Our Philosophy

Diversification

Not too long ago, an investment portfolio made up of strictly U.S. stocks and bonds provided ample diversification. Today, a diversified portfolio demands a variety of counterbalanced asset classes. Portfolios divided between only two asset classes tend to be more risky than a portfolio spread among a variety of asset classes. A well-diversified portfolio may include gold and precious metals, oil, timber, dividend-paying domestic stocks, international stocks, and fixed income. Although diversification cannot guarantee a portfolio from losses, proper diversification can help smooth out returns and reduce drastic swings in value. Retired and soon-to-be-retired investors tend to sleep better when portfolio volatility is reduced.

Our Efficient Frontier chart below illustrates benefits of diversification.

Note: We have made our calculations using a 10-year U.S. Treasury total return index from Young Research and a Large Capitalization Stock total return index from Young Research for the period 1871-2005. Young Research used data from the U.S. Treasury Department and Standard and Poor's to calculate their indices. The Efficient Frontier was calculated using annual returns and assumes annual rebalancing. Past performance is not indicative of future results.

The Efficient Frontier, using historical data, shows various portfolios invested in bonds and stocks. The vertical axis shows average annual returns. (Past performance figures, of course, do not guarantee similar performance in the future.) The horizontal axis measures risk. As you move along the horizontal axis, risk increases. Take a look at the diamond labeled "30% bonds / 70% stocks." It shows a return of 7.9% and risk of 13.2%. Now look at the diamond labeled "100% stocks." The return is not much greater for the all-stock portfolio. Your return improves only modestly, while greater risk is assumed.

Where do you best fit along an Efficient Frontier? Each investor has a different goal, and each mix of assets will vary. But in general, if you are in your 20s or 30s, you will achieve comfort and success in the upper right-hand corner of the chart. If you are in your 70s or older, you are most likely best served on the left-hand side of the chart. Those of you in your 50s and 60s fall somewhere in between.

Patience

Patience requires holding emotions in check. At no time in history have investors been subject to so much information. Technological advances, along with a 24-hour-hyped media force, provide investors with torrents of information on all things financial. This mix can easily lead to information overload, confusion, and emotionalism. Investors tend to feel they are "missing out," resulting in rash decisions. When patience and prudence are ignored, portfolios are at risk.

While we consider ourselves patient investors, instances do arise when positions need to be reduced or eliminated. Market and industry cycles, financial valuations, weather-related events, and global unrest are among the many factors that can trigger a transaction.

We urge you to practice discipline and patience. Attempting to forecast the market or nit-pick quarterly returns are efforts that need to be discouraged. You will find it easier to be patient if you first evaluate your personal risk tolerance, time horizon, age, and income needs. This process of evaluation will guide you and us toward achieving the diversification appropriate for your long-term goals.

The stock market, as measured by the S&P 500, has shown an affinity toward investors who are willing to remain patient by holding stocks over long periods of time. The three pie charts above show the percent of periods the stock market was down over various holding periods. In the 61 one-year periods from 1945-2005 the stock market was down in 14 years. In the 56 five-year periods the stock market declined in five of those periods, but in the 46 15-year periods the stock market was not down once. Patience has certainly proven itself as a virtue when it comes to investing.

Value and Compound Interest

When talking with investors about the power of dividends, we like to emphasize the following five points. Each makes a demanding case for the power of dividends, strengthened, of course, by the miracle of compound interest.

#1 Compound Interest Miracle: Albert Einstein described compound interest as "the greatest mathematical discovery of all time." Dividends always contribute to total returns and are your clear first choice as the raw material for compounding.

#2 Real Money: Companies that steadily increase dividends are usually durable businesses. Paying dividends requires cold, hard cash. When a company pays a dividend, there is a good probability that real earnings exist. The payout you receive in the form of a dividend is real money. Retained earnings (by a company), on the other hand, may or may not be reinvested to your benefit. And dividends can cushion your downside in bear markets.

#3 Dividends, the Control Factor: Ben Graham, the father of value investing, was adamant about the value of dividends. "For the vast majority of common stocks, the dividend record and prospects have always been a most important factor in controlling investment quality and value. In the majority of cases, the common has been influenced more markedly by the dividend than by reported earnings. In other words, distributed earnings have had a greater weight in determining market price than have retained earnings."

#4 Dividend-Payers Only: As Ben Graham wrote, "One of the most persuasive tests of high quality is an uninterrupted record of dividend payments going back over many years. A record of continuous dividend payments for the last 20 years or more is an important plus factor in a company's quality rating." In fact, Graham believed that "the defensive investor might be justified in limiting his purchases to those meeting this test."

#5 Profound Evidence: In a 10 July 2005 article in the Sunday New York Times: "At the end of the day, it is the compounding effect of these growing dividends, reinvested methodically in one's portfolio, that helps engineer big returns. For example, from 1995 to 2004 -- a period generally marked by a declining focus on dividends -- the S&P 500 rose 164 percent, based on appreciation. But by reinvesting small but growing dividends, investors earned 212 percent in total returns."