Thinking Out Loud

What is "risk" really?

Risk is the chance of permanent loss of capital.

Volatiliy is the daily, minute-by-minute, change in prices of stocks, bonds and other financial assets.

During periods on price fluctuation, some gut-wrenchingly so, loss of money does not happen until an action occurs. You sell.

Holding a diversified portfolio of great company stocks has never resulted in loss if you did not react to price volatility and sell.

The trendline for equities has been up and all the declines have been temporary.

The question for individual investors is: How much price fluctuation can you stand before you want to give in to the fear that something that has never happened will happen?

1. Plan. 
   1. Know when you want to sell.
   2. Know how much you need to walk away with from the sale. 
   3. Choose the right time to sell, but be prepared to sell anytime.
      1. Vision for business articulated
      2. Audited financials
      3. List of opportunities for business
      4. Environmental review
      5. Documented operational procedures
      6. Evaluate management - right people, right seats
   4. Know what you’ll do with your life after the sale.
   5. Know the value of your business…many do not.
2. Negotiations – Don’t negotiate with yourself. Get at least two competing offers first and never put a number on the table first. (You will be stuck with it).
3. Deal Team -Have your team in place 3 - 5 years prior to sale. You probably have a lot of work to do to get the business ready so you can get top dollar. You now have to put more effort into your role as Shareholder.
4. Always Look At How The Buyer Will Value Your Business. Have a valuation done using a Discounted Cash Flow analysis from the Buyer’s viewpoint. Often, the owner uses a multiple of EBITDA (often 4 – 7 times) and figures that’s the value. It depends. That value might be the low end value. A Buyer looks at the future and how the business fits within their existing structure or portfolio of businesses. There may synergies due to cost cutting, better manufacturing, better distribution, better talent or technology. Any number of reasons why the Buyer’s internal value assumptions and walk away price may be a lot higher than yours based on EBITDA. EBITDA is historical. The question in the Buyer’s mind is not what have you done, but what can you do going forward. As a Seller, you usually focus on Price; a Buyer focuses on Value.

These are just of few of the many issues to be concerned with…they’re a good start.

Our experience shows  that people buy life insurance for these reasons:

1. To provide replacement income for their family (i.e. provide a pool of money that can earn interest and dividends and pay income for a long time if properly managed)
2. To pay off debt - e.g. mortgages, home equity loan, college loans, credit card – allows the family to get out of the hole. The financial shock of losing your husband or wife can be devastating.
3. To pay college expenses for the kids - get them started in life without a debt burden
4. To pay death related expenses – medical and burial
5. To provide funding for business buy-sell agreements
6. To provide a donation to a charity or school (if it’s big enough, you might get your name on a building).

Are you and your family covered?

One of the primary risks that bond funds hold for investors is interest rate risk.

Bonds increase in price when market interest rates fall. Conversely, bonds (and bond funds) decrease in price (value) when market interest rates rise.

How can you estimate how much the value of a bond fund will rise or fall when market interest rates change?

Duration. Find the duration of the fund. It is specified in years. For example, a bond fund having a duration of 2.8 years will increase in value about 2.8% when market interest rates fall by 1%. Likewise the same fund will decline 2.8% in value if interest rates rise by 1%.

The duration of the fund can be obtained from the fund website (fund profile pages)or from Morningstar.com. Of course, you can always ask your financial advisor.