Financial planner positions clients for ungenerous market

Portfolios simplified with expenses pruned and taxes minimized

Dollars & Sense


Harold Evensky, one of the nation's best-known certified financial planners, thinks it is time to get real about what the stock market will provide to investors.

"I haven't figured out why not a lot more discussion is taking place about this," he said. "The way almost everyone invests does not make sense."

In what he said is the biggest overhaul in the past 20 years, Evensky has realigned his clients' portfolios to make the most of a market that, at best, won't be making much money for stock investors.

His Coral Gables, Fla., firm, Evensky, Brown & Katz, manages or directs the investment of about $350 million for wealthy clients.

What doesn't make sense, he said, is investing the same way you did back when stocks were making or exceeding their historical average of more than 10 percent return a year.

For most people, the only strategy they used then was to try to get the biggest returns, ignoring what it might cost to achieve them.

But big returns are history now.

Jeremy Siegel, Wharton professor and author of Stocks For the Long Run, has predicted 7 percent annual returns in the next five years. Roger Ibbotson, the Yale professor and well-known stock researcher, puts the figure at 8.1 percent for large-company stocks.

Evensky put his pencil to Ibbotson's number. Start with an 8.1 percent annual return. Subtract expenses of 1 percentage point - you might pay more or less in commissions, sales fees or get someone else to manage your investments. Then figure that taxes at 20 percent - the long-term capital gains rate - will nick another 1.4 percentage points off your real return. That nets you 5.7 percent.

Next, he subtracts 3 percent inflation and what you're left with is 2.7 percent real return.

That's a stunningly small number. Compare it with the historical annual average of 10.2 percent total return for large-company stocks, according to Ibbotson's data from 1926 through 2002. If you subtract Evensky's 1 percentage point for expenses, then take off 20 percent for taxes or 1.84 percentage points, you have 7.36 percent left. Take away 3 percent inflation and you have a 4.36 percent real, after-tax return.

If you were to invest $10,000 at that rate, at the end of 15 years, you would have $18,968.

At 2.7 percent, you'd have only $14,913.

Evensky thinks that the only way the average investor can cope with those measly numbers is to carefully manage what is paid out in expenses and taxes.

What Evensky has been doing for his clients is simplify their portfolios, pay less in expenses by using fewer investment vehicles and work diligently on minimizing taxes.

His new method uses what he describes as a core and satellite approach. For the stock portion of the portfolio, he might put 80 percent of the assets in the core and 20 percent in the satellite. In the core, Evensky would put 50 percent into a single position, such as a Russell 3000 index using an exchange-traded fund. For the rest, 20 percent would go into mid-cap or small-cap value funds and another 10 percent into international funds.

In this way, he has only four investments that, by design, should not overlap and should attain his goal "of capturing the market return for each piece of the market." Previously, there might have been six investments used.

His goal is to lower costs, certainly, by paying fewer managers, but they should also trade less than a larger group of managers. That, too, will cut the investor's tax bill.

At the same time, the new design has changed how he handles risk.

Previously, Evensky was careful not to take a large risk on any one part of the portfolio, because he knew how much risk the investor could stand and he spread that around evenly. Once he had the assets spread out properly, it was pretty much set.

Now, because the core holdings aim to match the market and therefore don't carry any added threats, Evensky uses the satellite portion to buy more volatile and aggressive investments.

He's making tactical choices, buying such things as commodities or junk bonds or hedge funds, all with the idea that these investments should outperform what's in the core portfolio. Taxes and costs aren't the issue in the satellite. The idea is to jazz up the portfolio's overall return.

If the bets go wrong, Evensky said, he's become more aggressive about taking losses, in some cases, as often as monthly. Losses, for tax purposes, can be used to offset the tax due on gains elsewhere in the portfolio.

Every dime, just about, makes a difference, he said.

"If we can save half of 1 percent on expenses, that's a huge extra return," he said. "We think this is about the only way to make money in the future - to keep as much of what little is out there."

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