The Jacobs Financial Group

Tactical Asset Allocation: Fine Tuning a Longer-Term Strategy

Strategic asset allocation, the practice of maintaining a strategic mix of stocks, bonds, and cash, has guided many investors in creating portfolios that suit their risk profile and long-term investing goals. This widely used strategy is a long-term, relatively static tool and is not intended to take advantage of short-term market opportunities.

Proponents of tactical asset allocation (TAA), in contrast, take a shorter-term view. TAA is the practice of shifting an asset allocation by relatively small amounts (typically 5% or 10%) to capitalize on economic or market conditions that may offer near-term opportunities. TAA differs from rebalancing, which involves periodic adjustments to your strategic allocation as a result of portfolio drift or a change in personal circumstances. With tactical asset allocation, you maintain a strategic allocation target, but fine tune the exact mix based on expectations of what you believe will happen in the financial markets.

Assessing Risk and Return

For example, suppose an investor started with an initial target mix of 60% stocks and 40% bonds on October 1, 2011. Believing that the stock market was undervalued and a recovery was in sight, the investor switched the allocation to 70% stocks and 30% bonds on that date. Between the date of the allocation change and March 23, 2012, the revised 70/30 allocation would have generated a return of 15.1% compared with the 60/40 allocation, which would have returned 13.2%.

Tactical asset allocation also can work on the downside. For example, suppose a hypothetical investor, sensing trouble in the financial markets in light of the credit crisis, reduced an initial allocation of 60% stocks/40% bonds to 50% stocks/50% bonds on October 1, 2007. Between the date of the allocation change and May 1, 2008, the 50/50 allocation would have generated a return of -1.6%, compared with a return of -2.9% for the original 60/40 mix.

Within an Asset Class

TAA also can involve shifting allocations within an asset class. For example, an equity portion of a portfolio may be shifted to include more small-cap stocks, more large-cap stocks, or other areas where an investor perceives a short-term opportunity. Note that mutual funds that invest in these areas may impose restrictions on short-term trading, and it is important to understand these restrictions before making an investment.

A tactical approach involves making a judgment call on where you think the economy and the financial markets may be headed. Accordingly, a tactical allocation strategy can increase portfolio risk, especially if tactical allocations emphasize riskier asset classes. This is why it may be a good idea to set percentage limits on allocation shifts and time limits on how long you want to keep these shifts in place.

In addition, when evaluating investment gains that are short-term in nature, such as those on investments held for one year or less, it is important to understand taxes on short-term capital gains. Currently, short-term capital gains are taxed as ordinary income, where the highest marginal tax rate is 35%. In contrast, long-term capital gains on investments held for more than one year are taxed at 15%.

May 2012 — This column is produced and is provided by The Jacobs Financial Group. (04-12)

Buying Decisions: Assessing a Business’ Worth

When purchasing a company, how do you settle on a fair price? There are steps you can take to better ensure a reasonable return on your investment for the amount of business risk undertaken.

Due Diligence

First, it is important to understand why the business is on the market. Is the owner retiring, selling for personal reasons, or simply lacking the expertise needed to run the business? Is the company profitable or losing money and in need of new management?

To answer these questions, review the history of the business and how it functions. You should understand the company’s customers and how its different departments work together. Examine the financial statements, including accounts payable and outstanding debt, as well as a list of inventory and equipment.

You should also review key employees, suppliers, leases, legal issues (such as zoning, government regulations, and lawsuits), insurance and taxes, notes and mortgages payable, and any proprietary information, including patents.

Additionally, ask about the ownership structure. Is it a sole proprietorship? A limited liability company? Are there outside interests involved? Also analyze how the business fits within its industry. Is it a viable competitor? Why, or why not?

Evaluating Value

If the business appears attractive thus far, you are ready to run the numbers. To gauge a rough idea of value, you can use the multiple of earnings approach. This calculation is based on annual actual earnings before interest and taxes (EBIT). Here are some general guidelines:

• Multiple of 8 to 10 times EBIT: A well-established and stable market leader that is likely to thrive regardless of management.

• Multiple of 5 to 7 times EBIT: An established company with a respectable market reputation that has inconsistent earnings and will need management guidance.

• Multiple of 2 to 4 times EBIT: An established company with significant competition and few assets that will need a strong management team.

• Multiple of 1 times EBIT: A small personal service company where the new owner will likely have few or no employees.

Don’t Go It Alone

Obtaining independent opinions can help buyer and seller agree upon a reasonable valuation to help seal the deal. Team members usually include an accountant, a business valuation expert, and an attorney. Ask your professional team for reputable candidates to consider for financing the sale. Begin exploring avenues early in the process as it may take time to find a lender and negotiate terms.

Purchasing a business is a tremendous undertaking. Conducting a thorough appraisal to ascertain value and tapping the expertise of competent advisors will hopefully result in a satisfying and rewarding endeavor.

May 2012 — This column is produced and is provided by The Jacobs Financial Group. (04-12)

Are Recent Stock Market Advances Sustainable?

The S&P 500 Index closed at 1402 on March 15, 2012, the first time the index closed above 1400 since June 5, 2008. The latest upward progression began in October 2011 when the debt crisis in Europe showed signs of receding and economic reports in the United States began displaying a more positive outlook. Between October 3, 2011, and March 23, 2012, the S&P 500 gained 27%, and U.S. investors have been riding a wave of mostly good news.

• Economic activity in the manufacturing sector, including new orders and production, expanded in February 2012 for the 31st consecutive month.

• Real gross domestic product, a gauge of economic growth, accelerated 3.0% during the fourth quarter of 2011, compared with 1.8% during the third quarter of the year.

• Although the unemployment rate remained high at 8.3% for February 2012, the rate declined from 9.0% in February 2011, creating optimism that the worst period of high unemployment may be over.

The question on the minds of many investors is: Will this momentum last, or is another crisis waiting in the wings? Risks remain, both within the United States as well as abroad. The European sovereign debt crisis appears to have stabilized, at least temporarily, thanks in part to the recent agreement among Greek private debt holders to accept a proposed restructuring of Greek sovereign bonds. If Europe is plunged into another crisis, Standard & Poor’s believes the fallout would affect U.S. business spending and equity prices.

Domestically, the recent escalation in oil prices has the potential to curtail consumer spending, especially if prices rise further. Standard & Poor’s estimated that each $10 increase in the price of a barrel of oil subtracts 20 basis points (.20%) from growth in gross domestic product in each of the subsequent two years following the price hike, assuming the cost remains elevated.

What Investors Can Do

Given questions that remain about the long-term health of the global economy, investors may want to consider the following:

• Consider overweighting equity holdings to U.S. stocks and emerging markets. This strategy could potentially avoid problems related to the euro zone. When analyzing potential holdings, review a company’s revenue sources to avoid significant exposure to Greece, Portugal, Italy, and other crisis-prone countries. In the United States, recent strong returns may create a scenario where the potential for future short-term gains is likely to be more muted.

• Keep bond holdings short term. Federal Reserve Chairman Ben Bernanke has stated that the Fed will continue to keep the federal funds rate low in an attempt to stimulate economic growth. But interest rates are likely to go up sometime, and when they do, bond prices are likely to fall. Consider keeping the majority of your bond holdings short term so that if interest rates increase unexpectedly, you will not be locked into long-term holdings that decline in value.

May 2012 — This column is produced and is provided by The Jacobs Financial Group. (04-12)

Do You Have Enough Disability Insurance?

The statistics are alarming: Nearly one-in-three Americans will become disabled for more than 90 days at some point during their working careers. Yet most workers don’t give a second thought to the need for disability insurance.

Many think they are covered through their employer’s benefit plans or sick leave policy, but this is often not the case. In fact, less than 40% of private-industry workers are covered by short-term disability insurance, while only 31% are covered by long-term disability insurance.

Even if you have insurance through an employer-provided plan, you may not be getting all the coverage you need. Typically, workplace group plans are structured to replace only about 60% of your salary for a set period of time. Could you and your family live on essentially half of your salary for a prolonged time frame? If you think you need more coverage, you may need to purchase a supplemental plan that will boost that replacement rate to 70% or 80% and increase the length of the payouts.

Finding the Right Coverage

What should you look for in a disability insurance policy? Here are some tips to help you find the right one.

• Understand the various definitions of disability. Some policies will cover you in the event you can no longer perform your “own occupation.” Others will cover you only if you can no longer do “any occupation.” Both tend to be expensive policies. A more wallet-friendly option will cover you for a “loss of earnings” disability. It is designed to make up the shortfall between what you earned before you were disabled and what you earn after.

• Define your time period. The average long-term disability claim is 31.2 months, or just under three years. Policies can be purchased for various time horizons, including up to your normal Social Security retirement age or for life. Bottom line: The longer your desired horizon, the larger the premiums.

• Premiums will go up with age. The older you are, the more you can expect to pay for your policy. Looking into disability coverage while you are younger could save you in the long run.

• Shop around. The coverage, riders, and premiums can vary widely from company to company. If you are shopping without the help of an independent agent, be sure to check out the policies from several firms and compare them carefully. You should also carefully review the strength ratings of the various insurers you consult – if the company you choose gets into financial trouble, you could find yourself holding a policy that pays out far less than you were promised.

May 2012 — This column is produced and is provided by The Jacobs Financial Group. (10-11)