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. STOCK pwcts rofl rniOAY. AUGUST 7 AMD AUGUST M. COMPANY SYMBOL AUG. 7 AUG. 14 Union Cvnp Fort J M M * Stont ContiiMf GuMstrtftn Carton KuMmM Honw Depot 42V 3l/ 19A ilCC FJ STO-E 44-/, CAC CIC KUH 5/» 34V. 44 HD DAI rDI Brtoo* 6 Strtton Suntnnt WachovU Savaonah B«nk • Frt«<lm*n't 41/. 30V20 407. BGC • STI WB s/. 321/. 42 e^iy 3 i /* C5 3£ 38'/, 68'A 82/> 25 /, 13A 4PX. 65/ 82 1 /. 26 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 0 •H2 H4 flfi 88 '90 ' Sourer Comm«fc« D*p«rtm«nt *p