Wise Money: Using the Endowment Investment Approach to Minimize Volatility and Increase Control

Wise Money: Using the Endowment Investment Approach to Minimize Volatility and Increase Control

by Daniel Wildermuth

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Product Details

ISBN-13: 9780071798044
Publisher: McGraw-Hill Professional Publishing
Publication date: 08/03/2012
Pages: 272
Product dimensions: 6.30(w) x 9.08(h) x 1.04(d)

About the Author

Daniel Wildermuth is the founder and CEO of the investment brokerage firm Kalos Capital, Inc. and the money management firm Kalos Management, Inc. Author of How to Keep and Grow Your Retirement Assets, he has been profiled on CNBC and BRAVO and in Forbes magazine for his expertise in advanced portfolio strategies for individual investors.

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WISE MONEY

Using the Endowment Investment Approach to Minimize Volatility and Increase Control


By DANIEL WILDERMUTH

The McGraw-Hill Companies, Inc.

Copyright © 2012Daniel Wildermuth
All rights reserved.
ISBN: 978-0-07-179805-1


Excerpt

CHAPTER 1

The Need for a New Strategy


The years 2008 and 2009 treated the average investor very poorly. Stock market losses in 2008 were horrific at 37.0 percent for the Standard & Poor's 500 Index (S&P 500) while the average equity sector mutual fund lost 39.70 percent. The average American worker lost over one-quarter of his or her 401(k) retirement plan savings in 2008. The beginning of 2009 continued the trend with the market declining more than 26 percent before sharply reversing as general panic subsided. The market actually ended up 26.5 percent in 2009.

The tremendous losses and volatility of these months and years left most investors not only frustrated but also often completely bewildered and overwhelmed. In addition, many supposedly safe investments suffered rough rides. In 2008, even investment-grade corporate bonds lost 5.3 percent. Almost the only place to hide seemed to be certificates of deposit or government bonds because they were the only assets seen as riskless during a time of tremendous uncertainty.

During this period of continuous tumult, I heard investors, journalists, and pundits echo similar sentiments that emphasized the horror of the situation and the futility of avoiding it. Others chose to dwell on the obvious challenges that only seemed to heighten the current panic. The overemphasis on near-term problems often resulted in recommendations to sell when challenges looked the worst and asset valuations were the lowest. The results were disastrous as far too many people, especially individual investors, unloaded their severely discounted investments at exactly the wrong time.

Of course, the drop in the markets brought out inevitable claims that we should have seen this coming and somehow timed the sale of investments. While this sounds wonderful, clairvoyance eludes nearly all of us. How do we know ahead of time that corporations will lose money, banks will stop lending, or people will panic?

This simple answer seems to be that we can't, and we don't. I don't believe this situation will change. Moreover, the same reality apparently applies to even the world's most sophisticated and resourced investors. During this downfall, much of the downward pressure on the markets resulted from professionals unloading their holdings. The world's largest banks and hedge funds often sold at huge losses at the worst possible time to deleverage their balance sheets. They needed cash at all costs just when cash was most expensive.

If the experts and investment insiders couldn't get it right and in this downturn often contributed to the disaster, how can individual investors avoid disasters? Unfortunately, I believe it's nearly impossible unless you completely avoid any type of investment vehicle. In most cases, however, a risk-free portfolio mandates holding only CDs or government bonds. Over a longer time frame, the loss of purchasing power resulting from lack of return can pose a greater risk to nearly any investor than potential investment losses. As a result, most people must assume some type of risk in order to generate real investment returns.

Yet when pondering investments in stocks, the question isn't will the stock market crash or will we have another crisis. It's a matter of when. The economy will almost certainly experience major challenges in the future and new technology developments will disrupt established industries or even national economies. In fact, the accelerating pace of change in seemingly every area of life suggests more frequent crises and challenges. The stability of 20, 30, or even 50 years is probably just a memory rather than a likely future. The introduction of the microchip into our daily lives likely ensures that nearly everything will permanently move at a faster and faster pace, including economic ups and downs.

So, if I'm saying that you can't avoid or foresee problems well enough to completely avoid them, and avoiding risk isn't really a viable strategy, what options are there? After all, more traditional investment approaches that emphasize stocks and bonds have provided both poor returns and tremendous volatility over the past decade. Given this environment and the likely unpredictability of global markets in the future, what can investors do?

Very simply, I believe more consistent and predictable success requires a different investment approach. The strategy utilized must be capable of weathering inevitable storms regardless of size and duration. The approach must provide the performance and stability most investors need while also satisfying income and liquidity requirements. Of course, this sounds wonderful, but is it possible?

I believe the answer is yes. The strategy I'm referring to has been developed and successfully employed by many of the world's wealthiest and most successful university endowments as well as institutions and private wealth managers across the globe. Endowments and institutions, with very large amounts of money at stake and very substantial intellectual capital, believed there was a better way to excel in a rapidly changing world. They developed an approach often referred to as the "endowment strategy," which deviates significantly from the traditional stock and bond models of yesteryear. The strategy isn't new; it's just not familiar to most individual investors.

Sophisticated endowments recognized that changes in the global economy and investment landscape provide new opportunities to increase returns while also lowering portfolio volatility. Moreover, these same institutions determined that success requires breaking from dated models and strategies developed for a dramatically different world and historical context.

Their performance illustrates their success. The average U.S. investor with a 60 percent stock and 40 percent bond portfolio earned exactly 0.00 percent for the 10-year period starting January 1, 2000, assuming modest fees of 2.0 percent for stocks and 0.5 percent for bonds. Unfortunately, most studies reveal that the average individual didn't do nearly this well, as the performance of most investors dramatically trail that of broad market indexes. By contrast, Yale, Harvard, and Stanford's endowments enjoyed a solid run over the same time period with returns across the three averaging just under 10 percent per year, including all fees.

You may be thinking that this strategy must be too complex or difficult for the average investor to adopt. Or, your lack of billions must prevent you from accessing the investments that have enabled the endowments to achieve their success. Not only do I believe the average investor can successfully employ this strategy, various other experts do too.

A broad study by the Journal of Wealth Management highlights investor possibilities. Very simply, the journal claims that investment returns earned by endowments resulted primarily from strategies replicable by individual investors. More specifically, after a very thorough review of Yale's performance during the 20-year period ending in fiscal year 2007, the Journal of Wealth Management concluded that even Yale's endowment management showed little skill or luck in selecting managers outside of the category of private equity. Their review of the 10-year data supported the same conclusion.

The source of the Yale endowment's success is critical. It results from the asset classes the institution invests in rather than the superior management of the funds within the asset class. With the exception of private equity for Yale, success derives from original investment choices, not contacts, managers, or skills out of the reach of any individual investor.

This conclusion bears repeating. Success results from strategy, not exceptiona
(Continues...)


Excerpted from WISE MONEY by DANIEL WILDERMUTH. Copyright © 2012 by Daniel Wildermuth. Excerpted by permission of The McGraw-Hill Companies, Inc..
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

Table of Contents

From the Author vii

1 The Need for a New Strategy 1

2 The Standard Investment Approach 9

3 The Endowment Model 17

4 Results 29

5 Recognizing Opportunity 37

6 Investor Needs 47

7 Domestic Equities 67

8 International Equities 85

9 Real Assets 101

10 Private Equity: A Stronger Move into Nontraditional Asset Classes 149

11 Absolute Return 167

12 Miscellaneous Types of Investments 185

13 Fixed Income 199

14 Putting It All Together 221

Endnotes 235

Index 247

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