MANAGING YOUR RISK

What Can We Do To Lower Our Risk? Just when you think your portfolio is coming back, we have a day like yesterday when the Dow Jones average lost more than 300 points. Retail stocks, financial stocks, and even energy stocks were hit hard. The sub-prime mortgage debacle and lousy housing markets are spilling over into a number of other sectors. Oil at $100 a barrel has resulted in consumers spending much of their discretionary money on gasoline to get to work and the grocery store. None of this adds up to a favorable economic environment. As I have said before, much of this correction is a healthy payback for the excesses of the previous 5 years when people bought bigger houses than they need and borrowed on their home equity to finance purchases they didn't really have to make. Stocks and real estate have dropped because they were driven to unrealistic levels by easy money. Everything became over-priced and now a correction is necessary. All this is an attempt to explain that which really can't be explained. The real question is in the first sentence of this paragraph. What is an investor to do? Here are some suggestions.



Get Out of The Markets. This is what happened in the late 70's and early 80's. (See my last month's post entitled, Turn Around and Run Like Hell). To a certain extent this worked in the 70's and 80's because people were able to get 8-12% on insured bank CD's. The trouble was that they saw these rates drop to 2-3% over the years that followed as inflationary excesses were wrung out of the economy. With rates already down to 3-4%, it is difficult to settle for returns that low. Despite my encouragement to stay with the markets, I have reduced my and many of my clients exposure to the markets by increasing cash reserves. A radical change to 100% cash is nothing I would recommend, so here is another approach.



Stop Worrying. Suppose you bought 1000 shares of 3M in August of 2007 at the high for that month of $91,000. Six months later the "value" of your investment is $78,000. That's a loss of $13,000. Or is it? What you bought was a share of an operating business. The market thought that business was worth $91 per share. A scant six months later, the market thought that business was worth $78 per share. Has the business really changed that much? Not to my way of thinking. Worrying about daily market fluctuations is like planting carrots and pulling them up every day to see if there are carrots forming yet. My philosophy is to buy great businesses like 3M and stay with them unless the fundamentals of the business change. The market is a manic-depressive. Don't let it make you one. There is another criteria I use .


Look For Cash Flow. I bet you knew this was coming. Using 3M as an example, in August of 2007 3M was paying a $480 quarterly dividend. Not a huge yield, but its close to what you would get in a bank. In addition, your tax rate is only 15%, less than half of what a high income investor would pay on a CD. Recently, 3M raised this payout to $500 per quarter. They have raised this dividend each year for several years (in 2003, the payout was $330 per quarter). Statistically, dividend paying stocks have been proven to be less risky than those who don't pay dividends. Using Dow Jones statistics, their are three times as many dividend paying stocks in the below average risk category than non-dividend paying stocks. Even if you earn more than enough money to fund your living expenses, the lower risk category of dividend stocks make them a must for virtually any portfolio.

I Spend Several Hours Each Day Studying The Markets. If you are one of my clients, remember I do it so you don't have to. That doesn't mean I encourage you to stick your head in the sand. If it is as much fun for you as it is for me, by all means do it. If not, spend your time doing things you enjoy. The main thing is not to spend it worrying.