FINANCIAL NEWS YOU CAN USE: Capital preservation (04/02/06)

FINANCIAL NEWS YOU CAN USE

Capital preservation

by Walter Prochorenko

As we saw in our previous article, there are many ways in which we can accumulate capital and ensure that it grows. However, as many millionaires have found, one of the hardest tasks facing people with capital is actually its preservation. In a world where many companies and individuals know your personal financial situation, there are a great many covetous and enterprising ones that want a piece of it. Size and celebrity of financial institutions does not always ensure security. As New York State Attorney General Eliot Spitzer's crusade recently proved, even the largest institutions are not immune to manipulative and cunning strategies to enhance their own bottom lines. Also who remembers the savings and loan scandals of the 1980s which could have ended far worse than they did, but still cost the U.S. government some $1.4 trillion in bailouts?

So, how should an average individual go about protecting his or her hard-earned capital and ensure that it will be there when he/she needs it? Experts have a great number of advice and solutions, but the main ones center around two: diversification and asset allocation.

Diversification can mean different things to different advisers and experts, but in this case it does not mean investing in 10 different stocks in 10 different companies. By diversification, we mean protection of assets through suitable and meaningful insurance policies, proper investments in diversified groups of financial instruments, tax and estate planning, and regularly reviewed wills and trusts.

As we have seen in our first article, insurance can be one of the most valuable tools an individual has for capital preservation. One's lifetime earnings are generally the biggest asset that one possesses. Unfortunately, most people, and for some reason the new immigration of Ukrainians and Eastern Europeans in particular, underinsure themselves. This is most likely due to the cultural and social aspects of life under the former Soviet regime. Insuring oneself with a small policy will not protect one's assets (including lifetime earnings) nor will it provide security for one's family. This can be a devastating error in judgment. Likewise, over-insuring oneself can be a waste of money that should be used for living.

There are presently dozens of various types of insurance policies and hundreds, if not thousands, of variations and riders that can modify them. The major groups and their major subcategories include:

Life Insurance

Term Life insurance
Level and decreasing term life
Whole life insurance
Single premium Life
Universal life (Option A and Option B)
Variable Universal life
Variable life
Health insurance
Health Maintenance Organization (HMO)
Preferred Provider Option (PPO)
Fee for service insurance
Long-term care (LTC) insurance although not strictly health insurance, it is placed in this category because it provides for care when the person is no longer able to care for himself or herself.
Auto insurance
Liability
Comprehensive and collision
Homeowner insurance
Basic homeowner policies
Liability insurance
Condominium or renter policies
Flood or other disaster coverage (these are important riders or additional insurances now since many companies exclude these from basic policies).

Note: Many of the life insurance products can be obtained through your UNA insurance professional.

As complicated as choosing between various insurance policies can be, diversification into different financial instruments can be even more so. We have already seen that worldwide there are more than 55,000 mutual funds. Plus, the Dow Jones organization indicates that, "Although the exact number of stocks in the U.S. is not recorded, some sources estimate it could be as many as 15,000."

If we add to this the thousands of government, corporate, and municipal bonds; the many newly established hedge funds; thousands of commodity and financial futures instruments; and a conglomeration of warrants, options, etc, the choices can be literally mind-boggling. Thus, investing in any or all of these financial instruments can be daunting at best. However, diversification is almost always recommended by experts, and proper diversification should enhance any portfolio.

Diversification and capital preservation can also mean protecting your assets through proper tax and estate planning and properly documenting your wishes and a lifetime of planning through wills and/or trusts. Unfortunately, for this type of planning there are no sets of rules to follow. Each and every case and situation is unique onto itself and should be treated as such. Your lawyer, your accountant, your financial planner and your insurance professional should be consulted when establishing such documents, since each can suggest the most effective and currently applicable regulations that can enhance them.

Once you have established the proper diversification strategies, you should review them at least on a yearly basis, unless the assets are too small to warrant such expenses.

However, the one area that will need your constant attention is your financial portfolio. Here, proper asset allocation, depending on your financial situation, age, risk tolerance, earnings status and years to objective, can make significant differences in how your portfolio is managed. According to Modern Portfolio Management theory, asset allocation has been found to be one of the most effective forms of portfolio maintenance. Although the uses of previous studies on asset allocation have been disputed by such authors as John Nutall in his article: "The Importance of Asset Allocation," other authors such as Jonathan Clements of the Wall Street Journal indicate that "asset allocation has a major influence on your portfolio's performance." Thus we believe that proper diversification with relevant asset allocation can be a most important tool to help preserve capital.

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