Key Investment Strategies Why is index investing so attractive? Index InvestingThe First Key of Strategic Investing INDEX & TRADITIONAL INVESTING. Under the heading "Wall Street Doesn’t Want You to Index" a senior columnist for the Wall Street Journal stated that index investing is "widely despised" by the professional investment community. The article explains that many mutual fund companies, brokers and financial planners "earn far fatter fees" and find it "easier to sell their services" if they avoid indexing and offer traditional investment strategies. (1) Traditional investing, in this context, refers to the process of selecting individual stocks in an effort to "beat the market." Indexing refers to the use of investment vehicles that replicate a market benchmark such as the Dow Jones Industrial Average, the S&P 500 and the NASDAQ Composite.THE FIRST INDEX FUND. One way to compare index and traditional investing is to compare index and traditional mutual funds. The first index fund, offered by Vanguard in 1976, was designed to replicate the performance of the S&P 500, a stock index of 500 of the nation’s largest companies. The concept was not popular in the beginning, but over time it became obvious that this strategy was beating the great majority of traditionally managed funds. As stated in an article in Forbes magazine: "Only one in three (traditionally) managed funds in operation since 1976 has beaten the Vanguard 500." (2) COST ADVANTAGE. What accounts for this poor relative performance by the traditional funds? The following chart gives us a good part of the answer. Assuming that both types of funds have identical gross returns, the average index fund starts with the following cost advantage over the average traditional fund: Index FundTraditional FundHypothetical Gross Return: 10.00 % 10.00 % Less Average Management Fees: (3)0.491.48Less Average Trading Costs: (4)0.251.30Assumed Net Return: 9.26 % 7.22 % Index Fund Cost Advantage: 2.04 % SUMMARY. The average traditional fund must add about 2.0% per year in performance just to break even with the average indexed competition. History shows that only about one out of three funds is able to clear this significant hurdle. (2) In addition, there is no reliable way to know, in advance, which traditional funds will fall into this index beating category. And note that these conclusions apply not only to traditional mutual funds but also to portfolios of individual stocks promoted by brokers and investment newsletters. In contrast, we invest primarily in index and other passive type funds and make available to our clients the significant cost advantage associated with this investment strategy. NOTE: The sole purpose of the above chart is to demonstrate the cost differential between two investment strategies. No inferences should be drawn from these figures regarding the past or future performance of either the general stock market or of managed client accounts. The fees and costs quoted above will fluctuate over time.Sources: (1) Jonathan Clements, The Wall Street Journal Sunday, August 3, 2003 (2) Michael Maiello and James M. Clash, Forbes, February 3, 2003 (3) Morningstar Principia ("Mutual Funds Advanced"), September 30, 2002 (4) Joseph Nocera, Money, April 1999 John C. Bogle, Common Sense on Mutual Funds, 1999 What is asset class diversification and why is it so important? Asset Class DiversificationThe Second Key of Strategic InvestingASSET CLASS DIVERSIFICATION. Most of the portfolios we review for prospective clients, even those with a large number of stocks or mutual funds, are not properly diversified. They tend to be concentrated in one major asset category, typically large company stocks. The objective of asset class diversification is to utilize multiple investment categories that (1) are uncorrelated with one another, that is, some categories may be advancing while others may be declining, and that (2) produce similar or competitive rates of return over time. Examples of such asset classes include large company stocks, mid-size company stocks, small company stocks, international holdings and real estate securities.CONCLUSION. Broad diversification across uncorrelated asset classes is the second key of strategic investing. How does the advisor reduce my investment costs? Reducing CostsThe Third Key of Strategic Investing A DOLLAR SAVED. The old expression (updated to allow for inflation) “a dollar saved is a dollar earned” is directly applicable to maximizing investor returns. At Stephens Asset Management we make every effort to keep investment costs as low as possible and every dollar thus saved is passed on directly to the investor in the form of higher portfolio values. These cost savings include, but are not limited to, the following items:DISCOUNT BROKERAGE. We use discount brokerage firms, such as Charles Schwab & Co., to reduce trading costs. These firms offer trading costs that are significantly less than those at traditional brokerage houses. LOW OVERHEAD. We carefully screen competitive products to ensure that those with the lowest overhead will be selected. For example, if one fund charges management fees of 0.50% and another charges only 0.20%, all other things being equal, we will select the fund with the lower cost. INDEX FUNDS. We use a combination of exchange traded funds (ETFs), Index funds and passive funds to reduce total operating expenses. Studies have indicated that index funds start with about a 2.0% cost advantage over traditional funds (see Index Investing). FLEXIBLE FEE SCHEDULE. Clients choose which fee schedule best fits their needs. Hourly fees, percentage fees and retainer fees are all offered with a choice of office based or phone based support services (see Fee Schedule). Does the advisor utilize tax-advantaged strategies? Tax-Advantaged StrategiesThe Fourth Key of Stratgic InvestingMAXIMIZING TAX DEDUCTIBLE CONTRIBUTIONS. We assist clients in establishing and then maximizing their contributions to tax qualified retirement plans, including IRAs, 401(k)s, 403(b)s and other retirement plans (see Retirement Accounts). INDEX & TAX-MANAGED FUNDS. Index and tax-managed funds typically trade much less often than traditional funds and thus generate, on average, less taxable gains in a given calendar year. In this way, index investing is inherently more tax efficient than traditional fund investing. TAX DEFERRED INVESTMENTS. When appropriate, we will assist clients in establishing and funding variable and fixed annuities. Traditional annuities often come with high commissions and high management costs. At Stephens Asset Management we utilize only commission free, surrender charge free, and low overhead annuities. REDUCING TAXABLE GAINS.TAX LOSS HARVESTING. Withdrawals from accounts often generate significant taxable gains. We help the client organize the order of withdrawals so that taxable gains are planned and reduced. CPA COORDINATION. With the client’s authorization, we review tax returns and consult with the client’s CPA to help ensure that the client is taking advantage of all appropriate tax strategies.