Zaks Investment Advisory Service

Model Portfolios on ZaksInvest.com Web Site – Part I

In previous programs, we talked about various financial instruments. This information is essential to making reasonable investment decisions, or at least to being able to understand professional advice. But right now we will take a pause to talk about the Zaks Investment Advisory Services Web site. The fact is, the site has lots of information on it, which is both fairly interesting and useful, but some of it needs to be explained.

If you go on the www.zaksinvest.com site, you will find that one of its tabs is called Portfolios. If you go to that page, the first thing to catch your eye will be a chart. The heading explains that the chart reflects the annualized rates of return of four portfolios, that three of them are Model portfolios, and that one – called Baseline – is a market portfolio to which the other three are being compared. In what sense are these portfolios “Model” ones, and how were their annualized returns calculated?

The portfolios are “Model” only in the sense that these are not actual portfolios of specific clients. According to the laws of our state and the SEC, I could not simply show off a client’s portfolio. But these are very real portfolios, made up of certain financial instruments that are described in detail on other pages of our site. All of the returns are calculated daily after the markets close, on the basis of market data. The portfolios are subdivided into three categories according to their risk: moderately conservative, average risk, and slightly more aggressive than average. These portfolios correspond to client classes: some prefer not to risk too much, others take a neutral view of risk, and someone else might want to create a riskier profile and at the same time, perhaps, see a higher rate of return. I would like to remind you what we mean by a portfolio’s risk: we associate risk with inconsistency and variability of returns. In other words, some portfolios produce approximately the same results year after year, (we would say that they have small variability of returns), while others soar up one year and fall the next, their returns spread all of the place; these portfolios have high variability of returns. In one of our previous programs, we even discussed t a method to calculating the level of variability of returns: it is called the standard deviation. This mathematical concept measures the variability level: the greater the variability (and the risk of a portfolio), the higher the standard deviation’s value. And, as we also mentioned in several of our programs, the riskier the portfolio, the potentially higher its return.

Take another look at the chart on our Web site. We see that a red graph runs on top. Over the entire course of last year, it was higher than all the other graphs. This graph represents the annualized returns of a Moderately Aggressive portfolio (it is marked by the letters MA). At the end of May 2007, its annualized return was about 19 percent. This annualized return was calculated for a three-year period. For reference: $1,000 at an annualized return rate of 19 percent over three years turns into $1,685. The graph itself shows you the annualized return rates over the past year. For example, one year ago, i.e. at the start of June 2006, the average annual return for the preceding three years (i.e. from the start of June 2003 through the start of June 2006) was also about 19 percent. At the start of January 2007, the annualized return rate was about 17 percent. But the Moderately Aggressive portfolio still had a higher rate of return than the other portfolios at every point of the preceding 12 months.

The second-best return was by a portfolio we called Basic. It is represented by the green graph and the letters BP, Basic Portfolio. At the end of May 2007, the Basic portfolio's average annual return stood at about 15 percent for the preceding three years. Thus, the less risky Basic portfolio’s return came in slightly below the riskier one’s. How do we know that this Model portfolio was less risky than the so-called Moderately Aggressive one? The table below the chart has a column called Standard Deviation. It shows that the Model portfolio’s standard deviation of returns was about 2.5 percent, while that of the Moderately Aggressive one’s was about 2.8 percent. As the text explains, the standard deviation is calculated based on monthly returns.

Here I would like to make one more observation. The fact that a certain portfolio carries more risk in no way guarantees that it will out-perform the market. For that, the portfolio must be efficiently constructed. We will discuss this notion in our next program.

I would like to remind our listeners that both the Basic and Moderately Aggressive portfolios achieved excellent results. We talked about how, historically, stocks return about 10-12 percent a year. We also mentioned that shares of small companies historically have had better returns, but were also riskier. The market, on average, grew over the past three years, so the fact that these two portfolios showed good results is not surprising in and of itself. However, the Market portfolio, to which we will return in our next program, grew by about 13 percent. So even our Basic portfolio came out fairly far ahead of the Market one. Meanwhile, the Moderately Aggressive portfolio outpaced the Market one by an average of six percent over the past three years.

And what were the returns of your investments for the past three years? If you know, you may compare them to our Model portfolios. If not, contact us and we will calculate them for you. This was Sergey Zaks. Thank you for your attention and until next time.