BI > APRIL 2001

Risk, Retention and Road Kill

Attributes of the Top 100

Risk. It's a personal thing. We define risk as the likelihood that our money WILL NOT be there when we need it. Your personal approach to investing is a matter of style, and we can categorize the risk characteristics of different types of investment from low to high. The NAIC Top 100 achieves returns approaching the NASDAQ with much less price volatility. See the accompanying table.

Time Horizon Does Matter

Investing in common stocks exposes individuals to a sometimes harsh reality -- stock prices fluctuate.

So does the value of your residence. The difference is that you can't look it up in the morning newspaper along with everybody else in the world. "Good morning, dear. Isn't it amazing? Our home value was up almost 2 percent last month. The completion of our subdivision had a great impact on everybody's house on the street. I wonder why we all lost value yesterday?"

Real estate values generally grow at a slower and more consistent pace relative to common stocks. But the values do fluctuate. It's also generally true that a home purchase is made with the intention to "hold" it for several years.

Short Run -- Risk is Expected Variation

The operative words in the preceding paragraph were "generally consistent." In other words, the market value of a home fluctuates fairly little week to week, month to month and as the years pass. The degree of variation is low. Common stocks are different. This year's Top 100 leader, Cisco Systems, sold for 82.0 during 2000 and has subsided to 37.44 as of 1/31/2001. That's a fluctuation of 54 percent from the high point.

Risk and Road Kill

Dallas, Texas -- July 1999. Southeastern Michigan chapter director Calvin Richards and I had landed in Texas and we shared a taxi to the CompuFest hotel. Our taxi driver was talkative and he had something on his mind.

"Whatcha in town for?"

We replied that we were in Dallas for one of our national meetings, a conference about investment education.

"Huh. I hate investing. I had been hoping to retire."

Our curiosity was triggered. Calvin and I, in unison, asked him to be more specific.

"Sure. A couple of months ago, I inherited a chunk of money. A nest egg on the order of $100,000. I'd been studying up, mustering the courage to jump into this stock market thing. I thought that diversification was important."

From the back seat, we agreed, suggesting that proper diversification tames risk. What did he invest in?

"Yeah. I knew I had to diversify so I split the money into four different piles and bought equal shares of Amazon.com, America Online, Yahoo! and eBay in late April. By mid-June, I was down 40 percent."

We suggested that these paper losses were a challenge and that he might look for opportunities to buy into some other quality companies.

"Too late. I sold the stocks. In six weeks, I lost $40,000."

We cringed, wished him well and speculated that his surviving proceeds probably found their way into a mattress.

Long Run -- Recognizing, Realizing Risk

The accompanying table provides some insight into the characteristics of different investment types. For any given year, it is "statistically natural" to expect the average return, plus or minus two times the annual variations. Take the NASDAQ for example. The average annual return has been 25.4 percent. This suggests potential range for any given year of a 39 percent loss to a gain of 89 percent -- figures hauntingly close to the actual results for 2000 and 1999, respectively.

In the same manner, the statistical expectation for the Top 100 would be from a 20 percent loss to a 60 percent gain.

Real risk? Not to long-term investors. The real risk is that damaged investors, harmed by a brief excursion in choppy waters, fail to recognize the value of longer time horizons. Sometimes they never return. And that places their future at risk.

Mark Robertson is director of online resources and senior contributing editor for BetterInvesting. He serves as a member of BetterInvesting Magazine's Editorial Advisory & Securities Review Committee. Mark can be reached at Robertson_Mark@comcast.net.