Market volatility is not synonymous with risk

Lauren Rudd | Sarasota Herald-Tribune

The latest economic data showed that new home sales declined more than forecast, while higher prices dampened demand. Consumer confidence collapsed for the first time this year, as inflation worries and increased unemployment likely dampened sentiment. So what now?

In more than half a century of experience, I know of no investment vehicle that can compete with common stocks to build wealth. Yes, such an investment strategy involves dealing with risks that can, however, be minimized.

What is making your stomach upset, however, is less the risk of investing in stocks than the recent heightened market volatility.

Let me reiterate that market volatility is not synonymous with risk. Do not confuse risk with daily price fluctuations. As I have said repeatedly, price fluctuations are random events that are not suitable for forecasting.

While such a statement is the opposite of what many tech traders believe, academic studies show it to be valid.

Therefore, short-term fluctuations in the market should be meaningless to an investor other than providing you with a lower entry point or an opportunity to lower your average cost.

Now for long-term investing ... no, it's not forever. Rather, it's two to four years.

In addition, Wall Street is the greatest equalizer in the world. Over time, the price of the stocks of most reasonably successful companies shows a reasonable similarity to their value.

This value can be estimated in part using a company's dividend performance. My oft-repeated guideline is 10 years of uninterrupted dividend increases driven by both organic growth and possibly acquisitions.

In the meantime, I mostly get questions by e-mail as to why I don't recommend a “mutual dividend fund”. For example, a fund whose prospectus says it will only buy stocks that are in the Dividend Achievers Handbook or among the Aristocrats (a group of companies with a history of 25 or more years of paying dividends).

While there are numerous mutual funds or investment strategists who claim to use dividend stocks as their primary investment strategy, I am not aware of any fund that strictly adheres to the 10 year minimum rule.

Such a strategy is easy to implement yourself with the Mergents Handbook of Dividend Achievers. The latest guide currently lists 267 companies that have increased their dividends for 10 or more consecutive years.

You don't have to and shouldn't own all of the shares like a mutual fund might. And you certainly don't have to pay a monthly management fee to a mutual fund to buy shares in one or more of these companies and keep them easy for you.

In my opinion, this would be a waiver of your investment responsibility. It is also unlikely that such an investment would produce mediocre results. The reason is that if you owned them all, your return on investment would simply fall back on the mean of the whole group.

What you should do is choose between 10 and 15 dividend payouts based on your personal investment criteria and goals. Next, determine the intrinsic value by using a website like ValuePro.net.

If the intrinsic value is at least 5% above the market price, use these stocks to start a new portfolio or add them to an existing portfolio. Either way, of course, you'd be using a brokerage house that doesn't charge commissions on stock deals.

Make sure, however, that your choices are varied. Mathematically, it can be shown that with 15 or more diversified stocks in a portfolio, very little additional risk needs to be eliminated through diversification. Therefore, putting together a portfolio of 10 to 15 stocks is more than sufficient for most investors.

It doesn't matter how many shares of each company you buy. The important thing is to buy an equal amount of dollars from each. Every company in your portfolio is weighted equally.

Even if your investment budget has only a few stocks of each stock and you can only start with two or three stocks, building a portfolio following the guidelines above is way ahead of building one.

You can write to Lauren Rudd at Lauren.Rudd@RaymondJames.com or call him at 941-706-3449. For back columns, go to RuddInternational.com.

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