Schultz Financial - Investment Approach

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Enhancing Performance and Reducing Risk

with Active Portfolio Management

At Schultz Financial Management we perform active portfolio management for high net worth individuals and families with the objective of earning consistent and attractive investment returns, regardless of the economy, interest rates, or stock market behavior.

In this report you will learn about active portfolio management, and the benefits of Schultz Financial’s unique investment approach.

Contents

I. What is Active Portfolio Management? .................................................... 2

II. Our Road to Active Portfolio Management .............................................. 3

III. Our Investment Approach / Philosophy .................................................. 4

IV. Our Unique Investment Strategies .......................................................... 8

V. Creating Your Customized Portfolio ...................................................... 11

VII. How to Get Started .............................................................................. 11

VIII. Biography ............................................................................................ 13


I. What is Active Portfolio Management?

Active portfolio management applies risk management techniques to the investing process in order to provide a smoother, more consistent, and more dependable result than buy-and-hold investing.

Investors who have accumulated a substantial nest-egg need to carefully consider how much risk they are willing to take, knowing that it may take many years to recover from a market setback. After two horrific bear markets in the last 15 years, many investors have recently questioned the wisdom of a "buy and hold" investment approach and have begun to embrace active portfolio management instead.

The theory behind buy-and-hold investing is the idea that markets are efficient and their price at any given time best reflects available information. But markets have shown that they aren't efficient, investors aren't rational, and if you buy stocks when they’re expensive and hold them, you will likely end up with disappointing results.

Historically, there have been long periods where the stock market has performed poorly, not even keeping up with inflation. This was true as recently as 1966-1982 and again from 2000-2014. Currently at about the 2000 level, the S&P 500 is still below its year 2000 peak on an inflation adjusted basis. Because of these potentially long periods of poor performance, we normally do not advocate a pure buy-and-hold investment approach for our clients.

Instead, at Schultz Financial, we engage in active portfolio management with the goal of staying mostly invested in stocks and high yield bonds during favorable market conditions, but reduce market exposure and increase cash levels when markets undergo meaningful corrections.


II. Our Road to Active Portfolio Management

Schultz Financial Management has not always specialized in an active portfolio

management.

Prior to 2002, we followed a common practice in the

financial planning profession, managing our client

portfolios with no-load mutual funds across several

investment categories of stocks and bonds. We

thought that this “broad diversification” would be

adequate to protect our clients from potential market

risk during bear markets.

However, we were disappointed with the damage

inflicted to our portfolios during the 2000-2002 bear

market when virtually all of the equity markets declined sharply in unison.

As a result of that experience, we decided to take a more active role in the

investment management process and make Schultz Financial an expert in active

portfolio management so that we could help our clients more successfully

weather bear markets.

Utilizing skills acquired previously as a software engineer, our founder, Richard

Schultz began applying software algorithms to investment data in efforts to

design investment strategies that could earn attractive returns, regardless of

market conditions. In late 2002, Schultz Financial Management began to actively

manage client portfolios using individual stocks, bonds, and exchange traded

funds (ETFs), and scaled back the use of mutual funds in client portfolios.

The change to active portfolio management proved to be a smart decision.

During the next bear market from 2007-2009, Schultz Financial was able to limit

Portfolio - refers to an investor’s overall collection of investments including retirement accounts, stocks, bonds, real estate, etc.


most of its clients’ portfolio declines to moderate levels so that by the end of

2009, their portfolios fully recovered to new highs – less than 1 year after the

market bottom. Whereas buy-and-hold investors would wait an additional four

years until 2013 to fully recover.

To this day, Schultz Financial Management continues to develop and refine its

active management techniques so we can further improve our clients’ portfolio

performance in a variety of market conditions.

III. Our Investment Approach / Philosophy

As you can see, through our use of active portfolio management, we add

significant value to our client investors beyond traditional management involving

mutual funds or ETFs.

Here are some of the ways we strive to enhance

performance and reduce risk through active

portfolio management.

1) Avoid Poor Performing Assets – Traditional

asset allocation invests in low yielding assets

such as U.S. government bonds. That’s because

a traditional approach depends primarily on

diversification to reduce portfolio risk.

However, since we use actively managed

investment strategies which can raise cash or

hedge long positions during market corrections, we do not have to rely on low

yielding assets for risk management. By employing actively managed

strategies that manage downside risk, we can make larger allocations to those

asset categories that can generate higher returns.

Investment Strategies are the building blocks that we use to create an investor portfolio. Each of our invest-ment strategies represents a specific asset category and investing style.


In short, active portfolio management can provide a greater upside potential

without necessarily taking additional risk.

2) Don’t Over Diversify – The more securities you hold in your portfolio, the

more likely it will just track the overall market. Unlike the average stock

mutual fund or ETF with over a hundred stocks, we manage our own

investment strategies that typically hold only about 20 stocks.

Being nimble is essential for adding value through stock selection. Because

we’re not handicapped by managing too large a portfolio or holding too many

securities, we can more nimbly buy and sell individual stocks at advantageous

price levels due to changes in price or market trends. On the other hand,

managers of mutual funds or 3rd party wrap account programs may take

several days or weeks to fully enter or fully exit a position.

3) Limit Losses During Down Trends – Riding the market down can be painful,

costly, and take several years to recover as we highlighted earlier. In our view,

reducing downside risk in our clients’ portfolios during bear markets is our

most important task.

Here are some facts about bear markets in stocks:

a. A bear market is defined by a 20% decline or greater

b. Since 1929, 16 bear markets have occurred

c. A new bear market begins on average ever 4.8 years.

d. The average duration of a bear market is approximately 17 months

e. The average time spent making up for loss from a bear market is

approximately 60 months.

As you can see in the following table, it is exponentially more difficult to

recover from a large loss than a small loss. For example if you have $1 million

worth of stocks in your portfolio that declined in value by 50% to $500,000,


you would then need a 100% return to get back to $1 million. Whereas a 10%

portfolio decline to $900,000 would only require an 11% gain to recover.

And perhaps more important, even the most determined buy-and-hold

investors often panic and sell near market lows - and then re-enter the market

at much higher levels, compounding

the potential problems with buy-and-

hold investing.

So, to effectively manage downside

risk in stocks and bonds, we have

developed “tactical” investment

strategies designed to systematically

sell securities and raise cash levels to

reduce market exposure during

market declines.

4) Profit From Volatility – Volatility

tends to increase during market

corrections. At Schultz Financial, we manage investment strategies that take

advantage of market volatility and seek to capture profits in bull, bear, and

sideways markets. Since these volatility based strategies tend to have a low

correlation to stocks or bonds, we refer to them as “alternative” investment

strategies. These alternative strategies will hold both long and short positions

in stocks, or other exchange traded instruments.

Our alternative investment strategies can complement a portfolio of stocks

and bonds, and help investors improve their overall portfolio diversification

without sacrificing performance.

Market Return Needed

Decline to Recover

10% 11%

15% 18%

20% 25%

25% 33%

30% 43%

35% 54%

40% 67%

45% 82%

50% 100%


5) Use Tax Efficient Investment Strategies – With the recent increase in tax rates

for both dividends and capital gains, tax efficient investing is becoming more

and more important to investors. Combining federal and state income taxes,

some investors are now paying taxes at a 50% rate! So we developed

investment strategies that can deliver good performance, manage downside

risk, and still be tax efficient.

a. Fixed Income Strategies:

For fixed income, we manage a tax free bond strategy for investors in a

high marginal tax bracket.

Investors that expect to be in a lower tax bracket in future years may

take advantage of our tactical high income strategy managed within a

tax deferred account so the income is not taxed until it is distributed,

most likely at a lower tax rate.

b. Equity Strategies:

For stocks, we manage both Core and Tactical investment strategies in a

tax efficient manner.

Core-Strategies take a more traditional long term approach to buying

stocks. They include high dividend paying stocks, quality growth

stocks, small cap stocks, and real estate.

Tactical-strategies hedge risk or increase cash during market

declines, while holding stocks with significant gains for more than a

year for favorable tax treatment. They include dividend paying and

global growth stocks.

6) Invest with a Statistical Edge – Following a disciplined proven system is

important for successful portfolio management because it removes the


emotional element from investing. It also eliminates the tendency to over

react to good or bad news, or to be influenced by popular opinion.

Most of our investment strategies follow a disciplined system that has been

modeled, tested, and proven effective throughout a variety of market

conditions for over 10 years.

At Schultz Financial Management, we are committed to continued research

and development in order to maintain and improve our investment

management expertise. We maintain active memberships, licenses, and

subscriptions with third party research firms, portfolio modeling software, and

data providers.

7) Cost Effective – Since we are true money managers and manage our own

investment strategies rather than using 3rd party managed wrap programs or

mutual funds, we tend to be more cost effective than most investment

advisory firms, often eliminating a layer of fees from the overall cost.

In many cases, hiring us to manage your portfolio will be nearly as cost

effective as if you managed your own portfolio using actively managed no-load

mutual funds. According to Morningstar, the average expense ratio for

actively-managed (non-index) equity mutual funds is 1.2%. At Schultz

Financial Management, we charge just 1.25% to manage investment portfolios

greater than $500,000.

IV. Our Unique Investment Strategies

Investment strategies are the building blocks for portfolio construction. Our client

portfolios normally include three or more of our uniquely managed investment

strategies, each representing a specific asset category and investing style. Below


we have divided our investment strategies into three groups according to the

investing style that we use.

1. Core Strategies for investing in stocks, bonds, or real estate are managed in

a traditional fashion with the objective of

staying near fully invested with low cash

levels throughout full market cycles,

including bear markets.

2. Tactical Strategies for investing in stocks

or bonds are more actively managed

with the objective of staying almost fully

invested during favorable market

conditions, but reducing market

exposure and increasing cash levels

during market declines in order to

protect against significant losses.

3. Alternative Strategies are used for investing in alternative assets instead of

stocks, bonds, or real estate. Our alternative strategies seek to take

advantage of stock market volatility with the objective of earning attractive

returns regardless of the direction of stock or bond markets.

Most of our investment strategies are uniformly invested across our client

accounts. That means that each client investor using a particular investment

strategy holds the same securities as other investors with the same strategy. The

only exception is with our core-bond strategies which hold individual bonds.

Below is a table that lists many of our investment strategies and their expected

performance characteristics in various market environments. Please refer to our

Investment Strategies Report for a full description of these investment strategies.

Investing style refers

to our approach to

buying and selling

securities within a

particular investment

strategy. We define

our three investing

styles as core, tactical,

and market neutral.


Table of Investment Strategies

Investing in Various Stock Market Environments

Market Performance

Asset Category/ Investing Style

Investment Strategy Name

Rising S&P 500

Sideways S&P 500

Declining S&P 500

Tax Smart

BONDS

Core-Bond Tax Free Bond¹ Good Good OK Yes

Core-Bond Short-Intm Corp Bond¹ Good Good OK No

Tactical-Bond Tactical High Income V Good Good OK Yes²

Tactical-Bond Tact Bond Sector Rotation V Good Good OK No

STOCKS

Core-Stocks Dividend High Income V Good Good Poor Yes

Core-Stocks Quality Growth Stock Excellent OK Poor Yes

Core-Stocks Aggressive Small Cap Excellent OK Poor No

Core-Stocks Defensive Sector Stocks V Good OK Mod Poor No

Tactical-Stocks Tactical Dividend Inc. V Good OK Mod Poor Yes

Tactical-Stocks Tactical US Large Cap V Good Good Mod Poor No

Tactical-Stocks Tactical Low Vol Large Cap V Good Good OK No

Tactical-Stocks Tactical Global Excellent OK Mod Poor Yes

Tactical-Stocks Tactical Small Cap Excellent OK Mod Poor No

ALTERNATIVE

Alternative Moderate Allocation Good Excellent OK No

Alternative Market Neutral Long Short Excellent Good Excellent No

Order from Best to Worst: Excellent, Very Good, Good, OK, Moderately Poor, Poor

¹ Holds individual bonds for client investor on a case by case basis. ² Tax deferred option using a low cost variable annuity to implement the strategy.


V. Creating Your Customized Portfolio

When it comes to portfolio management, many financial advisors will only help their clients with brokerage account assets or insurance products and leave everything else up to you. However, at Schultz Financial Management, we can help you get the best overall result by evaluating your entire portfolio. This means that In addition to brokerage account assets, we will consider other assets such as employer sponsored retirement plans, company stock, variable annuities, real estate, or other investments that you may already own. For example, if you have a 401(k) plan with your current employer, we can determine what mutual fund(s) offered by your plan will work best in combination with our investment strategies. As another example, if you already own a variable annuity or variable life

insurance policy, we can manage those investment choices for you in a way that

best compliments the other assets in your overall portfolio.

Ultimately, we want to design a custom portfolio just for you. Your portfolio will be created based on your tax situation, investment objectives, risk tolerance, and also take into account any preferences you may have for specific investment strategies.

VII. How to Get Started

If you’re interested in learning more about active portfolio management and how Schultz Financial Management can help you achieve your investment objectives, please call or send us an email to schedule a free 15-minute phone meeting.

During this brief call, you will have the opportunity to give us an overview of your financial situation and we will answer any questions you may have.


If it appears that our services are a good fit for what you’re looking for, we will request additional details from you and schedule a no-cost in-person exploratory meeting.

During this meeting, we will gain a better understanding of your specific investment objectives and expectations, and we can provide you with a clear understanding of how we would design and manage a custom portfolio to fit your unique needs.

If you’re interested in learning more, we will prepare a draft investment plan and sit down with you again for a no-cost, no-obligation review of that plan.

After the plan review, should you wish to engage Schultz Financial Management, we could begin the portfolio transition process immediately.

To schedule your free 15-minute phone meeting,

call us today at (800) 230-9136,

or email us at [email protected].


VIII. Biography

Principal and Founder, Richard Schultz has been providing investment advisory services to individuals and families for over 20 years.

Richard obtained a bachelor’s degree in Computer Science from Moorhead State

University, Minnesota in 1981 and moved to Orange County, CA where he worked

10 years as a software engineer in the aerospace and bio-medical industries.

While an engineer, Richard developed a good temperament for investing his

personal funds and decided to provide investment management services to

others. In 1991, Mr. Schultz obtained a Series 7 securities license and became a

registered representative for an independent brokerage firm where he prepared

financial plans and created mutual fund portfolios for clients. In 1995, Richard

obtained his Certified Financial Planner™ designation, and then launched Schultz

Financial Management, an independent fee-based financial planning practice. In

2001, he joined the National Association of Personal Financial Planners

(“NAPFA”), an exclusive association of fee-only financial planners.

In 2002, Richard began offering active portfolio management to his clients in

order to provide a better investing experience, especially during bear markets.

Rather than relying on conventional mutual fund diversification, he created and

managed his own investment strategies of stocks, bonds, and ETFs .

Since 2011, Mr. Schultz has been a member of the National Association of Active

Investment Managers (“NAAIM”), an association of active investment managers.

Schultz Financial Management is also listed as a 5 star rated advisor in the Paladin

Registry, and an approved MD Preferred Services Provider™ to medical doctors.

Currently Schultz Financial Management serves over 80 clients with more than

$80 million in assets under management.

Richard lives with his wife and two daughters in North Tustin, CA.

Documents

Schultz Financial - Investment Approach