EP58: How to Handle the Most Common Investing Risks

In this episode, you'll learn how to handle the 7 most common investing risks.

Covered in this episode:
- Risk 1: The dividend is not guaranteed
- Risk 2: Competitors
- Risk 3: Dishonest management
- Risk 4: Bankruptcies
- Risk 5: International issues
- Risk 6: Market uncertainty
- Risk 7: Natural disasters
Other ways to reduce your investing risk.

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Transcript

Speaker 1: 0:01

In this episode, I'm going to show you how you can minimize the seven most common risks that you will face as an investor. Hi, my name is Kanwal Sarai and welcome to the Simply Investing, dividend podcast. The goal of this episode is to teach you how to minimize and lower your investing risk. Now, this is the number one reason why people don't start investing there is a fear, a fear of losing all of their money and all of their investments, and that's why it's important to talk about the seven types of risks that you may face as an investor. So that's what we're going to do in today's episode. Let's get started with risk number one.

Speaker 1: 0:53

The dividend is not guaranteed. It may be reduced or eliminated at any time, and that is absolutely true. Companies have no legal obligation to pay you a dividend. They can reduce the dividend if they want, or they can eliminate the dividend at any time. So, as a dividend investor, how do you protect yourself against this type of risk? And we saw this during COVID. Some companies reduced or eliminated their dividends. Quick example Boeing, disney, general Motors. All three of them cut their dividend altogether during COVID. Now, the good news is that most companies did not reduce or eliminate their dividends. In fact, a lot of them did increase their dividends at that time. Well, not at that time, but after COVID. I can tell you from personal experience. I've been a dividend investor for over 23 years and I can tell you that my dividend income increased in 2020 from the year before. My dividend income increased in 2021 from the year before, and if we even go back to 2008, 2009 financial crisis, my dividend income went up in 2008, went up again in 2009, and again in 2010, and so on. So there are companies, quality companies and those are the ones we want to focus on where we can have some level of certainty, even though dividends are not guaranteed.

Speaker 1: 2:31

Now, remember, a dividend is a cash payment that a company makes to you as a shareholder, so you can spend that money if you wish or you can reinvest it. The dividends are deposited directly into your trading account. So let's take a look at just a couple of companies here. This is a very small list up on the screen. The actual list of companies that have been paying dividends for many, many years, many decades, is a much larger list. But now for now, let's just take a look at the companies on the list here.

Speaker 1: 3:01

You'll notice that some companies have been paying a dividends since the 1800s. For example, coca-cola has been paying a dividend since 1893. The Colgate Palmolive Company since 1895. Stanley Black and Decker has been paying a dividend since 1876.

Speaker 1: 3:22

Now, even more important than the year in which the companies started paying dividends, is the next column over and you can see it up on the screen now and this is the consecutive years of dividend increases. So if we take a look at, for example let's go back and look at Coca-Cola you can see that the company has been consecutively increasing dividends for 60 years. If we look at the Procter Gamble Company, 67 years of consecutive dividend increases. Think about how many market crashes, how many recessions we've had in the last 30, 40, 50, 60 years. But companies like these have continued to not only pay a dividend but to also increase the dividend year after year after year. And every time the company increases the dividend, it's more money in your pocket. You don't have to buy more shares, you just hold on to the ones you have. And when the company increases the dividend payment, then you will receive more dividend income. He knows what's going to happen in the future in the stock market or with dividend stocks. But when we take a look at a list of companies like this, we can have a high degree of confidence that they will at least continue to pay us a dividend next year and increase the dividend as well, because they have a history of doing so over the last 3, 4, 5, 6 decades.

Speaker 1: 4:46

So what do we do with risk number one then? How do we mitigate it? How do we lower the risk? Right risk number one the dividend not guaranteed. It may be reduced or eliminated. Well, the solution here is that you will invest in companies that have a history of paying dividends and have a history of Growing their dividend. So that's how we can minimize our first risk. Let's move on to risk number two. Any company that you invest in May face stiff competition from other competitors, from other companies in the same industry offering similar products and services, and they that may negatively affect the stock that you own. So how do you protect yourself against this type of risk? So for this, I'm going to use the same example that Warren Buffett uses when he talks about Corporations, and he compares them to a castle. So think of a corporation as a castle, and around the castle there is a moat. The wider the moat and the deeper the moat, the better off the company is going to be to protect itself Against competitors. So when you are looking to invest in companies, you want to look at companies that have a very large moat around them. So a good example would be Coca-Cola. Here is a company that's been around for over a hundred years, has been paying a dividend for over a hundred years and operates in over a hundred and forty different countries, and this company has brand loyalty, has brand recognition. You can go anywhere in the world, show the slo-go to someone. They will know exactly what you are talking about. They're the only company in the world that can provide you with a Coca-Cola if that's what you want to drink. Another example would be McDonald's. If you're looking for a Big Mac, there's only one company in the world that can provide you with a Big Mac, and that would be McDonald's. Now, sure, there are other competitors out there, there's smaller competitors out there. However, companies like this, like Coca-Cola, like McDonald's, they have large Brand loyalty and they have been around for a long time, and so their competitive advantage is much higher and they have a low-cost competitive advantage now, even though they are spending Lots and lots of money millions and billions of dollars in marketing every year in advertising. Just think if you had to start a company today To compete with Coca-Cola, with all the products and services that Coca-Cola has to offer today, you would have to spend billions and billions and billions of dollars in advertising and you still wouldn't get to where Coca-Cola is today, because they've literally taken hundreds of years to build up the brand. So what do we do about risk number two? When there is a concern that a company may face stiff competition and all companies will face competition at some point or another the solution here is that you will invest in companies that have a lasting competitive advantage. Think about the castle with the moat around it. The larger the moat, the better off the company is going to be able to keep its competitors away. So that's another way here that we can mitigate the risk number two that we're looking at right now. Okay, let's move on to risk number three Dishonest management and directors.

Speaker 1: 8:19

Now, this is a tough one because as investors, we rely on public information that is put out in the financial statements, the annual report, the quarterly reports. Those are the things that we look at, the data that we look at to make an investing decision. So if the company is lying about those numbers Whether it's the CEO, the CFO or anybody in the management of the company, or the directors are lying about that, such as the case with Enron we will have no idea that that is going on. Neither I won't have any idea, you won't, nobody in the public will know. And so this is a real risk, and how we protect ourselves against this type of risk is that we let our dividends become our margin of safety, become our margin of safety. So remember, when a dividend is given out, it's yours to keep. It's deposited as cash into your trading account. So if a company does go bankrupt in the future, they can't come back and take those dividends. They can't come back and say, hey, the dividends we've given you over the last five years you need to return those. No, that money is yours to keep, so that becomes your margin of safety. So let me give you a personal example of mine, and you can see how the margin of safety grows over time.

Speaker 1: 9:43

So in back in 2000, I purchased 185 shares in TRP. The share price at the time was $13.40. I bought 185 shares, so you can see my total investment at the time was $2,479. Well, ever since I've owned the shares in this company, the company has increased its dividend every Single year and I still own the shares today. So remember my initial investment was $2,479. I have received to date over $8,700 in dividends, so I've already more than tripled my investment.

Speaker 1: 10:26

So let's take a look at some of the numbers here if anybody's interested. The dividend at the time was 80 cents a share. The dividend today, as of this recording, is $3.72 a share. You can see the dividend yield based on my purchase price today is over 27%. That is a 27% return on my initial investment of $2,479. Every single year, as long as I own those shares, stock price can go up and down, and it has gone up and down since the year 2000. But the dividend has gone up every single year and so you can see that the total dividend received to date is over $8,700. So now, if this company was to go bankrupt tomorrow, that wouldn't be good news, but it would not affect my investment. I've already more than tripled my money just from the dividends alone, and that is the margin of safety.

Speaker 1: 11:25

Every time the company pays a dividend, your margin of safety grows. Every time the company increases the dividend, your margin of safety grows and it gets to a point where your dividends will cover your initial capital investment and then everything beyond that is pure profit. So this is a great example of where we can invest confidently in companies that have been growing their dividend and it protects us against this type of risk when you may have it's extremely rare, but you may have a case where either the management of the board of directors are dishonest and something goes bad with the company it either goes bankrupt or the stock price tanks. Well, the dividends are going to be your margin of safety. Now, if anybody is interested, the total return on the investment, including dividends, as of today, is a little over 625% return. So keep in mind we're going to make sure that the dividends become our margin of safety Because without the dividends, you are now at the mercy of stock prices.

Speaker 1: 12:38

So if the stock is trading at $50 today, tomorrow it could drop to 40. It could drop to 30. It could even drop to $10. Or, in the case of Washington Mutual or Enron or the Lehman Brothers, it could drop to zero if the company goes bankrupt. So the stock price you don't want to be at the mercy of the stock price Because that's based on market sentiment. It's based on hundreds of other variables that can affect a company's stock price, and so we don't want to rely on these hundreds of variables to keep the stock prices up. And especially if you're looking towards retirement, early retirement or to supplement your income today with dividend income, the dividends are going to provide you with that income. They're the ones who are going to cover your living expenses, not the stock price itself. So let's finish off risk number three, then, how do you mitigate this risk or lower this risk? You will invest in dividend paying companies.

Speaker 1: 13:40

Let's move on to risk number four. A company could go bankrupt, and again we saw that with Enron, we saw that with Washington Mutual. Wework has now filed for bankruptcy as of this recording. So companies could go bankrupt. So how do you minimize this type of risk? Well, for one thing, you want to make sure that you don't put all your eggs in one basket. The key here is diversification. So, over your investing career, you want to make sure that you diversify across these 11 different sectors up on the screen. You can see them here energy, materials, industrials, healthcare, financials, utilities, real estate and so on. This way, if one company goes bankrupt or one sector is in trouble, it is not going to negatively affect your entire investment portfolio. So diversification is key here. So that's how we are going to mitigate risk number four. The solution is that you will build a well-diversified portfolio of stocks. Now, you can't do that from day one, but you can start and then, over your investing career, you wanna make sure that your portfolio is well-diversified.

Speaker 1: 15:02

Let's move on to risk number five. Political unrest or governmental policy changes may hurt corporate profits, which may, in turn, affect the stock price or even the dividend. So how do we deal with risk number five? When it comes to international issues and again this is something that you do not have control over there could be political unrest in certain countries. There could be economic policy changes, trade laws could change, there could be sanctions imposed on other countries. The currencies will fluctuate in value. They can go up, they can go down. So how do you mitigate or protect yourself from all of these types of risks? Well, the key here is I mean, the short answer is you don't need to worry about it, but I'm gonna explain that right now. So the key here is let's take a look at just a couple of examples here. So Coca-Cola operates in over 190 countries. The Royal Bank is in over 37 countries. Exxonmobil is operating in over 50 countries. We have Johnson Johnson in over 60 countries. Walmart sorry, mcdonald's, walmart also is in over in a number of countries. I don't have that number here in front of me right now, but McDonald's operates in over 119 countries.

Speaker 1: 16:25

So the point I'm trying to get at here is these companies are international. They have facilities all over the world Could be manufacturing facilities, it could be retail stores, warehouses, offices all over the world and so these companies have departments and groups that are responsible for looking at the finances, to look at the corporate earnings and to ensure that if something was to happen in one part of the world whether it's currency getting devalued or whether it's the change in trade laws or sanctions or in other countries that these companies can manage and mitigate that type of risk. They have hired professionals, financial analysts, accountants and all kinds of experts in international law, in international business, and then they can handle those kinds of things. And if they need to change manufacturing from one part of the world to another, they can do that. In terms of warehousing, shipping products, selling products in different currencies, these companies can handle that. So this is not something that you need to be concerned about in detail. So how we mitigate and lower risk number five is that we invest in large international companies, and that minimizes the negative effects of policy changes in any single country.

Speaker 1: 18:02

Okay, let's move on to risk number six. A recession or a depression may reduce stock prices, and what we're really talking about here is market uncertainty. Right like I said before, no one can predict the future. I don't know what's gonna happen in the stock market next week, next month, next year, or even in the next five years and the next five weeks. So, because there is uncertainty, the market could go up, could go down. We have no control over that. So how do we mitigate this type of risk? So we do that by focusing on quality investments, quality stocks that are also priced low. So quality and value go hand in hand.

Speaker 1: 18:50

And so I created the 12 rules of simply investing. You can see them up on the screen right now. I'm not gonna cover them right now. I will cover them in a few minutes, towards the end of this episode, so stick around if you wanna get a description of what the 12 rules are. For now, all you need to know is that rule number one to 10, if a company passes the first 10 rules, we know that the company is a quality company, right? So, for example, we're looking at rule number five Is the company profitable? Rule number four is it recession proof? Rule number six does it grow it's dividend? Rule number eight is the debt less than 70%? So things like that will ensure that we're only investing in quality companies. And then the value is we wanna make sure that the stock is priced low. We don't wanna buy when the stock is priced high, we wanna buy when it's priced low, cause that's also gonna give you a little bit of a margin of safety there. So rule number 11 is to ensure that the stock is priced low. And how do these rules help us? They help us by ensuring that we only invest in quality companies, because when the market is uncertain or when the market crashes, it is the companies that have very low debt. And you can see that in rule number eight, it is the companies that are recession proof. You can see that in rule number four, it is those types of companies that will have an easier time surviving a market downturn, and that's the solution for risk. Number six is that you will invest in quality companies that are able to survive any market downturn. And so how do we do that? We always apply the 12 rules of simply investing before you invest in a company. Even if a company fails one rule, then we skip it, move on to something else. So that's how we ensure that we can lower our risk for market uncertainty.

Speaker 1: 20:51

Let's move on to our last and final risk, risk, number seven natural disasters. This is again a very real risk and again a risk that is outside of our control. For example, there could be a hurricane that wipes out a warehouse or a manufacturing facility. We've had ice storms in the past that last for a week or two weeks. Where the power is out, the companies have to shut down. They got to shut down the factories. So how do we protect ourselves against these types of natural disasters, including earthquakes? Right, that may stop a factory from running for like six months.

Speaker 1: 21:36

So the key here is diversification. Right, again, we're gonna diversify not only across industries, but diversify across international companies so that if there is, for example, a earthquake or a hurricane or something in one part of in one country where the manufacturing has to stop, international companies can then divert the manufacturing to someplace else where the factories are running. They can change warehouses and shipping and supply chain can get redirected. So international companies can do that. Small local companies cannot. So if there is a natural disaster in one part of the country and all of their manufacturing is happening in one place, all of their warehouses are in one place, well then the company's gonna be in trouble. Whereas international companies have facilities all over the world, they can keep running and not be negatively affected when a natural disaster occurs. So that's what we wanna make sure. Diversification is important. So how do we mitigate this risk?

Speaker 1: 22:52

Number seven we invest in international companies and we diversify our portfolio of stocks. So here are a couple of other ways to reduce your risk as an investor. You will invest in undervalued companies so that any further drops in the stock price are minimized. Remember I said that before you want to buy low, not when it's high. So we want to buy low when the stock is the stock price is undervalued. It's still a quality company, but the stock price is undervalued. And another way to reduce your risk is you will invest in companies that have a strong history of earnings growth, just as we looked at the dividend history and we saw companies that had 40, 50, 60 years of increasing dividends. We want to look at the history of earnings growth. We want to see the company have a track record of profitability and growing its earnings. So for more detail, for example, undervalued, is the stock price low?

Speaker 1: 23:58

We have our simply investing rule number 11 that covers the value portion of it when it comes to history of earnings. We have rule number five when we look at earnings growth. So right here you can see that just these two statements alone. We have rule number five and rule number 11 to reduce your risk, and in today's episode we've covered a total of seven most common investing risks. Well, guess what? Each one of those risks can be reduced and mitigated by the 12 rules of simply investing. So you can see the 12 rules are up on the screen here. This becomes your checklist.

Speaker 1: 24:41

Before you invest in any company, make sure it passes all of the 12 rules, not just 8 out of 12 or 9 out of 12 has to pass all 12. If a company fails even one rule, we skip it. Move on to something else. So rule number one do you understand how the company is making money If you don't skip it? Rule number two 20 years from now, will people still need its products and services? Rule number three does the company have a low cost competitive advantage? Rule number four is the company recession proof? Rule number five is it profitable? Rule number six does the company grow its dividend? And so we've go back 20 years to look at the dividend history. Rule number seven can the company afford to pay the dividend? Rule number eight is the debt less than 70%? Rule number nine avoid any company with a recent dividend cut. Rule number 10, does it buy back its own shares? Rule number 11, is the stock priced low? And we check for three things there the P-E ratio want to make sure it's low. We check the current dividend yield to the average 20-year dividend yield and then we check the P-B ratio, the price to book ratio Want to make sure that's also low as well. If the company passes all three conditions, it passes rule number 11. And then rule number 12, keep your emotions out of investing.

Speaker 1: 26:01

So for those of you that are interested, I've created the Simply Investing course. I cover all of these 12 rules in detail in the course. The course itself is divided into 10 modules. It's an online self-paced course. It's a video course. So module one we talk about the investing basics.

Speaker 1: 26:20

Module two I cover the 12 rules of Simply Investing in detail with real life examples. Module three I show you how to apply the 12 rules using a Google Sheet. You can put all the numbers in and the Google Sheet will highlight which rules the company passes and which rules a company fails. Module four is using the Simply Investing platform. Module five placing your first stock order. Module six building and tracking your portfolio. Module seven when to sell, which is just as important as knowing when to buy.

Speaker 1: 26:54

The next module is how to reduce your fees and risk, especially if you have mutual funds, index funds and ETFs.

Speaker 1: 27:01

Module nine is your action plan to get started right away. And module 10, I answer your most frequently asked questions and, for anyone else that's interested, I also have built the Simply Investing platform. Took a little over two years to build. The platform is a web app that tracks over 6,000 companies in the US and Canada every single day, and we apply the rules to all 6,000 companies every single day, and so you can see which companies pass the rules and which companies fail the rules. So you can ignore those companies for now or skip them and focus on the ones that are high quality and priced low. So you may want to write down the coupon code save 10, save10. This coupon code is going to get you 10% off of the course and the platform as well. If you enjoyed today's episode, be sure to hit the subscribe button. We have a new video out every week. Hit the like button as well, and for more information, take a look at our website, simplyinvestingcom. Thanks for watching.