all times.
Over time, stocks have provided the best returns of all the
financial asset classes, but these return advantages are
216
measured over long time periods, typically five to 10 years.

So be patient. Trying to time the stock market is generally
not a fruitful strategy.
The tortoise always wins the race with the hare because it
stays focused on the objective. Looking for quick gains is
speculation and usually entails excess risk. It takes a long
time to recover from losses.
Robert G. Morris joined Lord Abbett in 1991 as director of

Equity Investments and investment team leader of several
funds in the firm. He became a partner of the firm in 1995.
He has more than 29 years of experience in the financial
services industry.
Before joining Lord Abbett, Mr. Morris was a vice

president/manager of Equity and Equity Investment
Research at Chase Manhattan Bank and a research vice
president at Drexel Burnham Lambert, Inc. Before that he
was an industry specialist at Merrill Lynch, Pierce, Fenner
& Smith, as well as an investment research officer at the
Industrial Bank of Rhode Island.
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Inside The Minds
Mr. Morris received a BA in economics from the State

University of New York-Buffalo and an MA from
Northeastern University.
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INVESTING FOR A
SUSTAINABLE FUTURE
ROBERT ALLEN RIKOON

Rikoon-Carret Investment Advisors
Chief Executive Officer
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Inside The Minds
Finding Companies That Have Value
You should build a portfolio of stocks, not a stock

portfolio. The difference will determine whether you can
make money no matter what the current economic
conditions may be by finding companies that make sense.
To find companies that have value, an investor must

examine a combination of elements. The first and most
important thing is to spend time looking at the management
of a company, which means trying to understand the quality
of the people who work there. This does not just mean
getting to know the CEO, but going further into the
organization – to researchers and marketing people. What
we invest in is people – people we believe in and who we
think know the market in which they are trying to make
money, as well as whether their market is shifting. In the
modern business world, all markets are shifting all the time.
It takes a certain kind of person in a certain kind of
management structure to make me believe theirs is the
company where I want to put my money, that I want to be a
partner in their business through thick and thin.
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An essential issue is whether management is looking

forward and taking into account the myriad factors that are
unique to their business but common to all who work in
Corporate America. These qualitative issues are relevant in
terms of the financial structure of the company, the
products it is developing to meet an increasingly
competitive future, and its marketing strategy of creating
brand recognition and customer loyalty. Basically, you
should look at management as the number one, most
important thing and only then consider the financial
strength of the company.
Balance Within a Portfolio
Other than the occasionally speculative stock, which we all

are inclined to look for in our weaker moments, we should
make sure that most of our investments do not depend on
betting the farm on one particular product.
Deciding on the right balance when putting together a

portfolio of stocks depends on the temperament, time
frame, and overall life view of each individual. Some
people just naturally have a higher tolerance for risk than
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others. This is not something to be either ashamed or proud

of, but when we can recognize who we really are in terms
of our tolerance for looking at a down portfolio, only then
can we know how to begin structuring our long-term
investments. Some people naturally have more of an
interest in technology, biotechnology, small, or
international companies.
In an ideal world an investor will seek a mixture of large

capitalization companies, along with some more aggressive
names. The adage, “no pain, no gain,” is generally true in
stock investing, but it is no guarantee that if you experience
pain, there will eventually be gain. You need to have a
reasoned, thought-out, and balanced discipline to take
advantage of the market.
The first step in developing discipline is taken by looking at

industry diversification. Here, you must always be
cognizant of the S&P weighting among industrial sectors.
Then, depending on what you perceive as the
macroeconomic climate, you can make some basic
decisions that will either allow you to stand out among the
crowd or teach you a lesson. After many years I have found
that if I am very wrong, I can arrange to avoid having my
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mistakes hurt me that much through the use of some selling

strategies. If I am right on the big issue, I can preserve my
capital and grow it over time.
For example, in December 2001 our analysis of the

liquidity flooding the markets told us that the economy was
moving toward favoring cyclical and industrial materials,
as opposed to the successful strategy of the bear market of
2000-2001, in which we were weighing in a little more
heavily with some of the financial companies. Financials
were a huge beneficiary of the lowering of interest rates
that the government initiated to stave off a recession. Once
we think the interest-rate cycle has about ended, and we
feel the bond market is already looking ahead and seeing
interest rates higher down the road, we’ll want to be lighter
in the financial stocks. In effect, we’re always looking at
the big picture and trying to figure out how it will affect
industries, and only then do we move into specific
company selection.
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Strategy for Profiting in the Markets
In developing specific buy and sell approaches, investors

should try to be disciplined in taking profits. For example,
when the market was going up quickly in the latter half of
the 1990s, we were criticized for selling partial positions on
the way up. Take a company like Qualcomm. We didn’t
buy a lot of Qualcomm stock but had some at $2 a share
before it really hit the radar screen of the big investment
houses. When it hit $20 – since we bought it as a
speculative stock – we sold some. Then it grew to $50, and
we sold some more. When it hit $100, we were still selling
partial positions in Qualcomm. Of course, we were kicking
ourselves, at least in part, for selling it, but after we sold
some at $200, it started back down again, and we felt
gratitude for having instituted and stayed with the
philosophic framework that meant we were not caught in
the trap of trying to take all the money off the table at once.
We continued with the plan and sold some on the way
down. We still have some of the company in our portfolios
today, because we fundamentally believe in the company
and its business plan.
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Our philosophy also holds that if a company goes up

quickly, we want to take some of our money off the table
without moving totally out of the stock. It is crucial to
remember the truism that there are bulls, bears, and pigs:
Bulls make money; bears make money; but pigs get
slaughtered. We are not piggish about our stock position.
We try very hard to make a conscious choice before we buy
a stock as to the reasons behind purchasing it. To say
you’re in stocks to make money is like saying you go to a
bar to meet someone of the opposite sex. The point is that
in an area such as stocks, or dating, when you make
exceptions to your own basic rules of behavior, trouble is
sure to follow.
Knowing When to Take Your Money off the Table
When I first buy a stock I have already finished deciding on

the price point to take some money off the table. In
accomplishing this discipline you should use a combination
of price target on a percentage basis from entry with
technical factors on stocks that are experiencing a more
technical-driven breakout. By looking at the overlay of
those two factors, you can come up with a target.
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For example, one stock we owned in a lot of portfolios is

Horizon Organic, which on a technical basis had a
breakdown of about $12. On a charting basis, the stock
ought to trade out to $16 a share. Our entry into the stock
was $9, so we were inclined to take some of our profits on
HCOW’s quick move to $15. This didn’t mean we lost
sight of the basic business of the company or stopped
believing in it. On the contrary, we continued to feel the
markets for the company, based on consumer desire for
milk produced without growth hormones, was nowhere
close to peaking. We believe preserving principal is the
number one priority for investors and that everyone is more
capable of withstanding the future fluctuations of volatile
stocks if they already have their invested capital back in
their pocket.
Choosing the Right Aggressive Stocks to Buy
When deciding to buy more volatile stocks, you should

look for sector diversification. When a client asks us to
invest aggressively, it usually means they want to find the
next Microsoft or Amgen, or know ahead of time when a
company that has fallen on hard times is just about to turn
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around. The only way to do this is to buy before the

company has consistently increasing earnings, which is the
hallmark of growth companies.
As professional “growth at a reasonable price” investors,

we believe strongly in buying companies with existing
earnings. If you buy companies that don’t have current
earnings, somewhere there are fast-talking salesmen
dressed up like really good guys behind the scene.
Investment bankers are really good guys – but you need to

remember Wall Street loves a sucker! There are always
exciting stories out there, and the person on the street, by
the time they hear anything, is on the receiving end of the
investment industry’s brutal sales process. So don’t listen
to the professionals when it comes to aggressive stocks
because you will get skewered.
We tend to rely on our aggressive company selections by

looking for confirmation of growth prospects from
somebody in that specific field. As an individual investor,
you should buy only what you know. On the consumer
cyclical side, we own a company called Chico’s. From an
analytical standpoint, Chico’s is a very successful up-and-
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coming retailer. In fact, it was just rated the number one

stock in the four top-200 small companies. It’s a company
we are very familiar with, because it has three stores here in
Santa Fe. Most of the women in my office shop at Chico’s,
and they spend a good portion of their discretionary income
at the store. It’s important to have something you are
intimate with when you are dealing with up-and-coming
franchises or yet-to-be-proven businesses.
Challenges in Managing Portfolios
You can’t make money all the time. One of the most
difficult challenges in managing portfolios is admitting you
made a mistake. Facing this humiliating experience with an
open mind will help you learn when to get out of a losing
position.
My firm has a discipline on the downside where we target a

20 percent downward move. However, if it’s a volatile or
aggressive stock that makes regular moves of 20 percent
during most weeks of normal trading, we expand that
parameter. It’s very important that if we hit a 20 percent
mark on the downside on stocks with reasonably low betas,
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which means volatility relative to the S&P 500, we sell

without emotion. This doesn’t mean we don’t have
companies that go down 20 percent, and after we sell them,
they go back up again. Putting up with this kind of
embarrassment is like the rest of disciplined investing. You
end up saving more money by dumping companies that
keep going down than you would have made otherwise if
you had held onto the ones that eventually do go back up. If
you minimize your losses, the capital thus preserved can be
used to stay in the ones that go up. It is simple math.
I think it is critical to have a systematic selling discipline in

all positions, so you don’t ride any company all the way
down into bankruptcy. Unfortunately, you will never have
timely information if you depend on CNBC, CNN, Wall
Street Week, etc., because all of the people talking through
the media have an agenda that is different from yours. For
example, we didn’t own a lot of Compaq, but we owned
some and dumped it early when we were not convinced that
management had a plan to compete with Dell. We also
bought United Airlines because it had tremendous assets,
and if the airline industry becomes healthy again, those
assets will be worth something. We made a mistake in our
thinking about United’s management, in that they were not
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capable of reaching peace with their unions to pull the

company out of its primarily self-inflicted blues. We got
out of United at a loss and moved our money to UPS. We
felt confident that UPS and their employees were on the
same page, because the employees own most of the
company.
My Opinion: Lessons Learned From Enron
Enron is a classic example of management that looked as

though they were doing the right thing, when in fact they
were hiding the truth from the public. Enron Corporation,
based in Houston, grew from being a distributor of natural
gas and a utility company to become the world’s largest
trader of electricity and natural gas. The company also
became a huge telecommunications firm, a paper and
lumber trader, and one of the largest insurers in the United
States. It had more than $100 billion in revenue last year.
The collapse of Enron has caused and will continue to
cause huge aftershocks in many of the nation’s industrial
sectors.
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Enron Corporation employed more than 21,000 people.

Three quarters of its employees kept all of their retirement
savings in Enron stock, which went from a high of $90 per
share last year down to under $1. At its peak Enron had a
paper value of $67 billion, which stands now at under $1
billion. That is a $66 billion loss of value in less than one
year. To help put this into perspective: The total claims for
the World Trade Center terrorist attack should be
approximately $20 billion. An additional $20 billion or so
may cover the collateral damage done to adjacent real
estate, business operations, etc. The loss to New York
City’s economy and the U.S. economy at large is hard to
quantify, but let’s use an estimate of an additional $20
billion. This all adds up to $60 billion, so it is likely that the
economic magnitude of Enron’s collapse is similar to that
of the September 11th tragedy.
The list of players who were drawn into the widespread,

tangled web of Enron’s activities reads like a Who’s Who
of American finance. The answer lies in the inherent
conflicts of interest present in this situation. Two banks,
J.P. Morgan-Chase and Citibank, came to Enron’s aid
within the last month to pledge $1.5 billion. Chevron-
Texaco stood behind Dynergy, the short-lived white knight
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Inside The Minds
of Enron, to the tune of $3.5 billion. Several of the nation’s

largest mutual fund operators, including Alliance Capital
and Janus, rode Enron’s stock all the way down into the
tank. There are, of course, many individual and institutional
investors, including our own firm, as well as retirement
plans and less well-known mutual funds that were drawn
into the morass.
How could this happen? How could Arthur Andersen, with

some of the sharpest accounting minds in the country, or
Standard & Poor’s, whose entire business mission is to look
past superficial financial presentations to analyze the
underlying strength of companies, be duped by Enron?
The firms that were charged with responsibility for

overseeing the truthfulness of Enron’s financial statements
have been brought into the fray. Arthur Andersen, one of
the world’s largest accounting and consulting firms,
overlooked, or perhaps, as some people think, failed to look
at basic accounting errors. It is easy to think that Andersen
may have wanted to maintain its $52 million per year fee
relationship with Enron. Arthur Andersen, also accused of
looking the other way and having audit failures at Sunbeam
Corporation and at Waste Management, may face
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prohibitions on taking new audit clients for a period of

time. Some partners in the firm may be permanently barred
from practicing the accounting trade for other public
companies. These seem like mere slaps on the wrist, but
they could herald a downward spiral for this huge
accounting firm. This is an example of how you as an
individual investor have to look past the annual reports and
company conference calls and pronouncements to establish
your own opinion as to whether a company is one you can
understand and have confidence in.
During the period of Enron’s demise, intense lobbying on

the part of the company and its bankers brought pressure on
the paid watchdogs, called rating agencies, at the worst
possible moment. Standard & Poor’s, one of the best
known of these rating agencies, and Moody’s, a well-
known bond-rating service, both failed to anticipate
Enron’s problems. As recently as late October both firms
gave Enron top grades on its financial report card. As noted
above, if you had established a stop-loss on the stock in
your portfolio, you would have, by virtue of your
discipline, outperformed most professionals and done a
better job of protecting your principal than the most highly
paid Wall Street analysts.
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The tragedy faced by Enron’s own employees is among the

worst one can imagine. Those who put their faith and
money into their own company by choosing Enron for their
stock retirement plans got in the most trouble. Under
Enron’s internal rules, these individuals had no choice but
to keep their money in Enron stock until they reached a
certain age, and this fall, when the news got really bad, they
were not allowed to change their choice of investments.
There will be many recriminations exchanged in the
upcoming months and years, but it is clear that it was not
just individual investors who were duped. Professionals
who were supposed to have access to confidential and
complete financial information failed to see the warning
signs until it was too late.
If you have your money in undiversified positions in your

retirement plan, take heed from this disaster and get a good
chunk of your money into an index fund. Normally,
retirement plans have an index option I find more
compelling than the usual list of mutual funds offered. Ask
for an S&P 500 option if there isn’t one. Even the
participants in TIAA-CREF, one of the nation’s largest
retirement plans, had to rattle their sabers before the firm
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offered its employees a plain vanilla index fund in which to

invest.
The origins of Enron’s disaster began in the movement to

deregulate the American power industry. As supply and
demand for electricity and natural gas were left to the free
market, companies willing to take risk, like Enron, filled
the void. Another major factor that allowed Enron to grow
beyond its traditional roots as a gas pipeline business was
the lack of regulatory scrutiny on the rapid innovations
being used by Enron, especially in the risk management
area. Enron was willing to assume a variety of risks, and in
a magnitude that no one else could match. Enron gave its
customers the feeling that their power, energy,
telecommunications, and basic materials costs would not be
subject to the wild swings of the market, but would be
protected by Enron managing these risks.
To perform on its promises Enron created a vast and

complicated structure of companies and private
partnerships that loaned money to and took cross-
ownership in each other. The purpose of these maneuvers
was to present a far rosier picture of its business than
actually existed, to propel its stock price higher. The truth
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is that Enron executives fell prey to avarice and ego. They

were able to adhere to the strict letter of the law but
avoided the law’s real intent of protecting investors.
The basic cause of Enron’s decline and descent into

bankruptcy was a widespread loss of confidence in the
integrity of its management team. Enron obscured its true
financial condition through purposefully complex
transactions between the company and the private
partnerships that it set up. Once that condition became
public, Enron faced a fork in the road that many of us face
in our personal lives. The choice was between being honest
and coming clean about mistakes and problems, or trying to
hide behind legalese and accounting barriers.
Unfortunately, Enron, from its very top ranks down to mid-
level executives, failed the integrity test. It first gave out
minimal financial information and then, under pressure,
Enron’s leaders became defensive and denied having
conflicts of interest. The company chose to hire lawyers
and accountants instead of stepping forward in honesty and
humility to regain the public’s trust.
In businesses such as trading financial instruments, trust is

the key component to be able to continue operating. Once
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Enron lost the trust of the energy-trading community, and

then the rating agencies, its ability to stay in business
became severely curtailed. Rating agencies such as
Standard & Poor’s were upbeat about Enron until early
November 2001. But once Standard & Poor’s rated Enron
as “junk,” everyone knew many of the loans Enron had
taken would become due. Clearly, Enron would then be
unable to pay off the loans in such rapid succession as
would be required.
Enron lied about how much debt it took on, lied about the
nature of its reported profits, and hid the truth of the
enrichment of its own officers at the expense of
shareholders and employees. It seems there are very few
things Enron didn’t lie about. While it is small consolation
to shareholders and employees, company executives who
made off with tens of millions of dollars over the past
decade may end up in jail. It is clear that investors can no
longer rely on the rating agencies to do their homework for
them. The question for stockholders – not just in Enron but
also in other stocks we want to invest in – is what does all
this mean?
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For starters, when important members of a business’s

management depart suddenly, without adequate explanation
of their performance shortfall or giving their real views, it
is a cause for concern. Often the company and departing
managers are being silenced by mutual gag orders, so the
public has no information about what is really going on
behind closed boardroom doors. This built-in wall that
hides the inner workings of American businesses results in
a huge disadvantage for shareholders. The hardest thing for
anyone to do when the news is bad is to tell the truth. Full
and immediate disclosure of financial problems, slipping
market share, falling earnings, and other similar issues
ought to be encouraged, not discouraged. Unfortunately,
the system works against these kinds of disclosures.
As investors, one way to counter this inherent bias against

the truth is to hold fast to the time-tested principle of
diversification. We can keep our eyes open. News is readily
available about companies, but the reasons and meaning
behind the reported numbers are almost impossible to
ascertain without digging more deeply into the story. The
advice we continue to give is to look for solid, long-term
companies whose businesses are understandable and whose
financial statements are straightforward.
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How exactly do you know when to cut your losses? There

are two criteria. One is a mathematical criterion: Just
establish a percentage from your original cost, and put in an
open order, good till cancelled, to sell once that stock
reaches that price floor – and then resolve not to get in the
way of this automatic system to cut your portfolio losses.
This is very easy for ordinary people to implement.
But even if the stock’s price is not going down, when you
lose faith in management, it is time to exit. You lose faith
in management when you think they may be lying, or when
the younger members of top management leave for
undisclosed reasons without announcing where they are
going. So there are signs that management is not being
forthright, but they are very subtle, and you must read
between the lines to find the potential for lies.
Feeling Good About Management
On the other hand, there are several signs that management

is doing the right things within their company: Companies
buying back their own stock and companies that hit lists
like “The Top 100 Companies to Work For.” You can
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believe that a company that sees enough value in its stock

to repurchase shares in the open market and a company that
is liked enough by its employees to be listed among the
ranks of desirable companies to work for is investing in its
long-term future. These signs show the company is doing
something valuable on the financial side and valuable in
terms of providing a useful, beneficial product or service.
On a very basic level, those are two very easy signals of

good management. The other thing that is harder to know
when you look at a company is where it’s headed in the
marketplace. Take a company like Intel, which had
tremendous competition but was willing to tighten its belt
and reduce prices to keep market share. As a result of their
long-range competitive strategy, they continued to expand
even in a down market cycle, by building the next
generation in plants. This was important because they’ll
maintain their market share and even expand it when the
economy rebounds.
An investor should look for a company that is willing to

invest in the future and is not looking for short-term profits.
For this reason, we have no problem with companies that
don’t pay dividends. Another thing to look at is the
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management-compensation packages. If they are based on a

long-term review of strategic results, we like that a lot more
than one based on quarterly net income goals, which is a
financial number easily manipulated by those on the inside.
To make money in turbulent markets, you need adjust your

portfolio strategy to the times. For instance, we are much
more active traders now than we were three years ago. Our
tolerance for companies screwing up is more limited. The
market will always be turbulent and volatile. So the
question becomes: In the next few months, is the market
moving sideways, up, or down? A sideways-moving
market becomes a market where investors can’t rely on
sitting on the sidelines by owning only the indexes. When
the market is going up, and the bull market is running on
investor exuberance, indexes were great. In bull markets
you can use an exchange-traded fund or a mutual fund, a
NASDAQ index or an S&P 500 – it doesn’t really matter,
as rising seas raise all ships. In a sideways moving market,
you have to become a contrarian on a stock-by-stock basis.
You can make money in sideways-moving markets
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basically by shortening your timeframe as to when you take

gains and losses. It’s a lot more work, and the results are
not as spectacular as when the bull is rampaging, but it is a
way to increase capital, or at least not lose it.
In a true bear market, no one is going to make money on

stocks unless you are shorting the market, which means
betting that it will go down. Since I don’t know any
successful market timers personally – though I am
acquainted with many who say they are, and this includes
the fancy hedge funds run out of New York – I think an
individual investor’s real goal in a bear market is to
minimize losses and preserve capital, not to be greedy and
look for a guru who says they can predict the way the
market moves in the short run.
You also have to do more disciplined work in asset

allocation in a bear market, so that you are exposing your
portfolio to equities only at appropriate levels. Also, within
the equity-portfolio allocation, you always need to maintain
proper diversification. You need to be vigilant so as not to
be inclined to make big bets or guesses. If a client tells us
they want to hedge their portfolios against the risk of the
market going down, we do have a market-neutral strategy.
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Market-neutral means there are limits to your upside

potential for gain if the market goes up. At the same time it
provides a minimum amount of return if the market goes
down.
The issue of hedging to reduce risk in a bear market is

really overshadowed by the search for companies that are
gaining market share. We don’t want to abandon our core
positions in a bear market. Losing money means you
actually sold stocks and lost. Seeing the paper value of your
portfolio go down is not losing money. If you own 30
individual names on a portfolio, you need to be right on
only 16 of them. You need to know you are comfortable in
terms of the confidence that you own equity for the long
term and that you can wait to ride such companies as Bank
of America, Dell, Intel, and Pepsi back up.
Whether your portfolio goes down as the market goes down

is not the issue. The portfolio will go down unless you’re
shorting the market. There is no way to avoid going down
unless you think you’re a sharp shooter and can pick the
companies that are going up while the general market is
going down, which everyone desires to do but very few
people accomplish. I personally don’t know anyone who
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can do it. So we deal with bear markets by defaulting to the

companies that people have confidence in, and the chances
are good that investors will not bail out of them, even if a
raging bull psychologically challenges us all. Because the
danger is rooted in psychological issues, we feel it is
important that investors take their real-life losses that have
been limited to the stop-losses described above and put
their capital back into the market right away in defensive
stocks they understand and can live with through the hard
times. Then investors can hang in there until the market
goes back up, which will happen eventually unless the
whole system collapses.
In a world beset by uncertainties, taking on a lot of debt is

inadvisable, for both personal and business success. A
return to fundamental values, including integrity, clarity,
and simplicity, will go a long way toward making sure your
portfolio will not be the victim of the next Enron. When we
can take this kind of occurrence in stride, through effective
diversification, other companies and opportunities will
surely arise that are attractive to the prudent investor.
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Signals a Market is Going Back Up
In terms of market timing, we don’t make big adjustments

based on our guess as to whether the market will go up or
down. For us, it comes back to the individual issues within
a portfolio and the belief that our economic system is
basically sound, which means that the long-term trend of
the market is up. Our selection of individual companies
begins with our perception of where we are in the overall
economic cycle. If we think we are hitting a low point in
terms of general economic numbers – GDP figures,
industrial production, etc. – and that six to nine months
from now we will see better earnings results than we see
today, that’s a strong signal to buy. It is rare to have a clear
signal.
Given the amount of liquidity that had been put into the
financial system to prop it up and reinstall confidence after
the terrorist attacks in 2001, it was hard to feel that a short-
term rally would not take place. The unprecedented number
of interest rate cuts during that year signaled a tremendous
boom in economic activity at some point down the road.
For the first time in my 20-year career, I was compelled to
ask people not to buy any long-term bonds, which we
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generally think is an important part of a portfolio. I think

the right way to own $100,000 in bonds, for example, is to
own 10 bonds of $10,000 each, with one maturing every
year for 10 years. Sometimes there are reasons for holding
that money in cash, because all of the signs of economic
activity point toward an economic rebound. It’s not that the
Fed can actually move the economy or the market, but they
have an influence. When examining consumer confidence
and business spending, it’s really hard to know the truth,
because the financial media have their own spin on things.
In the final analysis, it is not necessary to predict, only to
take a well-though-out position and stick with it while
adjusting for company successes and failures.
Understanding the Direction of Stocks
When trying to pick a particular stock and understand

where it is going, it’s rare that we make a final decision
based on an analysis solely dependent on the numbers.
Though it is an important piece of what we do, it is more of
a second step in terms of checking out the ability of a
company to execute its goals with respect to specific time
frames and capital requirements. Some of our basic criteria
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are checking basic ratios and valuations, since we do not

want to pay too high a multiple on earnings based on
forward PEs – i.e., next year’s profit projections. For
example, if the S&P 500 is trading at about 22 times next
year’s expected earnings, whether or not those expected
earnings are accurate is a seminal question.
There is a relevant benchmark for each company in terms

of whether you are willing to pay over or under that sector
of the market’s traditional multiple, say 15 times earnings
on retail stocks or 30 times earnings on pharmaceutical
companies. Of course, you then also want to compare that
against historic growth and then against two- to five-year
expected growth. I think that’s a dangerous game to play,
because we just came out of a period during which growth
and corporate earnings were accelerated for specific areas
of the economy at the basic expense of others. A
tremendous amount of capital was directed toward the
technology sector at the expense of everything else, but in
particular, many of the industrial sectors suffered. To say
that technology should now be expected to grow at a faster
rate is sort of a joke because we are seeing the reversal of
some of those money-flow trends that lead to ever more
aggressive staffing of more and more people. As a result
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we’re not inclined to be big believers in peg ratios, for

example. It’s a part of the equation, but we recognize that
we have seen some extraordinary things happen over the
past five to six years that are likely to be a little different
over the next five to six years. For example, if you lay out
the scenario for entering a more inflationary period going
forward, there are tremendous implications for certain areas
of the market that are still largely neglected by a lot of
investors, such as basic materials and capital goods.
There is a historical price band that companies tend to sell

within. Drug companies are more expensive than aluminum
companies. It’s important that individual investors look at
the historical range of a price-earnings ratio, and try not to
buy a stock when it’s at the high end of the historical range.
At that point, the price of the stock takes into account the
change in earnings of the company in the economic
environment. To put it more simply, if a company is selling
over its historical price-earnings ratio by a significant
amount, it’s probably not a good time to buy it – unless the
company is about to metamorphose from a utility company
to a huge energy-trading company and, therefore, deserves
the higher evaluation. The Bloomberg system has a chart
called the price-earning band. It shows where a company
248
sits relative to its historical price-earnings ratio and where

the trend line is going. With this in mind, we are looking
for companies that are selling substantially below their
historical price where the trend line is moving back up. Our
goal of this kind of investing is to not be caught unaware by
bad news.
Consumer Confidence
The belief that good news is right around the corner seems
to be necessary for the sustenance of the American way of
life. It gives most of us the energy to keep coming back to
the marketplace with the resolve to pick up the pieces and
go on, even when things are difficult. This optimism about
rebuilding is a good thing because bad news is common
these days, and the worst of the bad news, as far as the
markets are concerned, is the continued prospect for long-
term uncertainty. I don’t feel most people fully appreciate
the potential downside of what I call a “crisis of
confidence.”
According to comments by former Federal Reserve Board

Chairman Paul Volker, the single most important factor
249
Inside The Minds
negatively affecting the markets is anxiety surrounding

America’s uncertainty as to what will come next.
Confusion about the potential devastating effects on the
economy that even the vaguest dangers produce has put
most economic forecasts in doubt. Fortunately, individual
investors have, for the most part, shrugged off these
worries and, acting out of common sense, carry on with
their daily lives. This is a key to successful investing:
ignoring the politically motivated announcements about
short-term economic indicators and focusing on long-term
health.
Regardless of what anyone says, it seems clear that the

state of the world economy is far more difficult to correctly
assess than most people appreciate. The U.S. economy
today looks as though it may have periods of sustained
increased unemployment. To this I think we must we add
higher costs of doing business due to security costs. Thus,
we are likely to see a long-term lowering of valuations for
the stock market as a whole. This would lend credence to
the theory that the speculative bubble of the late 1990s
might be followed by a significant period of historical
underperformance on the part of financial assets.
250
In the long run, we know all things run in cycles. What

matters now is that those of us involved in long-term
investing look beyond the current cycle and think ahead to
what will be coming. The business cycles of the past
decade were led by productivity-enhancing devices, and
this led to above-normal economic growth during most of
the 1990s.
Unfortunately, it is possible that now, under the specter of

continued disruptions to normal business activity, we are
likely to see more money going to defense, security,
information technology reliability, shipping costs, and
insurance, and that overall, our nation’s productivity will
go down, at least in the short run. This, to me, is the major
economic downside of any crisis of confidence. If things
pan out in this fashion, it will be as if we have succumbed
to terrorism’s main objective, which is to disrupt. Because
we are in a sustained period of psychological warfare,
fought over ideology through public relations and selective
information releases, our government and industry will
need to spend a great deal of time, effort, and money on
making Americans feel secure. What result will actually be
achieved in all this is debatable. What is not a question is
251
Inside The Minds
that we will all end up paying dearly for an environment of

fear.
Most people are not overly worried about their personal

safety but have a general sense of unease about the
economic future of the country. This is not to say that
stocks and bonds will not be productive in the upcoming
years, but that we will have to work harder to achieve less
than we came to previously expect. Each of us has the
opportunity to look around and move forward on our own,
given the incredible opportunities and resources that are
still available to us. The markets operate on a collective
sense of security, and we can achieve this if the common
ideals of freedom, true democracy, and rule of law hold
sway as they always have in the past.
Though the sense of comfort and predictability has, in large

measure, gone away, the good news is that this has opened
the door to new ways of looking at things in our economy.
Such openness, while it may be expensive in the short run
in terms of overreactions, may, in the long run, afford us a
way of redesigning businesses not only to increase long-
term productivity, but perhaps also to bring a more
equitable sharing of the resources and benefits of the
252
modern world with all people around the globe. In this

vision, perhaps our criteria of long-term profitability will
even take into account intangibles such as quality of life
and environmental sustainability. Who knows?
The Golden Rules of Investing
In conclusion, here are some of my golden rules of

investing:
1. Don’t be a pig.
2. Maintain diversification, even when it’s painful.
3. When it feels bad, that’s the time to take investment
action.
4. Don’t look at your short-term results as being money
gained or lost; try to keep your eye on the long-term
perspective.
Investing is a counteremotional process. If you feel

comfortable while you’re investing, you’re probably not
making a realistic appraisal of all the things that could
change and derail the process. Just as important, our firm
intends to continue “buy quality” at reasonable prices.
253
Inside The Minds
Remember to admit your inevitable mistakes early; don’t

think you know when a stock has reached its peak; and take
your losses early, rather than late.
Keep in mind the absolute necessity of getting to know the

management of the companies into which you are buying.
There is a widespread recognition that, because of the bear
market of 2000-2001, investing through traditional methods
of research and analysis is getting harder and involves more
independent thinking now than was required in the past.
Many people are torn about how new methods of electronic
communication, heated competition, and increased
disclosure will change the investment world. Enron was on
the dark side of this change, and the new winners will be
those who can think outside the box, act honorably, and
exhibit fiscal restraint while taking long-term risks.
Robert Allen Rikoon has been a registered investment

advisor since 1983. He founded Rikoon Investment
Advisors, Inc. (RIA), located in Santa Fe, New Mexico, in
1987. After receiving his BA from Harvard University in
1977 and an MBA from the University of New Mexico in
1981, Mr. Rikoon managed trust departments for eight
254
years for First Interstate Bank (now Wells Fargo) and

Idaho First National (now NationsBank). In 1987 RIA, Inc.
began with 10 clients and $10 million in assets. Thirteen
years later RIA, Inc. served more than 150 client families
with more than $300 million in assets by providing
investment advice and supervision of overall financial
affairs for individuals and families, nonprofit
organizations, foundations, and business retirement plans.
In October 2000 Rikoon Investment Advisors merged with
Carret and Company, LLC of New York City to form
Rikoon-Carret Investment Advisors in Santa Fe.
Mr. Rikoon specializes in advising trust beneficiaries on

how to assert control over investments in personal trusts.
His book, Managing Family Trusts, Taking Control of
Inherited Wealth, was published by John Wiley, New York,
in July 1999.
255
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Inside the Minds: Building a $1,000,000 Nest Egg (ISBN: 1587622157)
Building a $1,000,000 Nest Egg is an inside look at how ANYONE can save a million
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Inside the Minds: Leading Intellectual Property Lawyers (ISBN:1587621606)

IP Experts Share Their Knowledge on the Art & Science of Intellectual Property
Inside the Minds: Leading Intellectual Property Lawyers is written by IP chairs form
Blank Rome, Colley Godward, Debevoise & Plimpton, Foley & Lardner, Hogan &
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infringement, assignment, licensing, Internet and technology related issues, client
psychology and other important issues affecting the future of intellectual property. Also
covered are specific, proven legal strategies practiced by the leading IP attorneys of the
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Inside the Minds: Leading Labor Lawyers (ISBN: 1587621614)

Labor Experts Share Their Knowledge on the Art & Science of Labor Law
Inside the Minds: Leading Labor Lawyers is written by the Labor chairs from Morrison
& Foerster, Thelen Reid & Priest, Wilson Sonsini, Perkins Coie and more. These
Leading Labor Lawyers reveal the secrets to the art and science of labor law,
employment contracts, hiring and firing, non-competes, infringement, litigation, privacy,
Internet and technology related issues, client psychology and other important issues
affecting the future of labor law. Also covered are specific, proven legal strategies
practiced by the leading labor attorneys of the world.
Bigwig Briefs: Term Sheets & Valuations (ISBN: 1587620685)

A Detailed Look at the Intricacies of Term Sheets & Valuations
Bigwig Briefs: Term Sheets & Valuations is the first ever in-depth look at the nuts and
bolts of terms sheets and valuations. The book, written by leading venture capitalist
Alexander Wilmerding of Boston Capital Ventures, covers topics such What is a Term
Sheet, How to Examine a Term Sheet, A Section-by-Section View of a Term Sheet,
Valuations, What Every Entrepreneur & Executive Needs to Know About Term Sheets,
Valuation Parameters, and East Coast Versus West Coast Rules. In addition, the book
includes an actual term sheet from a leading law firm with line by line descriptions of
each clause, what can/should be negotiated, and the important points to pay attention to.
A must have book for any executive, entrepreneur, or financial professional.
Inside the Minds: Venture Capitalists (ISBN: 1587620014)
Inside the High Stakes and Fast Paced World of Venture Capital - Inside the Minds:
Venture Capitalists features leading partners from Softbank, ICG, Sequoia Capital,
CMGI, New Enterprise Associates, Bertelsmann Ventures, TA Associates, Kestrel
Venture Management, Blue Rock Capital, Novak Biddle Venture Partners, Mid-Atlantic
Venture Funds, Safeguard Scientific, Divine interVentures, and Boston Capital Ventures.
Learn how some of the best minds behind the Internet revolution value companies, assess
business models, and identify opportunities in the marketplace.
Inside the Minds: Leading Consultants (ISBN: 1587620596)

Industry Leaders Share Their Knowledge on the Future of the Consulting
Profession and Industry - Inside the Minds: Leading Consultants features leading
CEOs/Managing Partners from some of the world’s largest consulting companies. These
industry leaders share their knowledge on the future of the consulting industry, being an
effective team player, the everlasting effects of the Internet and technology,
compensation, managing client relationships, motivating others, teamwork, the future of
the consulting profession and other important topics.
Inside the Minds: Leading CEOs (ISBN: 1587620553)

Industry Leaders Share Their Knowledge on Management, Motivating Others, and
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compensation, motivating others, building and sustaining a profitable business in any
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Inside the Minds: Internet Bigwigs (ISBN: 1587620103)

Industry Experts Forecast the Future of the Internet Economy (After the
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market, emerging industries, international opportunities, and a plethora of other issues
affecting anyone with a “vested interest” in the Internet and technology revolution.
Bigwig Briefs: Management & Leadership (ISBN: 1587620146)

Industry Experts Reveal the Secrets How to Get There, Stay There, and Empower
Others That Work For You
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to break into higher ranks of management, how to become invaluable to your company,
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Industry Experts Reveal the Most Important Concepts From the First Phase of the
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These highly acclaimed executives explain where the future of the Internet economy is
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The Best of Guerrilla Marketing
Best selling author Jay Levinson shares the now world famous principles behind guerrilla
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Other Best Selling Business Books Include:
Inside the Minds: Internet Lawyers
Inside the Minds: Leading Accountants
Inside the Minds: Leading CTOs
Inside the Minds: Leading Deal Makers
Inside the Minds: Leading Wall St. Investors
Inside the Minds: Leading Investment Bankers
Inside the Minds: Internet BizDev
Inside the Minds: Internet CFOs
Inside the Minds: The New Health Care Industry
Inside the Minds: The Financial Services Industry
Inside the Minds: The Media Industry
Inside the Minds: The Real Estate Industry
Inside the Minds: The Automotive Industry
Inside the Minds: The Telecommunications Industry
Inside the Minds: The Semiconductor Industry
Bigwig Briefs: Term Sheets & Valuations
Bigwig Briefs: Venture Capital
Bigwig Briefs: Become a CEO
Bigwig Briefs: Become a CTO
Bigwig Briefs: Become a VP of BizDev
Bigwig Briefs: Become a CFO
Bigwig Briefs: Small Business Internet Advisor
Bigwig Briefs: Human Resources & Building a Winning Team
Bigwig Briefs: Career Options for MBAs
Bigwig Briefs: Career Options for Law School Students
Bigwig Briefs: Online Advertising
OneHourWiz: Becoming a Techie
OneHourWiz: Stock Options
OneHourWiz: Public Speaking
OneHourWiz: Making Your First Million
OneHourWiz: Internet Freelancing
OneHourWiz: Personal PR & Making a Name For Yourself
OneHourWiz: Landing Your First Job
OneHourWiz: Internet & Technology Careers (After the Shakedown)
Go to www.Aspatore.com for a
Complete List of Titles!

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About Aspatore Books

Business Intelligence From Industry Insiders

The Inside the Minds Series

About Big Brand Books

Inside The Minds:

First Printing, 2002

Cover design by Michael Lepera/Ariosto Graphics & Kara Yates

Edited by Jo Alice Hughes & Ginger Conlon

This book is printed on acid free paper.

A study conducted with over 5,000 top executives shows that

Aspatore Business Reviews

The Most Subscribed to Journals

Sanford B. Axelroth, Robert A. Studin 143

Gilda Borenstein 167

Robert G. Morris 201

Robert Allen Rikoon 219

Knowing When to Pull the Trigger

My personal approach to investing follows the classical

The art of investing has a couple of components that are not

priced; the markets are pretty efficient – that is, markets

The second part of the art of investing involves risk

For me, the art of investing is identifying a relationship you

saying this prospect has a better chance of paying me off

In looking at investors who succeed year in and year out, I

The Need to Change Strategy in Turbulent Markets

An investor’s style should change in several ways in a

great flux. For example, the market could move 10 percent

The second aspect of an investor’s approach that changes is

The third important thing in a turbulent market is to be

Even though I prefer to invest based on economic decision

Recently this has occurred on both sides. In the technology

Forecasting Market Direction

When a person asks where the market is heading, an

The direction of the stock market is quite often influenced

example, when stocks sold off rapidly in the fall of 1987, I

The second thing to watch when forecasting the market is

Investors don’t really forecast the absolute level of returns;

the growth rate of the economy and a look at the margin of

As with investing in turbulent markets, another factor an

To help you understand the market’s inclination, the thing

Fundamental and Technical Analysis

On the technical side of studying stocks and investments,

Groups of companies tend to cycle up and down. When one

Beyond the news flow issue, stock prices are always

On the fundamental side, a good investor can look at three

The second piece of analysis involves valuation. In

takes in its revenue, pays its expenses, and reinvests in its

I also look at relative valuation. For any company I am

The third thing to look at in a fundamental company

With timeliness, you look at trends in earnings and

When looking at business momentum, you look at the

When to Get In, When to Get Out

Deciding when it’s time to get in or out of a position is a

Sometimes, getting in or out of a position might be driven

For example, if the news flow going forward is neutral or

A lot of investors like to do what they can to avoid the risk

Getting out is about as tough as or tougher than getting in.

The art of investing is making good decisions when the

Nevertheless, if I see a stock reach my original sell criteria,

shouldn’t use your preset sell criteria as an automatic

Discipline, or having a process and sticking to it, is another

feels right to them. Although there are many ways to make

At the second level of discipline, you use that process on