| Sargent & Lundy Savings Investment Plan |
| THE ABCs OF BUILDING A PORTFOLIO |
| The following excerpts are from an
article in the Tuesday, March 17, 1998 "Wall Street
Journal". The opinions of the author, Jonathan
Clements, may or may not reflect those of the SIP
Committee. If investors were schoolchildren, a lot of them would spend time in the principal's office. The fact is, we often fail to follow the most rudimentary rules of investing. We are told constantly to save like crazy, build a well-diversified portfolio that includes a healthy dose of stocks and then focus on the risk and reward of the entire portfolio. Easy, right? It seems not. Many investors just can't bring themselves to follow these basic investment precepts. We don't save enough. Given a choice, most folks would rather spend than save. "We have this struggle with self-control," says Meir Statman, a finance professor at Santa Clara University. To get ourselves to save more, we draw on an array of financial tricks. For instance, we sign up for forced savings plans where money is automatically deducted from our paycheck or bank account and plunked straight into mutual funds. Similarly, we fund retirement accounts and make extra mortgage payments, thereby putting money out of easy reach. In an effort to boost our savings, we might also force ourselves to invest all windfalls, like tax refunds, medical-insurance reimbursements, overtime pay and year-end bonuses. We are scared of stocks. The long bull market of the 1980s and 1990s has made investors increasingly willing to buy stocks. But if the markets turn rough, sticking with these stocks could prove tricky, because of our intense focus on short-term results and our strong distaste for losing money. "People really focus on short-term performance, even if it's a retirement fund and they have a 30- or 40-year time horizon," says Shlomo Benartzi, a business professor at the University of California at Los Angeles. "The problem is that people also psychologically double losses. If you combine this short-term focus with the great pain from losses, you don't want to be in stocks." We don't diversify properly. Experts often advise building portfolios that include a broad smattering of large, small and foreign stocks. That way, a slump in, say, blue-chip stocks might be offset by gains in small and foreign shares, thus reducing a portfolio's overall price gyrations. The problem is, this broad diversification - which will reduce your portfolio's risk - means venturing into beaten-down companies and foreign markets. And that seems truly risky to many folks. Indeed, investors much prefer buying the stocks of companies they know and admire. "Investing in the familiar seems like a better way to reduce risk than diversifying," says Terrance Odean, a finance professor at the University of California at Davis. "But it's not. Good companies aren't necessarily good value. If you only invest in U.S. stocks, you give up diversification." We don't look at our whole portfolio. A well-diversifed portfolio will perform less erratically than its component parts, thus giving investors a smoother ride. But that assumes investors focus on the performance of the whole portfolio. Many don't. In reality, we often ignore the fact that one stock's loss may be offset by another stock's gain. Instead, we fret about the performance of each investment. "Because investors don't take account of the overall risk of their portfolio, they may be more conservative or more aggressive than they ought to be," Mr. Statman says. We are inconsistent about risk. Investors are told to figure out their tolerance for market gyrations and then build a portfolio that reflects this risk tolerance. In practice, however, not only do we fret about each investment, but also we tend to take different degrees of risk with different parts of our portfolio. "Investors think of their portfolio as layers," says William Reichenstein, an investments professor at Baylor University. For instance, he says, investors "have an income layer consisting of bonds, which is designed to make sure they aren't poor. With that portfolio, they don't want to take any risk. They have another layer, which is designed to five them a chance to become rich. And with that portion, they're very willing to take on risk." Is this such a terrible thing? "Thinking of a portfolio as layers is bad if it stops you from achieving a good stock-bond mix," Mr. Reichenstein says. "But to the degree that it helps you to avoid panicking when the market declines, it can be helpful." |
This page updated on 4/1/98