Then, during the second quarter, and in seemingly rapid-fire succession, came one catastrophe after another, all of which jarred financial markets worldwide:

• The intensification of the budget crisis in Greece which first arose in February and which then precipitated the risk of contagion spreading across Europe
• The ongoing concerns that European budget cuts would arrest economic recovery thereby causing global spillover effects and causing further problems with the continuing devaluation of the Euro
• The April 22 explosion of the BP oil drilling rig in the Gulf of Mexico
• The May 6 “flash crash” in which U.S. markets plummeted in a matter of minutes without explanation

Looking at these events, it’s tempting to ask what the next catastrophe will be. In fact, based on the last six months, many commentators are already labeling this as the “calamity” decade, even though it’s only just begun. One thing is certain: the media focus on these various problems tends to create huge levels of stress and anxiety in the minds of investors, particularly those who are either in or approaching retirement.

Wisdom from the father of value investing

Benjamin Graham, a Columbia University professor and the author of The Intelligent Investor, has effectively shaped the views of a generation of value investors, including Warren Buffett, for the past 75 years or more. In fact, it was in 1950 that Buffett enrolled at Columbia in order to study under Graham and later joined his firm after graduation.

Benjamin Graham gave a talk in 1963, exactly one week before the JFK assassination, entitled “Securities in an Unsecure World”. And included in this talk were three principles of investing which investors, nearly 50 years later, must still bear in mind.

Principle One:

Invest in stocks and bonds only so far as you can live with fluctuations in price

This principle should be distinguished from a slightly harsher variation which has been seen with more frequency lately: “Invest only what you can afford to lose”. With respect to either interpretation, investors have to understand their own individual ability to live with volatility. This is something that investors were reminded of in 2008—many of us discovered our true risk tolerance in that tumultuous market.

In his 1963 talk, Graham said he believed that by implementing sound policies, almost all investors should be able to invest without losing sleep, even in the highly unstable and insecure world which followed the Cuban missile crisis.

Today, our goal with every client is to tailor an individual portfolio which incorporates the investment objectives of that client. To that end, and given the continued current uncertainty, we have been recommending keeping a larger than normal percentage of assets in more liquid and shorter-term investments, particularly for those clients presently in or near retirement.

Principle Two:

The price you pay when you invest in any asset is the key to long-term success

Over long periods of time, the entry level at which one makes an investment is one of the most important factors in achieving success. In other words, an investor must pay a reasonable price when they buy. After all, those who bought companies such as Intel and Cisco 10 years ago have lost approximately 70% of their investment—not because these aren’t exceptional companies, but because the price they paid was too high.

In his same 1963 talk, Graham warned that despite the high level of instability and insecurity in the world, investors must always maintain allocations to stocks, bonds and cash. He suggested holding a minimum level in stocks at all times (25%) but limiting the maximum percentage of stocks to no more than 75% at any given time.

He also went on to suggest that the exact percentage should be determined by value considerations—owning more stocks when the market seems low in relation to value (for example, March 2009) and owning a lower percentage when the market seems high.

There are many contradictory views on today’s valuation levels. Benjamin Graham’s methodology for valuing markets would suggest a fair value for stocks today to be the current price of 18 times earnings. Other commentators believe stocks are presently overvalued and that there is little room for error in the event of a double-dip recession.

Principle Three:

Staying Focused on the Long Term

Benjamin Graham was quoted as saying that “volatility is the enemy of investors in the short term but that it is the friend of investors in the long term”. So staying focused on the long term is a critical factor in achieving long-term success in investing.

Graham’s student Warren Buffett has been quoted frequently in the past few years. In our first quarter 2010 newsletter, we repeated Buffett’s two keys to success—having a sound plan and sticking to it. And of the two, we reminded our readers that the second part is always the most difficult part for investors—the sticking to it. However, there are some investors who simply do not have a sound plan in the first place, which presents a major obstacle to long-term investment success.

Discipline, Focus, Objectivity

At the risk of repeating a timeworn cliché, in our experience the only way to invest successfully over time is to maintain discipline and a long-term focus. Markets like we’ve seen of late create understandable stress and can lead to short-term decisions which prove unwise. The cost of acting impulsively can cost investors dearly.

Individual investors probably should be more concerned with strategic issues—how much money they need to save, what asset classes they want to emphasize and how long they expect to hold them—rather than make emotional judgments about the investment marketplace.

How to Measure Success

The vast majority of investors still rely on printed monthly financial statements for information on how they’ve been doing with their investments. This is not always the most accurate gauge of investment success over the long term.

Instead, it is more appropriate to look over a five or ten year period (or longer) to measure success. The longer you own equities, the more you lessen the extremes on both the high side and on the low side of returns. By measuring returns over the long term, rather than on a day-to-day or month-to-month basis, you are able to create an experience that most investors can live with—one that fits within the parameters of their risk tolerance and allows them peace of mind.

It is also critically important to measure success in other ways. The protection and preservation of capital is presently our primary consideration for all clients. By reducing equity exposure in the manner prescribed by Benjamin Graham during periods of excessive valuations, one can create a buffer to protect portfolios—particularly for those in retirement—from short-term volatility and thus reduces risk levels along the way.

Fiduciary Standard of Care

You may be familiar with ongoing news stories related to financial reform. One aspect of that reform is aimed at imposing the fiduciary standard of care on all investment professionals, a standard of care in which a client’s best interests are always put first. At this firm, since our inception more than ten years ago, our duty has been and continues to reflect that of a strict fiduciary standard. We will examine this subject in greater detail in a future newsletter as I believe it is critical to understand this distinction going forward.

Conclusion

In closing, I would like to summarize the five core principles that shape our approach to investing here at Andrew J. Fama Asset Management, LLC. These five principles were enumerated in detail in our first quarter newsletter, but bear repeating once more given the tremendous uncertainty and the elevated levels of risk now seen in global financial markets.

1. Concentrate on Quality

Our portfolios have been and will continue to be focused on only the highest quality investments and those which are best able to withstand corrections going forward.

2. Look to Dividends

Historically, dividends make up 40% of the total return of investing in stocks and have helped provide stability during periods of market turbulence.

3. Focus on Valuations

“Buy low, sell high”—having a strong price discipline on buying and selling is paramount to successful investing.

4. Build in a Buffer

Our objective is to ensure that cash flow needs are set aside in more stable investments. We are presently focused on the preservation of capital as a paramount consideration.

5. Stick to Your Plan

The key to success is having a diversified plan appropriate to your risk tolerance—and then sticking to it.

I thank each of you for the opportunity to work with you in managing your financial investments within the context of your individual needs and in conjunction with your risk tolerance and overall investment objective and look forward to a healthy and prosperous remainder of 2010.

Sincerely,

Andrew J. Fama, Principal

Andrew J. Fama Asset Management, LLC

Registered Investment Advisor

*Past performance is no guarantee of future results*

*Nothing contained in this quarterly newsletter should be construed as investment advice*