Portfolio management is a dynamic, continuous, and systematic process for managing risk. The goal of Chevy Chase Asset Management is to deliver the maximum after-tax return for each client’s portfolio within pre-determined risk parameters. This process entails four basic steps.

• Set the Objective of the Portfolio.
• Determine which Strategies to utilize.
• Monitor Financial Markets and Client Needs.
• Adjust and Measure the Portfolio's Performance.

Our first step is to determine our client's investment objective. This requires an analysis of their current and future needs, with the aim of defining their return requirements and corresponding level of acceptable risk. We determine if the objective of the investment program is to produce current income in the form of current yield, or long term capital appreciation. For example, does our client need current income on which to live or cover some specific expenses, or do they need the funds to grow for some future expense? The importance of current income can be determined by measuring the minimum investment income required from the portfolio. We accomplish this by subtracting income generated from sources outside the portfolio (wages, Social Security, pension income, etc.) from the current income needs of the client. The resulting deficit is required from the portfolio. The portfolio is therefore constructed backwards, thereby making up the deficit in income.

There is a common misconception that current income needs must be met from the current yield generated by a portfolio and that capital gains should always be reinvested for the future. In reality, it makes no difference whether current needs are met from dividends and interest or by liquidating part of your principal value. For example, if one portfolio has a current yield of 5% and appreciates by 4%, it generates a 9% total return. The 5% income could be used to meet current income, while the other 4% is allowed to accumulate as growth. The same end could be accomplished by investing in a portfolio that has no current yield, but grows at 9% annually. In this case 5% of the fund could be liquidated annually to meet current needs, while the rest of the assets are allowed to grow. Ultimately, it is the total return that is important. There is no need to artificially break this total return into current yield and growth components. Indeed, since capital gains tax rates are often less that ordinary income tax rates, the latter approach might be advantageous in terms of after-tax returns and growth rates.

The second component is determining the importance of preserving nominal or real values of the principal of the portfolio. If our client has a portfolio that earned 5%, our client has more money from a nominal perspective of the end of the year. If inflation rose by 6% in that period, the client has lost real purchasing power. The more importance attached to real returns, the more inflation protection must be built into the investment program. This in turn determines how much of the investment must be put into fixed income securities (bond) versus equities (stocks).

Risk Tolerance

The second component in objective setting is the investor's risk tolerance. This is where we must determine how much volatility in portfolio value that can be accepted by our client. There are quantifiable measurements that can be performed, but it ultimately boils down to one thing: our client's comfort level. A client's risk tolerance can be addressed at three levels.

The first is by the Normal Asset Mix (i.e., the proportion of stocks to cash to fixed income). Over 90% of a portfolio's return is attributed to this mix. A conservative investor would have more cash and bonds than an aggressive investor. Secondly, a range within the normal asset mix is important in adjusting the portfolio to changing economic conditions. Finally, the quality of securities can be tailored to a client's specific risk tolerance. For example, we may only buy AAA rated bonds.

Liquidity

The third factor in setting the objective is liquidity. The amount of liquidity that is required is based upon the probable need for ready cash. This falls into three categories:

1. Emergency cash
2. Cash needed to meet specific upcoming obligations (such as taxes)
3. Cash needed for investment flexibility

Time Horizons

The fourth factor is the client's Time Horizon -- when is principal and/or income needed (and how exact is that final need)? Specifically, a client's time horizon factors very heavily in determining optimum long-term "normal" asset allocations.

Taxes

The fifth factor is our client's tax situation. Again, our goal is to maximize after-tax returns. This requires an in depth understanding of our client's tax situation. Depending on that information, the portfolio will be built to take advantage of investments that offer the best after-tax return.

Each Client is Unique

Lastly, we strive to identify any unique needs or preferences of our clients. These could include preferences in types of securities, or even types of industries. (i.e., tobacco, media, chemicals, etc.)