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Bruce W. Brigham, PhD
Strategies for Reducing
Investment Risks
AAII Baltimore Subchapter
August 20, 2005
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Overview 1
I had already started to diversify, in order to reduce overall
risk, by buying shares in about 30 different sized companies in
several sectors – financial, manufacturing, services, natural
resources (oil), and retail – through DRIP (Dividend
Reinvestment Program) programs, 1 to 5 shares at a time.
In this manner, I was able to test equity diversity relatively
inexpensively.
However, the paper work in handling so many accounts was
excessively time-consuming; I gradually whittled them down
to a dozen companies.
I also began two IRA accounts with which I held mutual funds
representing different sized companies and different investing
styles: value, growth and blended.
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Overview 2
These have gradually expanded to include three IRA
accounts, each with a different low cost internet-based
brokerage, plus a tax-shielded multi-purpose account. The
latter provides a guaranteed rising income as inflation
protection, a self-directed multiple mutual fund account with
insurance and estate transfer protection.
The reason for the several IRA accounts is that each provides
a different set of NTF (No Transaction Fee) no-load mutual
funds, which I use to keep trading costs down. I check my
funds on a monthly and quarterly basis.
In addition, each account provides for inexpensive trading in
lower cost ETF (Exchange Traded Funds), which are useful
for trading without the time holding restrictions and penalties
of many, perhaps most, mutual funds.
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Overview 3
My preferred fund categories have evolved
to include mid and small caps with value
and blend styles, US and international with
real estate, natural resource and energy
services content, plus Latin America for
emerging markets, and long term inflation-
protected U.S. Treasury bonds (TIPs).
Obviously, I believe in diversity with a big
―D‖, as a means of minimizing potential
losses. 4
Overview 4
Underlying these holdings, and how I
change them over time, are a series of
conclusions I have drawn from carefully
observing the behavior of many markets
over some time, plus considering a wide
range of viewpoints from economists,
market historians and researchers, as
well as so-called professional investment
specialists.
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Basic Rules for Investing
First, my two Basic Rules of Investing
(which have been attributed to
Warren Buffett, among others):
1. Do NOT lose money.
2. Refer to #1.
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Basic Rules for Investing 2
Second, Brigham’s definition of Losing
Money:
1. 10% of a single investment (ugh!)
2. 5% of a portfolio (scream!)
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Basic Rules for Investing 4
Transferring to financial/economic/investment/business
publications the research analysis skills I’d developed over the last
half century in other fields:
1. I found about the same proportion of jargon-loaded baloney
as in those other fields-- about 95%. Around 5% of it has enough
logical soundness, conceptual value, and procedural thoroughness
to merit further consideration.
2. A great many, perhaps most of textbook economic
assumptions and definitions have little relationship with everyday
reality.
3. Within equity markets are many sectors whose relative
prices are constantly fluctuating.
4. There are major asset classes, i.e., equities, currencies, natural resources,
commodities, bonds, real estate, utilities, transportation, whose relative prices continually
change in larger, slower, interrelated patterns.
5. Larger percentages of total returns are related to being in the ―best‖ sector of a ―best‖
asset class at a given time than can be attributed to owning a specific stock.
6. Under this constantly shifting complex minuet of changing relative values are
discernable repeating basic cycles of varying lengths.
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Basic Rules for Investing 4
Transferring to financial/economic/investment/business
publications the research analysis skills I’d developed over the last
half century in other fields:
1. I found about the same proportion of jargon-loaded baloney as in those other fields-- about 95%.
Around 5% of it has enough logical soundness, conceptual value, and procedural thoroughness to merit further
consideration.
2. A great many, perhaps most of textbook economic assumptions and definitions have little relationship
with everyday reality.
3. Within equity markets are many sectors whose relative prices are constantly fluctuating.
4. There are major asset classes, i.e., equities, currencies,
natural resources, commodities, bonds, real estate, utilities,
transportation, whose relative prices continually change in larger,
slower, interrelated patterns.
5. Larger percentages of total returns are related to being in
the ―best‖ sector of a ―best‖ asset class at a given time than can
be attributed to owning a specific stock.
6. Under this constantly shifting complex minuet of changing
relative values are discernable repeating basic cycles of varying
lengths.
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Basic Rules for Investing 3
Observations of daily Wall Street media noise
from talking heads from TV, newsletters, daily
papers, popular investment magazines, etc.-
1. Buying fads directed toward individual
investors come and go.
2. Prices of each fad tend to peak with
their popularity, and drop not long after.
3. Wall Street always has something for
others to buy, but rarely anything to sell, and
always makes a commission.
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Cyclical buy/sell patterns – “buy low, sell high”
- basically re: U.S. stock indices
A. Very short term – markets tend up (Hirsch)
1. Last trading day of month + first 3 trading days of next month.
2. Last trading day before and first after each major holiday
B. Short term (Hirsch)
1. October through January – up
2. Mid-June through September – flat
C. Mid term (20 months – 78.4 weeks) (Stan Harly)
1. Last low – 10/25/04
2. Next high (?) – 8/X/05
3. Next low (?) – 6/X/06
D. Long term – 4 years (Larry Williams)
• Expected bottoms: 2006, 2010, 2014, …..
E. Long term re dollars (5 year +, 5 year -) ( Robert Carlson)
1. Current bear – 5/ /02 – 5/ /07
2. Parallel plus – international stocks and bonds up when $ is down
F. Long term (10 years) re U.S. stock indices (various sources)
• Every year ending in 5, indices up
G. Very long term – 16 to 18 years up; 16-18 years flat or down
• but when stocks are down, hard assets are up – real estate, natural resources,
energy, metals
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Some Examples
A. Using the Rydex, Nasdaq and S & P index funds, using IV, A, above, buy
2 days before last trading day of month, sell at end of 2nd trading of
next month.
B. Buy international (non-dollar-denominated bond funds), such as
American Century International bond, at beginning of ―down dollar‖
cycle (IV, E, above); sell 4 years later, before ―up dollar‖ cycle begins.
C. (re G, above). As 2000 approached, I considered the length and
strength of the equity bull market that began in 1982, plus the frantic
―this time is different‖ statements, the skyrocketing stock prices of
many companies drowning in debt with no incomes.
It was getting too hot in the kitchen for me: as happened
every 16-18 years, the music was going to stop suddenly. When it
started again, a different set of dancers would (and did) come alive; in
this case—real estate, natural resources and long term bonds.
I shifted gears from mostly U.S. equities to mostly those
3 asset classes during 1998 and 1999, and had returns of 20 – 30% per
asset class per year from then on, while the general equity markets
crashed and burned.
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Avoid assumptions and oversimplifications
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. Indirect Vs. Direct Investing
- to avoid basic risk factors
A. Real Estate
1. Direct
a. owning undeveloped land
risks: long term holding costs,
uncertain payoff
b. managing property
risks: tenants, toilets, taxes
2. Indirect (avoiding above risks)
a. REITs
b. REIT funds (CGM)
c. Timber (PCL)
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. Indirect Vs. Direct Investing
- to avoid basic risk factors
B. China
1. Direct
– starting up or investing in Chinese
companies
2. Indirect
- commodity suppliers (BHP)
- shipping (TKA; ISH)
- Argentine agriculture/agriculture
realty
15
Unbalanced Barbell Approach
Medium- risk, Very high risk,
Low risk,
high return
Medium
appreciation Income
holdings producing
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Examples of Globally-based Investment
Considerations
1. The EU is in disarray. Its largest continental member, Germany,
is in economic, social and political turmoil. Scandals and serious
management problems have hit Volkswagon, Daimler-Chrysler
and the nation’s largest bank. The leadership of the bank has
been forced out by its shareholders. The DAX, the major
German stock index, is at, or close to, a major low.
However, 50% of the firms in the DAX have recently become
controlled by American and British institutional investors, who
are forcing management changes. The popular down-rating of
the DAX by most investment advisors is an important contrarian
signal. Further, three large American hedge funds have recently
started to invest in Germany.
As a result, investing in the DAX through the Ishares Germany
ETF, EWG, seems worth considering.
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Examples of Globally-based Investment
Considerations
2. When considering ―foreign‖ investments, ask where the profits
come from. The answers may surprise you.
For example:
• Only 35-40% of the earnings of Sony and Toyota come from
Japan; more than that comes from the U.S.
• Aflac insurance, based in Columbus, Ga., gets 80% of its profits
from Japan.
• Tupperware makes more money in Germany than in the U.S.,
while the reverse is true of Daimler-Chrysler.
• The bulk of Coca Cola and McDonald’s profits come from outside
the U.S.
Conclusion: if you invest in global companies, wherever
based, (usually very large cap) you are to some extent
diversifying internationally.
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Examples of Globally-based Investment
Considerations
3. Long term bonds have returned 25-30% over the last three years,
despite the efforts of Greenspan’s Fed. He has called this puzzling as
he has steadily increased short-term rates and reduced the money
supply.
• I find his attitude very strange. The world’s bond markets (much larger
than the stock markets) have been strong for three years and show no
sign of weakening. This is the usual reaction to widespread
disinflationary forces, such as the huge cheap labor resources of
Russia, China and India increasingly being involved in relatively ―open‖
global trade. As a result, American clothing prices continue to drop as
textile manufacturing, which had once fled from New England to the
South, then to Mexico and Thailand, is relocating to China (65% of U.S.
clothing). This is disinflation, by definition, leading to higher long-term
bond prices. (What doesn’t Greenspan and company understand that is
clear to the rest of the world?)
Conclusion: American Century long term zero-coupon Target
Maturity Bond Funds are worth a careful look, as will be the to-be-
reissued U.S. Treasury 30-year bond.
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Examples of Globally-based Investment
Considerations
4. Another Example: Order a computer from
Dell, from Texas, right?
Not exactly; to design, make and deliver
your computer involves:
• Over 50 locations (offices, factories,
transport depots)
• Controlled by 20+ companies, in
• 13 countries, supported by a
• Dozen worldwide transportation and
communication networks
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Avoid assumptions and oversimplifications
A. Most (all?) investment/financial advisors, brokers and writers are selling something –
how are they compensated: what do they get for your money?
B. For a specific investment idea try for 3-4 opinions from sources with different backgrounds.
C. Use investment sources for different perspectives and various ways of thinking about investing.
1. Barron’s, WSJ, IBD each have various perspectives.
2. Martin Weiss’ ―Safe Money Report‖, while somewhat bearishly apocalyptic at
times, has ideas for both the conservative and speculative investor. His ratings of
the financial strengths of companies have been ranked #1 by WSJ, and his ratings
of the financial strength of financial institutions are used by several US
government agencies in preference to their own (+ free e-letter – Money
Markets).
3. Robert Carlson’s ―Retirement Watch‖ is a middle-and long-term-based advisory,
middle-of-the-road to conservative in nature, using mutual funds and ETF’s.
4. The most wide-ranging resource I know, who considers everything from global
currency trading to sentiment indicators, drawing on scores of sources, is John
Mauldin. His investorinsight.com newsletter is free!. Especially see his 8/5/05
issue.
5. Another excellent free source on funds is Ulli Niemands ―No Load Mutual Fund
Tracker‖, sucessfulinvestment.com.
6. Main point: avoid being taken in by claimed one-to-one oversimplified pseudo
cause and effect relationships as reasons for buying this or shorting that.
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Bruce W. Brigham, PhD
Strategies for Reducing
Investment Risks
THE END
AAII Baltimore Subchapter
August 20, 2005
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