Your Personal Mission Statement

You should be aware of the fact that every company in which you might invest runs its operations based upon a mission statement that keeps it focused on those objectives it wants to achieve as its business goals.

People need mission statements as well - especially individual investors. Why? To help you identify what's important and what you value most in your life. That way, you'll focus your efforts on those things that you really want for your financial goals.

If you ever read the mission statements of those companies you really admire, over and over again you'd notice that the same few qualities keep topping the list:

* a dream
* determination
* discipline

These are the same qualities that you can use to become a successful investor!

Strange as it may seem, committing words to paper has a way of turning thoughts into action. And it doesn't matter whether your mission statement is one line, one paragraph, or one page. What really does matter is just how serious, and how prepared you are in order to reach your goals.

Writing a personal mission statement helps you keep going in the right direction. And you create your personal mission statement by spending some time thinking about your current situation, then imagining where you would like to be financially in one year, five years, or even more years from now. But you must be both specific and realistic in what you plan.

In order to achieve your dreams, it's very important that you write your goals down, and then post them in a place where you can refer to them often, because by so doing, they will serve you as a constant reminder and help you to stay focused on those investing goals that you really want to achieve!

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One Sure Way To Avoid Value Traps

Perhaps you've been in this situation before. After doing a vast amount of research, you finally come across a stock that appears to be too good to be true. It has a strong market position along with rising profits and sales. And best of all, a price-to-earnings ratio that is really, really low - like about one-third the P/E ratio of the S&P's 500 stock index - which would place it at about 7 right now.

But you have two concerns: 1)that the company has a fair amount of long-term debt; and 2)that it's involved in a business that is extremely sensitive to the economic cycle... So what do you do?... You buy. And then you buy more when the stock goes down another 20% because after all, it has a very tiny P/E. But the stock keeps falling...and falling...and falling... Hey guess what?...Welcome to the Value Trap!

It is a very easy thing to do: losing money in the market by betting on "cheap" stocks that just kept on getting cheaper and cheaper and cheaper. The problem? These shares really weren't as cheap as their low P/E ratios indicated.

Now this is not to be construed as a total condemnation of P/E ratios as they do have a place in evaluating many prospects. But they may not tell the whole story in terms of risk. Indeed, P/E ratios, as well as book value, look solely at a company's equity value. And while they may work fine in many cases, they don't work so well for companies that have a lot of debt and/or cash on their balance sheets.

A better way to value a company while still remaining within the P/E framework is to replace its equity number in the equation with its enterprise value. A company's enterprise value is the market value of a corporation's total capitalization (debt plus equity, minus cash).

Why it's important: It gives a different perspective on a stock's valuation. Traditional P/E ratios may not fully capture the risk of owning certain stocks, especially those with debt loads.

How to calculate it: You take a stock's market capitalization (stock price times outstanding shares), add the company's long-term debt, and then subtract its cash assets. To convert to a per-share number, divide enterprise value by the number of shares. When using enterprise value per share in a P/E ratio framework, simply divide the enterprise value per share by trailing or forecasted 12-month earnings per share.

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Investing's Four-Letter Word

There is a word that rarely if ever gets mentioned in the financial media and I can almost guarantee they will never utter it on CNBC, but you need to know it. The word I refer to represents a type of investment that is very unsexy and therefore it won't hold your attention in the way that stocks, bonds, or commodities would. And yet, this item is becoming more attractive with each passing day so you need to start paying attention to holding c-a-s-h!

A noted research strategist from Merrill Lynch has recently increased his suggested allocation to cash, while pointing out that stocks have returned just 2.7% a year for the past seven years which is less than you can get on your cash right now. And cash returns are about to get even better!

Most people have their money in stocks and real estate, but these are overpriced. Stocks are expensive with a P/E of 20, and a tiny dividend yield of 1.8%. And real estate seems to be the popular topic of conversation among the "trivial many" and we should remember what Warren Buffett teaches about how we should behave when others are greedy.

Cash in the bank that pays 4%, with no fears of risk, looks pretty good - especially when we factor in the "not so hot" prospects for stocks and real estate over the coming years.

So you need to pay attention to your cash level relative to your riskier assets. And if it's extremely low, ask yourself why...and then determine if you should start increasing your cash position.

Cash is the four-letter word in the investment world, and your broker won't get rich by recommending that you increase your cash position. But a very safe 4% a year is nothing to ignore - especially when you compare it to a world of risky overpriced assets that may not be able to beat the return on your cash over the next five or ten years!

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Investor Inertia

You may have heard an old saying that goes like this: "If you always do what you always did, then you'll always get what you always got!" That statement ought to be food for thought for every investor.

I believe that one of the main obstacles preventing most investors from achieving a greater degree of success as a result of their investing efforts is the fact they suffer from a condition which I term, "Investor Inertia."

What is that?

"Investor Inertia" is a natural tendency to continue to do on a regular basis that which we as investors have grown accustomed to doing. And we do this on a daily basis without really recognizing that if we continue to do it, we will produce the same results tomorrow as we had yesterday!

Some people wonder what exactly is the primary obstacle to becoming a successful investor. Is it lack of money, lack of knowledge, or perhaps lack of time? The answer, I believe, is that while one or more of these problems can pose a temporary hindrance to us as investors, the greatest obstacle of them all is "Investor Inertia."

The issue is not lack of money, as any determined person can always find new avenues to increase his or her income. The issue is not lack of knowledge as we live in the midst of a veritable information explosion, so knowledge is available merely for making the effort of seeking it out. And the issue cannot be time, because most of us waste a significant portion of each day by involving ourselves in mundane activities where the time spent could easily be redirected toward more worthwhile pursuits.

So the answer pure and simple is "Investor Inertia."

If, every time you turn your attention toward your portfolio and continue to do with it what you did the day before, you will produce the same results tomorrow as you did yesterday. It's that simple!

But if, on the otherhand, you created a game plan to produce results that are in harmony with your tolerance for risk, and are also consistent with the goals you have determined to be your personal objectives as an investor, and you act consistently in accord with those goals and objectives, you will produce a different and a more positive result.

You cannot expect different results to occur if you do not act differently!

"Investor Inertia" is a very powerful force. It almost compels you to want to do tomorrow the same thing you did today in your approach to investing. And if you allow yourself to fall victim to it, then you will continue to produce the same exact results you always have. What you need to do in order to counter this pattern is to generate an act of will, followed by very specific conduct.

So how do you break the pattern? It's simple. Create a game plan, commit yourself to this new game plan, execute it daily without any question and without any exception. And never forget - you have no greater reward as an investor than when you overcome and beat "Investor Inertia."

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Inflation Expectations

Inflation can damage your portfolio in two primary ways. Expectations of future inflation are one of the main drivers of financial market behavior. If inflation expectations suddenly jump in the wake of a spike in oil prices, bond prices may plummet. Their link to the markets comes from the second way inflation hurts investors: It depresses the value of fixed income instruments, such as bonds and loans, because it makes the cash flows they throw off less valuable.

Often those who seek to hedge their inflation risk are advised to simply increase their allocation to equities. The assumption is that stocks will rise in inflation-adjusted terms because companies are free to raise the prices of goods and services to keep pace with inflation. Unfortunately, this is a misconception. Corporate profits are the difference between the cost of raw materials and the cost of finished goods, and since inflation typically originates in the raw materials sector, corporations can't raise prices until margins are squeezed down. That means profits have a hard time doing well in an inflationary environment.

As investors have realized that equities are an imperfect shield from inflation, there has been growing demand for products designed especially to hedge this risk. The most popular is the U.S. Government-issued TIPS - Treasury Inflation Protected Securities. But there are also new mutual fund, managed account, structured product and derivitives instruments on offer that may be of use to private investors.

The government began issuing TIPS in 1997, and it is now a mature and easily accessible product. Government-issued TIPS are the most realistic option for a lot of investors. TIPS have a payoff that changes in line with the CPI for urban areas (CPI-U), published monthly by the Bureau of Labor Statistics. They perform well in a rising interest rate environment, but usually underperform other government bonds when inflation falls or is stagnant. Despite the low level of inflation in recent years, it has been enough to boost the otherwise anemic performance of this instrument.

Just as with ordinary Treasury securities, TIPS pay a coupon that is a fixed percent of the principal amount. Unlike conventional bonds, however, the TIPS principal value is adjusted to reflact changes in the CPI-U. That means their price is very different from conventional Treasuries. As with a conventional bond, changes in the behavior of interest rates will also affect the relative performance of TIPS. And because these instruments have a very low risk profile, portfolio managers suggest they be used as the foundation for a fixed-income portfolio.

There are other methods of ensuring a real return on investments. One simple way is to invest in a real return mutual fund or managed account. Some of these invest in TIPS and other international inflation-linked government securities. Pimco manages a real return fund that is mostly invested in TIPS, but also includes other assets such as high yielding emerging market bonds. Another type of mutual fund/managed account invests in commodities or securities that track commodity prices, because these tend to rise in an inflationary environment. Real return funds typically charge a 3 to 4 percent sales charge.

Another tool for hedging inflation is a structured note with an inflation-linked payoff. With something like this, an investor can purchase an investment tied to the performance of the Dow Jones AIG commodity index, in which the initial investment principal is guaranteed, so the instrument has very little risk. Index-linked products of this nature typically offer an investor some percentage of any positive move in the index.

Most people believe that inflation remains tame at this time. But the growing pressures in the housing and energy markets, along with the falling dollar and the fact that the Federal Reserve is crippled from raising rates too much by fears it will harm the economy, raise legitimate concerns about its reappearance. Individual investors who worry about its caustic effects on a portfolio now have a variety of tools to manage it, while earning a respectable return.

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Be Careful of Securities Analysts

If you are like many investors, you buy stocks because your broker recommends them. But did you know that most brokers get their tips from someone called a securities analyst? How reliable is his or her research?

Securities analysts are highly paid investment sleuths who work for brokerage houses, banks and other financial institutions. They spend their time finding stocks that they think will make a profit. But many analysts are too often bullish on the wrong stocks.

Analysts often fall in love with their stocks, just as novice investors do. And they occasionally fear that gloomy forecasts will alienate the managements of the companies they follow. Sometimes an analyst is under pressure to give a company a good report because the analyst's parent firm is acting as the well-paid underwriter for that company's new stock issues. Therefore, it is smart to ask any broker who recommends a stock to you if his firm has an investment banking relationship with the company he is pushing. If it has, you should be extra careful.

Analysts also tend to pass news along first to big, institutional customers and then to the retail brokers who do business with smaller investors. This puts you at the rear of the information line and, in many cases, that is too far back to take any profitable action on the tip. In general, it is wise to patronize brokerage houses that freely publish their analysts' recommendations and keep track of the resulting profits or losses in those stocks.

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Working With Tax-Deferred Accounts

You may not be aware of this important fact, but ever since the advent of the 15% tax rate on long-term capital gains, it no longer makes much sense to own stocks in either 401(k) or Traditional IRA accounts, since you'd eventually be paying 25% or more in taxes whenever you take a distribution from such accounts.

If you qualify, a Roth IRA is the best way to accumulate wealth because eventually, you will be able to withdraw the money completely tax-free. In your Roth IRA, then, you should own whatever you think will grow the most, and that generally means stocks.

Tax-deferred retirement accounts other than Roth IRA's are best for investments that don't enjoy the 15% rate on dividends and capital gains. These include corporate bonds, REITs, some preferred stocks, closed-end funds, and Index ETFs.

There is a good source of information on these and other fixed-income investments called Quantum Online, and you can find it easily in our "Links" section.

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The Virtues of Simplified Investing

When you watch the financial news on television, you may think investing is hopelessly complex - just a jumble of numbers, symbols, and hyperactive floor traders shouting and making strange hand signals. The reality however, is very different. Successful investing is not that difficult, it's just intimidating. And investing really is easier than most people think.

The essence of successful investing lies in being able to tune out the "noise" and focus instead on the big picture. For most of us, yesterday's market moves or the latest lists of hot funds merely serve as a distraction to the simpler, but far more important drivers of wealth creation, like your savings rate and overall mix of stocks, bonds, and cash.

You can build a successful long-term investment program with just a few simple components. But bear this fact in mind: "Simple" isn't the same as "easy." As important as your financial decisions, is the resolve to stick with your program.

Make a realistic plan. Review your finances honestly and carefully. Keep your goals, and determine what you need to do to achieve them. Then create an investment plan. Remember to be realistic. Don't expect your portfolio to earn a return of 25% each year - the historical average annual returns of stocks, bonds, and cash investments are 10.6%, 7.2%, and 5.8%, respectively. Those returns were before expenses and taxes.

A portfolio that has the appropriate mix of stocks, bonds, and cash investments for your needs is easier to create than you think. It can be accomplished simply by investing in a single balanced mutual fund. But be sure to watch the expenses.

It's all too easy to get caught up in the short-term volatility of the stock and bond markets and to chase performance, reacting emotionally when making decisions about your investments. However, keeping a level head and resisting the urge to change your portfolio are traits of successful investors. So stay the course and resist the urge to make sudden changes.

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Facing Up to Your Fears

Let's admit it: the personal finances of many investors are a mess. They don't keep good records; their savings are scattered and not earning nearly as much as they could; and their family budget is all but nonexistant. If this sounds like you, then I have some good news. Yes, you can get your personal finances together.

Your greatest obstacle in doing that is fear. Yet when people recognize their fears of finance, they often choose to confront and conquer them. Fortunately, the three most common fiscal fears are easy to identify. They are fear of responsibility, fear of risk, and fear of wealth - believe it or not.

Victims of fiscal irresponsibility are plagued by inaction. What they really yearn for is someone who will make their financial decisions for them. So, often they unquestioningly invest in what some broker - or perhaps some fairly successful friend - advises them to invest in. And often they get stung.

Then there is the fear of risk. Victims are afraid to do anything with their assets for fear of doing the wrong thing. So they keep their money in low-yielding money market funds or U.S. Treasury securities or Federally insured bank certificates of deposit.

As for fears of wealth, people sometimes feel undeserving of increased incomes or substantial inheritances. And if they have investments, they're afraid to change them even when a security plummets. They feel guilty about earning more than their parents did so their guilt translates into immobility.

Facing up to your fears about money and then taking steps to act and put your finances in order is one way to sleep free of worry or guilt. And, in a world where so much seems to be sliding out of control, it's reassuring to know that, if you're willing to make the effort, it's still possible for you to determine your own financial destiny.

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Selling Without A Broker

Did you know that you can sell stock that you own without using a broker? That way, you can save the money that you would normally spend for the sales commission.

The procedure for transferring ownership of stock is not all that difficult. First, sign the back of your stock certificate and have your bank guarantee your signature. That is to protect you against forgeries. Then, fill in the new owner's full name, as well as his or her Social Security number and address. Next, get the name and address of the transfer agent of the company in which you own stock. This should be available at the company's web site. Finally, send the stock certificate by registered mail to the transfer agent. Also attach a letter explaining that you are selling the shares. The transfer agent then will issue a new certificate in the new owner's name... And what is the charge for this service?... Nothing at all.

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There's No Need To Diversify If You Buy The Right Stocks!

Let's pause for a moment and consider this possibility: Imagine that from this point in time forward, you are never going to buy another stock again, if you thought there was a reasonable chance that you might have to sell it in less than ten years.

No matter what happened, be it wars, inflation, recession... you've decided that you aren't going to sell unless it's absolutely necessary, a matter of financial life or death.

Under that scenario, investing would become a whole new ballgame. You'd be focused on making the best possible investment decisions you could make. In fact, you might even stop investing altogether for several months while you brushed up on key investment concepts, and learned a lot more about accounting and finance. (And incidentally, that is not a bad idea!)

You would be tightly focused on investment success as never before, along with the accompanying peace of mind that you would gain from that move. In addition, you would do away with all short-term considerations, and you'd stop trying to anticipate the market. Instead, you would finally get down to the serious business of taking the best possible advantage of the opportunities the market delivers to us every few years in the form of lower stock prices.

Warren Buffett once said that investors should behave as though they were given a punch card at the beginning of their investment careers. And each time you buy a stock, you would punch a hole in the card. When you've punched twenty holes in the card, you're done buying stocks for the rest of your life.

Now that may sound just a bit extreme, but the basic idea behind it is that of being highly selective in your investment decisions, which is exactly what investors should be doing these days.

What investors need today is to invest with a capital "I." No speculation. No trading. Understand that when you add a new stock to your portfolio, you then become a part owner in that business enterprise. And hopefully, you will have made that new investment only after having done the most thorough possible research. Buying a new stock ought to mean that you've found a business that you really want to be in. To invest any other way would be to play the loser's game which does not represent a winning approach to investing!

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NEXT MEETING: Thursday - August 18, 2005

This month as promised, we will devote the entire meeting to an in-depth presentation based upon The Zurich Axioms. These are both the Major and Minor principles that have guided the fabled "Gnomes of Zurich" to make tiny Switzerland become the repository for more than one-third of all the world's wealth!

Some of these Axioms will clash with things that we have all been taught in the "one-size-fits-all" school of investor education. But once you understand, you will then be able to see why such things as diversification are not necessarily the best thing for you to do as an investor. As a matter of fact, the Zurich Axioms will show you three reasons why diversification can be a very bad thing to ever do with your investment capital.

We will also have a specially prepared syllabus to pass out to everyone who attends, and this will highlight all 12 Major and 16 Minor Axioms so that you can further study these principles at your leisure.

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We meet at DePaul University's Naperville Campus, located at 150 West Warrenville Road in Naperville, Illinois. The room number will be posted on the easel that stands near the reception desk in the main lobby.

Meetings begin at 7:00 P.M. and end promptly at 9:00 P.M.. These meetings are open to anyone who shares our interest in learning more about investments and investing. We do have a yearly membership fee of $15 to help defray the costs of maintaining a group such as this. And non-members may attend for a donation of $5.00 per meeting.

In September, we will resume our Fall Speaker Series.

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Play The Dow For Profit With This Simple Strategy

Here is one of the smartest and simplest strategies for someone with at least $10,000 to invest. Buy roughly equal dollar amounts of the 10 highest-yielding stocks among the 30 issues that make up the Dow Jones Industrial Average (DJIA). Then a year later, sell any that have fallen out of the top 10 and replace them with the new high yielders.

The odds of beating the market averages with such a system are mind-blowing. The Dow's 10 top-yielding stocks outpace the overall DJIA more than two years out of every three. And that kind of performance adds up.

True, there will be years when this strategy isn't necessarily going to be a big winner, but nonetheless, discounting brokerage commissions and taxes, this high-yield strategy is worth sticking with.

There are three solid reasons why it usually pays off:

1. Stocks with high yields are often out of favor with investors and therefore cheap. Any good news about the companies can make their share prices zoom.

2. The 30 Dow companies are large and generally have solid balance sheets. By acquiring only such issues, you tend to bypass truly rickety operations.

3. The stocks' high yields automatically deliver nearly half the usual market return. Since the Dow earns 10.9% on average, locking in a 4% to 5% yield gives you a real edge.

This strategy calls for buying all 10 top yielders - no exceptions - based on the previous year's payouts.

Here now are the top 10 dividend paying stocks in the DJIA as of June 30, 2005.

General Motors (GM) ...........................Yield 5.50%
SBC Communications (SBC) ...................... " 5.37
Merck (MRK) ................................... " 4.76
Verizon (VZ) .................................. " 4.61
Altria Group (MO) ............................. " 4.39
J. P. Morgan Chase (JPM) ...................... " 3.81
Citigroup (C) ................................. " 3.71
DuPont (DD) ................................... " 3.16
Pfizer (PFE) .................................. " 2.67
Coca-Cola (KO) ................................ " 2.57

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Now there is also another version of this strategy that plays the 30 DJIA stocks in a slighly different manner. This adaptation excludes both Altria and General Motors. It dismisses General Motors because its erratic dividend history renders it ineffective as a means of signaling timely purchases, especially whenever it has ranked No. 4 or higher on the list. And it also dismisses Altria Group because for more than eight years, Altria has never ranked lower than fourth on the list, thus to use Altria in this strategy would amount to a buy-and-hold approach.

The basic process of this alternate version of the Dow strategy is not as straightforward as the first version cited above. Here, we are told to purchase the top 4 high-yielding Dow stocks - excluding both Altria and General Motors - and then to hold them for a period of 18 months, after which time you would then replace any of the group that has fallen down with higher-yielding stocks.

Either of these two versions can be said to represent an attempt at market timing because buying all of the stocks at once could be viewed as a prediction that the prices of the shares will rise after the purchases are made. But in any event, this is an interesting approach and one that is worthy of further investigation.

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