Dangers and Opportunities Lurks

Most investors that I talk to know they want to protect and grow their wealth. They are looking for an investment that will help them do that. Should they buy an annuity or a mutual fund? But they are missing the Big Picture and, in doing so, are putting their financial future at peril.

Do you remember... the 1970’s? The oil crisis, gas lines, high unemployment? Inflation caused wealth to deteriorate. High interest rates brought the economy to a crawl. Most people fought to maintain the wealth they had worked years to accumulate only to see it shrink. Some, though, understood the Big Picture and dramatically increased their wealth.

I believe it is vital that investors stop and look at the Big Picture today. Ignore it and you may see your wealth (and your lifestyle) evaporate. See and understand it and you may prosper.

Looking at the Big Picture means taking a step back and determining what you think will happen over the next 10-20 years. What will the world be like? What changes do you think will happen? What trends do you see developing?

What you see when you stand back may frighten you. It shouldn’t. It’s about recognizing potential dangers so you can protect yourself. And it’s about spotting opportunity so you can grow your wealth. Your view of the big picture can then guide where and how you invest.

For instance, let’s say I’m a farmer trying to determine what I should plant. I see the big push for ethanol right now and that it’s caused the price of corn to sky rocket. So should I plant corn instead of soybeans?

That’s the decision most of us would probably make. And that’s the point. The ability to spot opportunity not only involves what we believe, but also what we think everyone else believes. Think about it. If all the other farmers see the same thing I do, and I would plant corn, then it’s very likely that most of them will, too.

If a lot of farmers stop planting soybeans and plant corn instead, what’s going to happen? There will be more corn and fewer soybeans. What if too much corn floods the market and corn prices drop? What will happen to soybean prices if there is less supply?

Doing what everyone else does is only going to result in the same returns as everyone else. If we can spot opportunities that others are missing, we have the ability to have greater returns. As a farmer, I can play the trend (plant corn), play the counter trend (plant soybeans), or hedge my bets and plant both.

As an investor, we can further analyze this situation to find ways we can profit from it. The amount of ethanol that can be produced per bushel of corn depends on the starch content in each kernel. If a way could be found to increase the starch content in corn, that high-starch content corn will be more valuable than the rest.

We’ve all heard that the person who made the most off of the gold rush was the person selling shovels. In the same way, it may be the companies that produce the genetically modified seed that prosper from the ethanol craze. Or the companies that produce the fertilizers and insecticides that will be needed.

Monsanto (MON) is a company that specializes in producing genetically modified seed. They are ‘selling shovels’. As a result, their profits and the value of their stock have soared. A $10,000 investment in Monsanto at the beginning of 2004 is worth over $40,000 today. It’s up almost 30% in the first 6 months of this year.

If farmers are planting corn, there isn’t going to be as much feed for livestock. That means that the price of meat, milk, chicken and eggs and other groceries will rise, causing higher inflation throughout the economy. If I don’t recognize that and take steps to protect myself, I could see the purchasing power of my wealth shrink.

This is just an example. So, what do you think are the major trends that might occur in the next 10-20 years? If you’re right, what should you do to protect and grow your wealth? These are issues I’ll be discussing in the next few articles.

Nationally-syndicated financial columnist and Certified Financial Planner® Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA. He’ll answer your financial question – FREE at www.guardingyourwealth.com.

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Controlling Portfolio Risk

Millions of people fail to own stock market based investments because they fear losing their money. That’s understandable. Lots of people lost 30%, 40%, 50% or more between 2000 and 2002. But it doesn’t have to be that way! Don’t let the fear of losing money keep you from an investment that can help you better reach your financial goals. Read on to see how.

Risk can and should... be managed. We do it every day in other areas of our lives. For instance, we manage the risk of getting hurt in a car wreck by putting on seat belts. We manage the risk of our house burning down with fire insurance. But somehow we throw out such common sense when investing in the stock market!

There are many ways to manage the risk of owning a stock. One traditional way is by spreading your money among several different stocks. This is called diversification. If you have 10 different stocks and something happens to one, hopefully the other 9 will be OK.

A second way is through Asset Allocation. This means that you should own a mix of bonds, real estate and equities because they go up and down for different reasons. Typically, if stocks go down, bonds go up.

Almost everyone utilizes diversification and asset allocation to minimize risk. But don’t stop there. Don’t have a false sense of security because your advisor tells you that your account is diversified. Taking one or two additional steps will make the difference between breaking out in a cold sweat and sleeping like a baby during a serious market decline.

One additional step is to have a pre-defined level at which the investment will be sold. This is referred to as a ‘stop-loss’. Some of you may be familiar with it, but have you thought about it in terms of how much money you have at risk?

For instance, if you had $10,000 invested in Enron, how much money were you at risk of losing? It was $10,000 because a company went bankrupt and the price of the stock became worthless. Therefore, every dollar was at risk.

If you had a stop-loss at $9,000 then the stock would have been sold once it declined to that level. Enron didn’t become worthless overnight; it declined in value over a period of months. Relying on diversification and asset allocation would have resulted in a $10,000 loss. A stop-loss would have resulted in a $1,000 loss. Which would you prefer?

A second additional step can be taken to keep your profits from disappearing. It’s referred to as a trailing stop-loss. As the share price of the stock goes up, so does the level at which the stock will be sold if it drops in value. Once the trailing stop-loss is at a point higher than what you invested, your principle is protected.

There are negatives to using a stop loss. The value of the stock could drop to that level, get sold because of the stop and then jump right back up in price. But that may be a small price to pay for the protection it offers. I use sophisticated, multi-stop techniques to reduce this risk for my clients, but that’s something that’s next to impossible to do on your own.

Also, a stop-loss doesn’t guarantee that the stock will get sold at that point. Once breached, the sale is executed at the next available price. If a stop is at $9 a share and the stock opens the day at $8, then the sale might be at $8.

Where a stop loss is placed will depend on the type of strategy being used. If it’s a longer-term investment that you want to give plenty of room to run, then you might use a 15% stop. If it’s a shorter-term, more speculative oriented investment you may want a 3% stop.

The key is that your risk is significantly reduced. If you knew that your risk of loss was around 5% (or less), wouldn’t you feel much more comfortable being invested in the stock market?

Like a seat belt and fire insurance, a stop and trailing stop-loss can drastically reduce the risk of investing. We would never dream of owning a home and not having fire insurance. We should approach investing the same way.

Nationally-syndicated financial columnist and Certified Financial Planner® Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA. He’ll answer your financial question – FREE at www.guardingyourwealth.com.

Read more!

Your posted comments on this and other questions are welcome.
If you have a question for Jeff an answer is just a click away.
Find a wealth of information at Jeff's website.