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CUSTOMER OF THE MONTH (NOV. 1999) |
For ProVise Management Group,
Crystal Ball is the Key to Optimizing Portfolio Profit
During the past five years, many investors have come to believe
that the market only goes one direction: up. The danger of this
assumption is that it fails to acknowledge that all portfolios contain
risk, and that virtually all portfolios are capable of losing value.
ProVise Management Group, a SEC-registered Investment Advisor that
specializes in asset management and financial planning, understands
that proper portfolio management requires a rigorous analysis of
risk. To help design the most profitable portfolios that satisfy
the client-determined risk levels, ProVise has invested in the use
of Crystal Ball Pro software.
William L. Raddatz, CFP is the Vice President-Financial Planning
and Senior Plan Writer for ProVise. According to Raddatz, portfolio
design is both a science and an art. When ProVise begins to construct
a client's portfolio, the two critical elements that must be thoroughly
identified are the client's risk tolerance and a corresponding asset
allocation. ProVise establishes the client's risk tolerance through
extensive interviews and a Risk Tolerance questionnaire program
developed by the American College in Bryn Mawr, Pennsylvania.
Once ProVise is satisfied that they understand the types and amount
of risk a client can accept, they perform a Crystal Ball analysis
of the client's current portfolio. In an Excel spreadsheet, they
examine the potential of each asset. Key asset characteristics include
its category (aggressive growth, global/foreign, high yield bond,
etc.), its dollar value, the percentage of the total portfolio that
it represents, its measure of risk, its target return (using historical
asset class returns) and weighted target return, and its three-
or five-year historical average annualized return. Crystal Ball
assumptions include each asset's weighted target return and weighted
beta.
After the portfolio simulation is complete, ProVise helps their
client to understand the current risk level by showing them the
certainty level for the overall portfolio's target return. Very
often, the client will see that their portfolio has a substantial
potential for negative returns, sometimes 30% or more. "Seldom do
we find that a client's portfolio's risk is commensurate with the
client's risk tolerance," notes Raddatz. "Often, the portfolio has
considerably more risk than is apparent. This is where Crystal Ball
comes in."
ProVise then constructs a new portfolio spreadsheet that contains
a combination of current and new assets. They import the assets'
monthly returns from one of several available services, such as
Morningstar, and use Excel's data analysis (under the Tools menu)
to correlate the data. The correlated data is then entered into
the Crystal Ball Correlation Matrix. Uncertainty within the model
is reflected in the measure of risk (beta) and target return for
each asset. ProVise defines these variables as Crystal Ball assumption
cells, either as a normal distribution, using an asset's historical
mean return and standard deviation, or as a uniform or lognormal
distribution in the case of T-bills and money market assets. ProVise
typically runs 8,000 trials using Latin Hypercube sampling.
The proposed portfolio is then optimized for the client's risk
tolerance and target return. In the new model, the value of each
asset selected for the new portfolio is defined as a decision cell.
A constraint is applied for each asset class, such as aggressive
growth, where the asset class's value will equal $xxx,xxx. The OptQuest
program then optimizes the portfolio by maximizing Target Return,
while Risk (beta or standard deviation) is set to a selected maximum
limit. Then a final Crystal Ball simulation is run on the optimized
portfolio to demonstrate the portfolio's reduced risk and/or enhanced
return to the client.
ProVise also uses Crystal Ball Pro's optimization tool to determine
the client's probable cash flow and/or asset accumulation values
during his or her retirement. As before, ProVise first creates a
cash-flow spreadsheet, defining "inflation" and "target return"
as assumption cells. This information is graphically presented using
a color trend chart with confidence bands of 50%, 75%, and 90%.
ProVise has found this method of optimization to be superior to
other optimization products, in flexibility, reliability, and ease
of use. The recommended portfolios are optimized efficiently, accurately,
and quickly. "This has been a great time and money saver," said
Raddatz. "Although the portfolio selection and management processes
are dynamic, the client receives an optimized portfolio that fits
like a handmade suit, which from time to time may need slight adjustments."
In Raddatz's opinion, both ProVise and its clients benefit from
the use of Crystal Ball Pro. "We present our plans and portfolios
with a level of confidence that we could not have had before Crystal
Ball Pro. At the same time, our clients love the graphic "confidence
bands" in the trend chart we use for projected accumulation values
or cash flow. We can show them that they have an X% chance of not
running out of money over their life expectancy, and the clients
are able to actually see the risk that is in the proposed portfolio."
William Raddatz can be contacted at raddatz@provise.com
or via the ProVise web site at www.provise.com.
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