Dear Friends and Family,

RISK is an important factor in building portfolios but not always understood or addressed correctly. Here are several different examples and approaches to handle financial risks.

1] The Risk of a loss of all the capital invested in a particular security is probably the biggest concern. This risk is greatly over emphasized, as a total wipe out is extremely rare. It does occur however and even with large corporations. Enron and Lehman Brothers are recent examples and even AAA securities with implied U.S. Government backing have failed.

2] The Risk of loss when needing to withdraw substantial funds during a major market downturn is also a concern. This Risk should be looked at as the percent of time the market is in a major downturn multiplied by the chance of needing a major withdrawal. Experience indicates that both these percentages are low numbers and therefore the risk of occurrence is a low percentage event.

3] The Risk of depleting capital with income withdrawals during market downturns is a major concern of retired individuals and definitely should be planned for.

4] The Risk of inflation is a significant risk to portfolios. Since the establishment of the Federal Reserve 100 years ago, the Dollar has lost 95% of its value. The FED now has a model with a goal of losing only 86% of the dollar’s value in the next 100 years.

5] The Risk of not meeting retirement goals by poor planning and or poor execution is probably the major risk for individuals. Poor planning in general is trying to a eliminate one or more of the above risks while increasing the exposure to the other risks. Poor execution is generally abandoning a good long-term plan because of a temporary short-term event.

Protection approaches to Risks

1] Dividends and interest earned help reduce the risk of withdrawals negatively impacting portfolio results.

2] Corporate share reductions increase ownership percentages in portfolios. Sales of some of the increase can be used to fund distributions.

3] Short term debt securities and “risk free” insurance products, can be used to protect against inflation. However, the cost of this protection in lost capital appreciation can be high and the yields are low.

4] Long term bonds can provide additional interest payments to cover withdrawals, but the total returns are low, and the inflation risks are high.

5] For longer periods, Quality and Safety factors for common stocks can provide protection on the downside without reducing upside potential. Quality and Safety for bonds however perform differently. AAA bonds pay the lowest interest rates.

6] Diversification reduces the risk of calamity. The best research indicates that portfolios of 20 to 30 securities are optimum. These allow for best ideas while reducing risk by over 80% of the single security portfolio.
7] Patience, markets are volatile, but most declines are relatively short in duration.

8] Your financial plan may be disrupted at any time by events both personal (births, career changes) and outside your control (tax changes). Your investment plan should generally be longer term.

9] There are ways to borrow for short term financial needs during market deep declines.

Katz Family Financial