Knowing the Risk

Taking Charge of Your Investments: Part 2

Bernard Madoff, allegedly ran the largest Ponzi scheme in US Investment History, milking $50 Billion from investment firms, pension funds, nonprofit corporations, wealthy retirees, and large investors. How did he do it with the Securities and Exchange Commission (SEC) regulating the industry and auditors, auditing his investment fund? The SEC is made up of political appointees who come from investment firms. That is like having the fox guard the hen house. The objective of the auditor is to get paid. They are not interested in blowing the whistle on the firm. If they did, who would want to hire them to audit their firm? They just want someone to approve what they are doing so that the public would trust them. This is why people like Mr. Madoff can milk the life savings out of the investing public. That is why you, the investing public must learn to invest your money. No one but you can be trusted with looking out for your best interest.

We will start by learning the three classifications of investment policies that people follow. First is the investor. That is a person who knows how much money they are starting with to invest. They know how much money they expect to make in a certain period of time and how much money they will have at the end of the investment.

Second is the intelligent and unintelligent speculator. The intelligent speculator is a person who analysis the security to determine its quality and prospects. They will also evaluate the risk of the security. Then the person will commit to making the investment. The unintelligent speculator will go on the bases of the information supplied by the sales person suggesting or selling the investment. People who act on tips are unintelligent speculators. These are the people who Bernard Madoff attracts.

The third person is the gambler. That person will commit money or property to a venture with little or no chance of success to make big gains or profits. One example would be a person who buys Pennsylvania Lottery Tickets or a bet on a race horse to win. Usually they loose more money than they make.

The investor and the intelligent speculator must know the many risks associated with investments. Even just holding cash has its risks. Interest rate risk is when interest rates rise unexpectedly, making income investments like corporate bond prices fall. Your cash as well as investments can be in danger because of purchasing power or inflation risk. Inflation Risk is when the purchasing power of money falls causing you to use more dollars to buy the same amount of goods and services. So if you had a dime in 1970, you could have bought a large candy bar. Today, you would need a dollar to buy that same candy bar.

Common Stocks rise and fall. Investors might have to sell or because of emotions will sell stocks at a loss. Risk in this area is measured in degrees of stock volatility in a given stock or portfolio. This is known as Market Risk.. This is related to psychological risk. That is being influenced by waves of great optimism or pessimism in the financial markets or in individual stocks. This is also related to investing in fads like alternative fuels or faddish coffee shops.

Non-investment Grade Bond Investors are subject to Credit, Financial, or Business Risk. That is the risk that corporation’s credit and cash position will deteriorate due to business conditions or bad management decisions. The company may file for bankruptcy or go out of business causing a loss to the investor.

Below are three investments representing companies that have been in the news. All three have the potential to make a lot of money for the investor provided that they stay in business until their bonds mature. In my opinion Ford is the better investment as far as Business Risk.

$1,000 Bond issued by Ford Motor Credit Corporation 5.25% of 06/22/2009, price is $816.90, Yielding to Maturity 49.691%.

$1,000 Bond issued by Ford Motor Credit Corporation 5.25% of 12/21/2009, price is $693.60, Yielding to Maturity 45.517%.

$1,000 Bond issued by General Motors Acceptance Corporation 4.15% of 04/15/2009, price is $769.70, Yield to Maturity 94.545%.