September 2008 - The Parklander Magazine

FINANCIAL INFO
Composing Your Financial Symphony
By John Abrams
My son, Matthew has just completed his first year at the Frost School of
Music at the University of Miami. One of his objectives is to develop his
craft of music composition. He has enlightened me with the sounds of
Bach, Beethoven, Brahms, Roger Sessions, and John Cage.
Any composer of serious music will tell you that creating a symphonic
work is a delicate balance of sounds, melodies, dissonance and
harmonies. Each instrument creates unique sounds, vibrations and
timbres and when heard alone, may not create the effect intended by the
composer. For instance, a flute may not have the colorful sounds, but
when introduced with the sounds of oboes, French horns, and clarinets,
you have the beginning of a masterful composition. Hence, the true art
of creating a masterpiece is combining melodies, counterpoint and
harmonies which results in intended blended sounds.
In this respect, composers and investors share some similarities.
Successful investing typically combines a number of different
investments of various durations simultaneously in order to create a
portfolio that is “in tune” with the investor’s goals and objectives. It’s no
coincidence that such a technique is the foundation for one of the most
basic financial investment principles- asset allocation.
Asset allocation is the process of attempting to decrease financial risk by
investing monies in different asset classes. The major asset classes that
investors are familiar with include stocks, bonds, and cash; however, there
are dozens of other asset classes, i.e., real estate, currencies, commodities,
derivatives, etc., that can make up an entire masterful well- diversified
portfolio. Mutual funds often represent a combination of asset classes, but
they may consist of just one asset category, such as a gold fund. At that
point an exchange traded fund (ETF) may be a better “instrument”
because of liquidity, lower management costs and individual ownership.
Overall, asset allocation may help reduce investment risk or “beta” while
achieving potentially higher returns. That’s because different categories
of investments react differently to specific changes in the economy,
interest rates and geopolitical landscape.
Now, in 2008, stock values are plummeting within the major indexes,
however bond values are also decreasing, especially those with shorter
durations. This is due mostly to the Fed Chairman, Ben Bernanke,
lowering the Fed Funds rate to 2.00 % which inversely raises the prices of
those bonds. Does this necessarily lower the prices of stocks on Wall
Street Not necessarily. As we saw the Fed lower the rates, we saw the
stock market go up in prices.
So, opposing correlations between asset classes typically reflect
the supply and demand in those markets. For example: when the demand in
bonds increase it’s usually because the interest rates are raised higher, and the
money usually shifts out of the stock markets into bonds, because higher
rates translate into higher costs for corporations and banks.
The problem with trying to create an asset allocation today is that the
stock market is now a bear market (20% down from its high on
10/08/2007), and the bond yields are going up because of inflationary
pressures. If you allocate into bonds, you will lose value as the bond yields
move up, an inverse relationship. If you move into stocks, you will lose
value as the Fed can’t lower rates any more to help spur more growth.This
is the scenario of a recession that most economists will recognize probably
later this year. If this recession becomes global, then it will become more
protracted. So how do you asset allocate your portfolio There are many
asset classes to move into other than stocks, bonds, or cash.
We’ll cover those asset classes next month when we compose our
greatest composition that is music to our portfolios.
132 SEPTEMBER 2008
John Abrams is an Investment Specialist, and a Financial Services
Representative for Cypress Financial Group, an office of MetLife.