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itig 0nay dtis past summer, while sail- l°cal 6 <“'lesaPeakc Bay, I tuned in a stock neWS stat'on t0 find out how the that th^n^61 c'osed. When I heard do\vn6 ^°W ^ones Average had closed headed !jecord ^ P°>nts, I immediately nateiy i °r l^c nearest marina. Fortuity C|- Was able to make adjustments to that litt?ntS f>ortf°k°s the next day, so lo\ving6 t'ama8c occurred during the fol- pluttgg Weeks, as the market continued to This eni0re tkan 100 additional points, the ‘‘pXfer,'fnce °f being isolated from againS? °' Ibe market reminded me tarn a *'lc mvestor who cannot simply rriakg sWarskl'P toward the nearest port to Abs Ifni*ar adjustments to his portfolio. Vestor ■ntee ownership describes an inis a(jsln tke volatile capital markets who ^ f°r prolonged periods. Most
S,UCcessfnl';i.Cler thiS a major obstacle to distinC( U 'nves,'ng. However, there are if oneat*vantages to absentee ownership lects thaV°ids high-risk investments, se- estabij h proPer investment vehicle, and With a fCS c*ear **nes of communication st°ckb f'nancial intermediary, e.g., a theSe e. er' Although I focus on stocks, apply °Ul‘delines for the absentee investor Risk° a" caP‘tal markets, that y0^anasement—Logic suggests |ti°neyUjlave a high probability of losing So* you insist on trading pork bel- lhe rnid'lj/he deck of an aircraft carrier in 'hat on6 'he Indian Ocean. The idea fish jse Creates wealth by taking undue risk Vahd. This year, in fact, low- high-ri p S have generally outperformed '"'Port St0cks' P'sk management is an to assuant 'nvestment goal. If you decide yottfseif£ 'he r'sk of stock ownership by PUfCha .’ y°u can best manage the risk by beta st°cks with low “betas.” The diuch tn 'n8 °f a stock tells you how agains, at stock can be expected to move dard & a star*dard index, usually the Stan- With a K°or ^00. For example: A stock 50% eta of 1.5 theoretically will be •he ^ 0re volatile than the market. For Pigc]Cnj,entCe owner, it would be more ar°und V° ch°ose a stock with a beta at or t)lv '.e market beta, which is 1.00. ers,fication reduces volatility and
e<lin8s / November 1986
risk. Placing all your capital into one or two stocks is usually just as foolhardy as trading pork bellies. If you do not have the capital to create a diversified portfolio, then mutual funds can provide you with one.
“Concept” stocks (those valued for the expectations for the future of the industry, not current earnings; e.g., “biotech” stocks) and “hot tips” can be tempting—especially when they work. The problem is that the investor in these stocks will often act on emotion, rather than analysis. Even though concept stocks and hot tips often have merit, they can be subject to violent price swings. And . . . Murphy’s Law states that violent price swings southward will occur as soon as the investor is northbound—in the North Atlantic.
For the absentee investor, risk management means acknowledging the problems that absence can create, and attempting to hit a lot of singles instead of a few home runs. The goals of investing in risk capital should be to conserve capital as well as personal sanity, to earn a good rate of return, and to gain experience. Play the home-run game when you are landlocked at the Pentagon for three years.
Investment Vehicles—The process of selecting the proper investment vehicle must begin with a realistic estimate of the size of the capital commitment. For the wealthy investor, professional portfolio management is available through banks, trust companies, brokerage firms, and the like. The wealthy investor will probably have his portfolio actively managed on a discretionary basis. But even at this level, the professional will insist on establishing—with the investor—certain levels of risk and diversification.
For the remaining 95% of investors, the choice ultimately depends on the amount of active management they are willing to tolerate. For the more passive investor, mutual funds are the way to go. They provide a vehicle to achieve the designated levels of risk management with just a small capital commitment. So vast and important is this area of investing that next month’s column will be devoted to it.
Other than mutual funds, there is a selection of common stocks, or such variations as convertible preferred stocks and options. Your choice of stocks should be based on sound, fundamental analysis. Usually, your best ideas will come from those areas in which you have a strong personal or professional interest. Use the library, company literature, and reports from brokerage houses to build a basis for your personal analysis of a company.
If you practice good risk management, your stock portfolio will consist of a minimum of ten separate companies and a maximum of 25. Because of the prolonged-absence problem, it is wise to place an upper beta limit of 1.10 (10% more than the market beta) on your portfolio. A portfolio beta is calculated simply by multiplying the beta of each stock by its capital cost. The sum of each of these calculations is then divided by total capital cost. This produces what is commonly referred to as the dollar-weighted beta for a stock portfolio. (The last bit of mechanics determines the optimum point, in terms of price, at which stoploss orders should be placed for each stock—more on this later.)
The absentee owner should consider using convertible preferred stock in his portfolio. “Converts” generally offer higher yields than common stock. At the same time, they possess growth potential because the owner can convert them to the common stock of the issuing company at any time. Investors unfamiliar with converts can learn about them from any of the professional sources discussed in this article.
Options give investors the right to buy or sell stock at a specified price for a specified period of time. Options should not be used by anyone expecting to be away from the pulse of the market for more than 24 hours. Otherwise, they should be used by only the most sophisticated investors, as a means of generating more income from a portfolio.
Altogether, most readers probably will find that mutual funds are the best invest-
139
ments had been made when he ^ jea
larly serving on prolonged Perl° ^ after
duty. And he went on to confess ■ . ..... ■ n thp needeu
retiring—and having all the nee lytical resources available to 1 cormed taneously—he had generally the
U. S. Naval Institute, Annap 21402.
toll5’
ment vehicles to select, since many require initial investments of as little as $500.00. They also offer varying levels of risk management, and—most importantly—they allow the magic of compounding to occur. Professionally managed portfolios usually require a minimum capital contribution of $50,000. And lastly, active management of a personal portfolio requires a minimum initial capital contribution of $15,000, if one is to practice proper risk management and keep transaction costs under control.
Communication—In my opinion, the actual success or failure of investing rests with good communication between the absentee investor and the person he employs to give advice and execute trades— e.g., a stockbroker, trust officer, portfolio manager, or financial planner. From a perspective of more than 17 years of experience, I suggest the following:
- After you have established your personal investment objectives, determined your risk tolerances, and chosen the desired investment vehicles, contact a broker—or whomever—and clearly state your intentions, mentioning the fact that you are subject to prolonged absences.
- At some point in the conversation, ask pointedly whether that person can work effectively with you under the conditions you have described. Then ask why he or she thinks so.
- There are probably 15,000 people in the United States who would like to do business with you. Do not settle for the first person you talk to. Do place a lot of faith in your initial gut reaction when you first talk to those who would manage your money.
- When you finally decide on an intermediary ask immediately for the domestic and toll-free numbers of the firm. If none are available, state that you will call collect when transacting business.
- If you are creating a portfolio with this person, ask for technical advice on the placement of stop-loss orders. A stoploss order is a set minimum price limit for a stock, at which point you want the stocks to be sold. This provides vital downside protection against major losses in a falling market, when you cannot be contacted. As a rule of thumb only, stops can be placed 10% below the 200-day moving average of the stock. However, the technical analysts of most major brokerage firms make stop recommendations available to all brokers. Once you have decided on your stops, clearly communicate the stop prices to your broker; they must be implemented during periods of absence.
- Always touch base with your broker
prior to a deployment or other a Verify your stock positions, adju ^ ^ implement your stop-loss or e' jeel
issue any other instructions. con-
uncomfortable about current mar t0 a
ditions, tighten up your stop sjtjon minimum, or take a partial cas P jn. in your portfolio—e.g., 70% 0 “ caSh vestment in stocks, 30% in cas( aC. equivalents, such as money m counts or T-bills. r had with a
I remember a conversation ^th a retired Navy captain, who vvas^tera good client and a good frien ■ g( he particularly rough time in the m .^veSt. stated that his most success u ^
more poorly than the market. ■ ^tetri ght professional help, you can gj Smooth sailing and good inv^^
ill
Editor’s Note: Al Baker w ^ your specific questions on finan, ppase ters in this column each eedings’' send them to: Al Baker, c!o ProC,;<. ylD
Vincent Astor Memorial Leadership Essay Contesi
United States Naval Institute, Annapolis, Maryland 21402 (301)268-6110
The United States Naval Institute and the Vincent Astor Foundation take pleasure in announcing the Eleventh Annual Vincent Astor Memorial Leadership Essay Contest for Junior Officers and Officer Trainees of the U.S. Navy, Marine Corps, and Coast Guard. The contest is designed to promote research, thinking, and writing on the topic of leadership in the U.S. Navy, Marine Corps, and Coast Guard.
FIRST PRIZE: $1,500, a Naval Institute Gold Medal, and a Life Membership in the Naval Institute.
FIRST HONORABLE MENTION: $1,000 and a Naval Institute Silver Medal.
SECOND HONORABLE MENTION: (two to be awarded) $500 and a Naval Institute Bronze Medal.
The first prize essay will be published in the U.S. Naval Institute Proceedings. The Institute's Editorial Board may elect to publish any or all of the honorable mention essays in any given year, but is not obligated to do so. The Editorial Board may, from time to time, publish collections of the award winning essays and other essays in book or pamphlet form.
This contest is open to:
- Commissioned officers, regular and reserve, in the U.S. Navy, Marine Corps, and Coast Guard in pay grades 0-1, 0-2, and 0-3 (ensign/2nd lieutenant; lieutenant (junior grade)/1st lieutenant; and lieutenant/captain) at the time the essay is submitted.
- U.S. Navy, Marine Corps, and Coast Guard officer trainees within one year of receiving their commissions.
ENTRY RULES
1. Essays must be original and may not exceed 4,000 words.
- All entries should be directed to: Executive Director (VA^L
U.S. Naval Institute, Annapolis, Maryland 21402. ^ (f)e
- Essays must be received on or before 1 March 19
U.S. Naval Institute. ^aCn
- The name of the author shall not appear on the essay ^ author shall assign a motto in addition to a title to the es t (tie motto shall appear (a) on the title page of the ess®, oUtside title, in lieu of the author’s name and (b) by itself on tri stl0l)|(j of an accompanying sealed envelope. The sealed envelop ^e, contain a typed sheet giving the name, rank, branen o ^ the address, and office and home phone numbers (ifaval xhp identity essayist, along with the title of the essay and the motto, in ^ ^ of the essayist will not be known to the judging memDe Editorial Board until they have made their selections.
- The awards will be made known and presented to the su<^ ^ competitors during the graduation awards ceremonies ie& respective schools, if appropriate, or at other official cer ^ pre. Mrs. Astor or her personal representative will be invite
sent the first prize each year. prox-
- Essays must be typewritten, double-spaced, on paPer imately 8V2 x 11”. Submit two complete copies. goar(j
- Essays will be judged by the Naval Institute’s Editoria ^ for depth of research, analytical and interpretive n’0t be original thinking on the topic of leadership. Essays shou merely expositions or personal narratives.
Deadline: 1 March 1987
WIN $1,500
140
Proceedings
/ Nove1’'1
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