Document 6505021

INVESTING
COLUMNS
LOCAL STOCKS
How to judge — and try to control — risk
V i r t u a l l y no aspect of life comes
with the luxury of complete
certainty. Rather, there always
seems to be some sort of a riskreward tradeoff, and investing on
Wall Street is certainly no exception.
In reviewing
.
some basic
investment
concepts dealing with risk,
keep in mind
that how we
judge risk
determines
what we ask in
return.
Risk can
.Streetwise
come in
many flavors.
Lauren Rudd
For example,
when you purchase Treasury bonds
you know with complete certainty
that you will receive both your
interest and principal. This is
because the full faith and credit of
the United States government guarantee the bonds. In other words, the
government can always print
money to pay you.
But there are no guarantees that
while you are holding Treasury
bonds you will not lose some purchasing power. This is known as
inflation risk. Furthermore, you
may not be able to reinvest your
interest payments at the same rate
that induced you to buy the bonds
in the first place. This is referred to
as reinvestment risk.
Some types of risk are unique to
fixed income investments, whereas
other types apply more to stocks.
While ihere are time-tested1 methods for reducing risk, remember
that risk can never be removed
entirely.
For fixed income investments,
the two greatest risks derive from
inflation and your ease of reinvestment. If inflation and interest rates
are rising, you do not want to be
locked into long-term investments.
Just the opposite is true if the scenario is one of low inflation and
falling interest rates. In Wat case
you want to lock in the higher rates
with longer term bonds.
Laddering a bond portfolio is a
way of controlling both inflation
and reinvestment risk. To ladder a
portfolio you simply structure your
portfolio so mat it is evenly divided
among the spectrum of maturities.
For example, suppose you purchased notes that mature in two.
four, six eight and 10 years. Every
two years some of the notes mature
and you replace them with new 10year notes.
The ladder in this case ensures
that you are at most two years away
from being able to reinvest a portion of your funds at a higher interest rate if rates are moving upward.
If rates move down, a minimum of
80 percent of your funds is still
invested at the higher rates. The
same logic would apply to any inflationary pressures.
Bom stocks and bonds are subject to credit risk. When you invest
in bonds, the risk of default should
be of paramount concern. A lower
return is nothing compared to no
return at all. The best protection
against default is to limit yourself to
those securities rated BBB or higher
by the Standard & Poors Rating
Group. Bonds in this category are
commonly referred to as investment grade bonds. You can also
reduce your credit risk by diversifying your bond portfolio. Never buy
too many bonds from one issuer,
regardless of rating.
Stock investors seldom take credit risk into account. But if a company's balance sheet suffers from a
credit deficiency, it will eventually
show up in the price of that company's stock. More importantly, in a
corporate liquidation stockholders
are the last to receive any sort of
payment and rarely do so. If you
want to remove as much credit risk
as possible from stocks, buy only
seasoned blue chip companies with
a track record of paying dividends.
One of greatest hazards involved
in buying stocks is commonly
referred to as event risk. This simply
means that unforeseen events can
adversely affect the price of your
stock. Event risk can involve a single
company or an entire sector. The
only practical way to remove this
risk is through diversification. To
effectively utilize diversification you
must balance your portfolio in
terms of both sectors and individual
companies,
Even a well-diversified portfolio
is subject to market risk, meaning
that'investor sentiment may turn
against an entire class of investments. Again, your only defense is
to diversify your portfolio among
asset classes such as stocks, bonds,
money market funds, Treasury bills,
and even possibly some commodity
holdings such as gold. You can also
utilize foreign stocks as an asset
class, but now you introduce both
currency and political risk.
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12/4
Market Highlights
Week ending August 14. 1998
DOW (Industrials)
NYSE
S&P500
AM EX
S&PMidCap
NASDAQ
You can write to financial
columnist Lauren Rudd c/o the
Savannah Mominq News, P.O. Box
1088, Savannah, GA. 31402.
INVESTING 101
Equities are still abound investment — did you doubtit?
By Laurtn Rudd
Savannah Morning New s
S t o c k s recently hit a scary
stretch of road, one marked by
steep hills and valleys. After
soaring for nearly eight months, the
Dow Jones Industrial Average fell
just shy of 10 percent in four weeks.
But then the markets bounced back
a little. That buoyed the spirits of
some, but left others searching to
see where the bear might be hiding.
And what about the pundits —
what do they predict? They arc hard
at work grinding out monumental
works on what the future holds.
Some will try to prove that the markets have begun a pronounced
recovery from a normal correction,
more details to follow upon receipt
of your check. Other* will try to convince you that the bull is now a bear
and only .1 12-month subscription
can ward off (he dangers (hat lurk
ahead.
Save your investment funds for
what you intended them for, invest
ing in stocks. The answer is im|>ossible to determine at this point.
However, if an explanation of son's
is necessary to let you sleep at night,
then rest easy. There are numerous
indications to suggest that equities
are still a very sound investment.
(Did you really doubt it?)
Acting almost like a self-fulfilling
prophecy, the market's recent drop
adhered to analysts' predictions of a
5 to 10 percent correction for the
major indexes. Furthermore, it is
likely that corporate earnings will
continue to rise this year even if a
strengthening dollar drags down the
overseas profits of some multinational companies.
But if the recent bouts of sharp
selling have left you chewing your
fingernails wondering whether it is
lime to look for a way out, consider
this: Lx)king for a way out is not
what made Warren Buffelt (he second wealthiest person in Uie United
States. Nonetheless, some of you
will undoubtedly l>egin (o lose faith
in your investments. You will begin
to question your judgment in deciding to take on the perplexities of
Wall Si reel.
If you find yourself thinking this
way, then the following thoughts
may provide some encouragement:
When you invest in stocks is not
nearly as important as the discipline
of buying regularly. Since 1965, if
you bought stocks once a year and
12O- MorningNews • Sunday, August 16,1998* * *
picked the worst day to invest, 30
years in a row, you ended up with
an annual return of 10.6 percent. If
you were incredibly lucky and
picked the best day of the year, 30
years in a row, you ended up with
an annual return of 11.7 percent.
The difference is a grand total of 1.1
percent. It is the discipline of buying
regularly that counts.
Stock prices move up about 10.8
percent a year, on average, because
corporate profits rise about 8 percent a year on average. If you add in
a 2 percent dividend yield you have
a total return in the neighborhood
of 10 percent. Even if we have an
economic decline during which corporate profits grow at only half the
normal rate, or 4 percent a year,
stock prices should follow suit, rising an annual 4 percent a year.
Assuming the 2 percent dividend,
you would still get a 6 percent return.
Exiting (he stock market to avoid
a decline simply means that you arc
likely to miss the next rally. Consider
this: If you were out of stocks in 40
key months out of the past 480
months (40 years), your annual
return dropped from 11.4 percent to
2.7 percent. In other words, you
would have done better with a sav-
ings account.
Seizing opportunity, however,
requires study, personal responsibility and willingness to make decisions. Some of the most successful
long-term investors believe that
with good information and a longterm outlook the average investor
will do well. Who? Peter Lynch, who
built Fidelity's Magellan Fund into a
giant. And let's not forget the words
of Benjamin Graham, who wrote
the book on value investing and
inspired some of the mosi successful modem investors. Be an
investor, not a speculator, he said.
Always differentiate between
price and value. If the fundamentals
of the companies you invest in are
solid, then slay the course. But only
select from among the highest qua!
ity stocks. Be exceedingly careful if
you purchase a stock based on recommendations of others. Financial
prophets do not exist. No one is
going to pan the Red Sea of financial risk and lead you to the land of
high returns.
You can write to financial columnist
Laurtn Rudd cfo th« Savannah
Morning Ntws, P.O. Box 1088,
Savannah, CA. 31402.
Saving less money
Americans' personal savings rate
has dipped to an all-time low.
Annual personal savings rate, by year:
19.0% I
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