Can you double my money...without any risk?

Over the years that we have been managing money we have dealt with many clients who have asked some version of this question. Usually it is asked in jest, because most people understand that any investment that offers substantial return also involves some degree of risk.

All "riskless" investments like CD's or money-market funds essentially have a 0% return once taxes and inflation have been deducted. It is true that they secure the current value of principal, but over time, especially if one needs to live off the income, the value of that principal is guaranteed, even if slowly, to decline. Real long-term growth (growth that is greater than the assured losses brought by taxes and inflation), cannot be obtained from bank deposits, money markets or bonds.

To see just how much different rates of return can effect your net worth and retirement security over time click here to play with one of our interactive planning calculators:
How do different Rates of return affect my savings?

In building a portfolio we generally follow a rule of having between 20 to 40 individual stocks in a portfolio at any given time, along with three or more complementary mutual funds. This provides adequate diversification without becoming unmanageable. In portfolios of less than $500,000, we often utilize mutual funds exclusively.

Recognizing that higher returns only come from owning pieces of healthy, growing companies (stocks and mutual funds), the most important advice we offer each client is how much of and what kind of companies and funds to own. In doing this, our goal is not to eliminate risk, which is impossible, but rather to understand it, to manage it, and to minimize its effects. Following are the rules that guide which stocks we buy and what types of mutual funds we purchase.

Rules of Company Selection

1. Buying stocks whose Price-to-Earnings ratio is lower than the market reduces risk more reliably when you are buying larger, widely followed companies. The consistency of the "High- Yield Dow" approach, which is an example of a successful low PE strategy, does not work as well with smaller stocks.

2. Buying stocks based on the previous year's earnings gains is dangerous if the value of those gains has already been bid into the stock's price in the form of an above market PE. This is another way of saying that today's high flyers that are getting all the good press are always good stories, but rarely good investments.

3. The most important variable for judging a "growth" stock is its Relative Strength. That is the strength of its price movement versus other companies in its industry group, as well as the relative strength of the entire industry versus the market as a whole.

4. The most important variable for judging a "value" stock is its Price-to-Sales ratio. Using this variable instead of the more popular PE ratio helps to weed out earnings gains that are a result of accounting adjustments and write-offs as opposed to those that come from a growing demand for the company's products and services.

5. Most small-capitalization strategies owe their superior returns to micro-cap stocks with market capitalization's below $50 million. This is a highly profitable area of the market but is also a very dangerous area. Because of the greater volatility and lack of liquidity these kind of stocks should only be approached with great caution. Often the best way to own these smaller stocks is through a well selected mutual fund.

Beyond Managing Money

We feel that our job involves much more than just managing portfolios. As a part of our annual review with each client, we set their assets in the context of the amount of money they are likely to need for a financially secure retirement.

This is the "financial planning" part of our work. For clients who are pre-retirees, this involves setting appropriate goals for saving as well as investing. The kind of monthly saving targets that one sets for the last five to 15 years that you are working can dramatically affect the standard of living that you will be able to enjoy in retirement.

For many clients, this planning role includes reviewing and making recommendations about insurance coverage as well as investments. It can even at times involve the discussion of how to reduce spending to free up money for more important retirement needs. 

Contact Information:

Starfire Investment Advisers, Inc.
3000 Town Center, Suite 2235
Southfield, MI 48075
Phone: (248) 352-2211
Fax: (248) 352-4535

Contact: Ronald W. Humenny

The activities of Starfire Investment Advisers, Inc. and the advice provided by Starfire Investment Advisers, Inc. and/or Ronald W. Humenny are not affiliated with any Cumulus network broadcast station.

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