Latest Safe Money Advisory Newsletter

The Model of Investing

September 2012

“Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.” - Warren Buffett

I’m fairly certain most conservative investors know they’re conservative. I’ve never

run into a conservative investor who, after telling me they were indeed conservative,

turned out to be an aggressive investor. There’s something about losing money that

rankles the skin of a conservative investor. They are fans of Warren Buffett’s Rule No. 1!

So, I have a few questions: Do you, the conservative investor, know how to allocate your money to

avoid the volatility that gives you sleepless nights? How do you know which assets to use and why you

might use them? How does an individual asset fit into the total picture? Can an average investor really

understand why his or her money is placed in one investment over another? Do you need a degree in

finance to understand it? Is there a simple way to understand how to allocate your assets to

accomplish your goals? There is a new model of investing being used by thousands of people to

answer all the questions above. It’s the ABC Model of Investing and here’s how it works.

The ABC Model of Investing

First, imagine that all your investible assets are liquid (with no strings attached) and we could arrange

them in any way you like. This includes all your CD’s, money markets, annuities, stocks, bonds, mutual

funds, REITs etc. Next, let’s say that you could throw all the money on the table and place it wherever

you would want it to go. Of course, I realize not all of your assets are actually liquid and in a position to

move, but this exercise will give you a glimpse of what you value in the types of assets in which you

might invest and how to allocate them. Finally, let’s divide assets into categories, A, B, and C, which

represent three types of assets.

Category A: Cash “Yellow Money”

Category A is your cash reserves. Cash assets potentially carry low returns, but the principal is

guaranteed and interest is compounded. These accounts are typically taxable and have optimum

liquidity. However, they can also be set up in various tax advantaged strategies such as traditional

IRA’s, Roth IRA’s, etc. Most often, these are bank-held assets like CD’s, savings accounts, and money

markets.

Financial advisors will often refer to this as short-term money, or emergency funds. If your furnace

breaks down, your roof leaks, or you have a medical emergency, category A is where you save for such

an occurrence. If you are saving for an exciting vacation or a new car, this is where the money goes. It

is also where you might want to keep a savings account to replace any income lost due to a prolonged

illness, injury, or job loss. You will want to have six months to a year of income put away for these

instances.

Category B: Fixed Principal Assets “Green Money”

Category B holds Protected Growth assets. This category offers potentially moderate returns, is tax-

deferred and offers partial withdrawals. The principal is protected, and previous years’ gains are

retained as interest. The annual returns on these assets vary greatly. In my own practice, I have seen

them yield from 0% to as high as 16%. Some include bonuses from 2% to 8%. These assets are

designed to be the middle ground between CD’s and the market. During the five-year period from

October of 2004 through September of 2008, Index Annuities averaged 5.42%, while CD’s averaged

2.78%.

I prefer using Fixed Indexed Annuities in Category B, which links the interest credits to the

performance of a market index, such as the S&P 500, S&P Midcap 400, DOW, Russell 2000, Euro Dow,

etc. Category B money is set aside for a longer period, often 5-10 years. Annuities have strings

attached for withdrawals, but can be an excellent source of income over a lifetime. In other words,

don’t allocate money to the B Category in which you would need more than 10% of next year,

especially considering it has a 10% tax penalty for withdrawals of interest prior to age 59 ½.

Generally assets in this Category offer only partial withdrawals without a penalty, yet many include

riders that waive surrender fees in the event of a nursing home stay or terminal illness. Indexed

annuities are designed to function as the middle ground between lower interest rates of bank and

savings accounts, and potential higher returns of risk oriented market money.

The ABC Model looks at fixed income assets different than Wall Street does. Over the years, Wall

Street has used a laddered portfolio of bonds to accomplish the goals of Category B, yet a bond can

lose value. From 1999 to 2009, if you were holding Lehman Brothers, Bear Stearns, ENRON, or World

Com bonds, you might have thought you were safe, but found out just how much you could lose in a

bond. That is why we use fixed principal assets in this category rather than bonds which are fixed

income assets.

In contrast to bonds, Category B has three Green Money Rules: protect your principal, retain your

gains, and guarantee your income. If an asset can’t do those three things, it doesn’t belong in the ABC

Model’s Category B. Bonds don’t follow those rules so they must go in the next Category.

Category C: Risk “Red Money”

Category C represents the Growth column. We call investments here our “Red” Risk Growth assets,

which move up or down with the market. Investors usually chase higher returns over time, though

these assets can gain or lose 30% in a year, or even more. The S&P 500 lost 38% in 2008, but the

average of 1995-1999 was over 25%. The market “giveth” and the market “taketh” away, there are no

protections or limits. This money is invested in securities like stocks, bonds, mutual funds, variable

annuities, options, REITs, and the like. The principal isn’t protected and last year’s gain may be lost in

a downturn of the market. While these accounts are associated with a longer time horizon they are

usually more liquid due to the “sellable” nature of securities, unless they are in a variable annuity,

which only offers partial withdrawals.

The majority of the assets found in Category C are in retirement accounts such as 401(k)’s, 403(b)’s,

IRA’s, and variable annuities. Category C monies can also be found in the form of non-qualified (after-

tax) brokerage accounts, mutual funds, stocks, or bonds, held by an individual, jointly, or even in trust.

You can be your own manager or hire a professional investment adviser to manage this part for you.

This is the growth column, yet because of its high risk nature, we paint these investments Red.

Here’s an example of the ABC Model. If you had $500,000 of investable assets and wanted a 10%

“Yellow”, 50% “Green” and 40% “Red” money split, you would have about $50,000 liquid in bank

accounts (Category A), $250,000 in fixed principal assets such as fixed indexed annuities (Category B),

and about $150,000 in securities such as stock mutual funds, bond mutual funds, or managed

accounts(Category C). With this allocation you only have 40% exposed to market risk. Needless to say,

if the market experienced another 38% drop like in 2008, only 40% of your portfolio would be exposed

to a loss. Sixty-percent would not have lost one red penny!

My suggestion is that you find a financial planner who uses both the ABC Model of Investing and the

ABC Four Step Planning Process to help you determine the risk already in your portfolio and the risk

you want in your portfolio. Remember Buffett’s Rule No. 1 and you’ll understand the power of the ABC

Model of Investing.

Dave Vick

President, Vick & Associates, Inc.

September 2012

Respectfully submitted,

Orlando FernandezSenior Retirement Planning & Insurance AdvisorCell: 954-234-4728

Warren Buffet’s 2 Primary Rules of Investing for a Successful Retirement:

Rule #1 - Never Lose Money Rule #2 - Never Forget Rule #1