High Level Investing For Dummies

By Paul Mladjenovic

Enhance your investment portfolio and take your investments to the next level!

Do you have an investment portfolio set up, but want to take your knowledge of investing a step further? High-Level Investing For Dummies is the resource you need to achieve a more advanced understanding of investment strategies—and to maximize your portfolio's profits. Build upon your current knowledge of investment, particularly with regard to the stock market, in order to reach a higher level of understanding and ability when manipulating your assets on the market. This approachable resource pinpoints key pitfalls to avoid and explains how to time your investments in a way that maximizes your profits.

Investing can be intimidating—but it can also be fun! By building upon your basic understanding of investment strategies you can take your portfolio to the next level, both in terms of the diversity of your investments and the profits that they bring in.  Who doesn't want that?

• Up your investment game with proven strategies that help increase profits and minimize risks
• Avoid common pitfalls of stock speculating to make your investment strategy more impactful
• Understand how to time the market to maximize returns and improve your portfolio's performance
• Uncover hidden opportunities in niche markets that can bring welcome diversity to your portfolio

High-Level Investing For Dummies is the perfect follow-up to Stock Investing For Dummies, and is a wonderful resource that guides you through the process of beefing up your portfolio and bringing home a higher level of profits!

• Language: English
• Publisher: Wiley
• Release date: Nov 6, 2015
• ISBN: 9781119140832

Paul Mladjenovic

Paul Mladjenovic is a well-known Certified Financial Planner practitioner and investing consultant with over 21 years' experience writing and teaching about common stocks and related investments. He owns PM Financial Services.

Book preview

Introduction

Today’s stock market has entered historic times for both good and bad reasons, so investors have to be sharper than ever. Knowledge and information can be more valuable than money. Plenty of investors have lost a fortune due to a lack of knowledge of what was happening. Conversely, plenty of people with limited funds have applied their knowledge and slowly built a fortune.

Money is only the fourth most important ingredient to your financial success; the first three are knowledge, time, and discipline. In High-Level Investing For Dummies, I emphasize those key points and much more. This book has everything from insights from history’s greatest investors to descriptions of the stock investing and speculating vehicles that seasoned investors and money management pros use to enhance their profitability.

To say I wish you great success is putting it mildly. I am grateful to you, the reader, for allowing me to be a part of something as intimate as your aspirations and goals. Furthering your financial success so that you can help yourself, your loved ones, and your honorable pursuits (such as charities or personal endeavors) is a personal honor for me.

Make it a great investing day!

About This Book

Out of all the worn-out slogans from the past hundred years, I think the best one for this book is the more you learn, the more you earn. I’m proud of my book Stock Investing For Dummies (four editions and counting!), and I think it’s a valuable addition to your library, but I couldn’t fit all the profitable information into it that I wanted. That’s why I’m so glad to be doing this follow-up book, High-Level Investing For Dummies. I can’t think of a better one-two combination in the stock investing world! Having this book in your possession suggests you’re a serious wealth-builder who understands that stocks, exchange-traded funds, and derivatives can be powerful and intricate parts of your strategies.

As both a long-time observer and participant in the stock market, I’ve seen many market conditions and learned that any time is a good time to profit from the market’s moves. The issue is not the market itself; the real issue is you and your knowledge! There are always wealth-building opportunities in both bullish and bearish markets, and this book will help you profit from all kinds of shifts in the market, whether they’re up, down, or even sideways.

Take this book and the information and guidance within it seriously, and your financial security (and net worth) will grow, no matter what’s happening in the stock market. You may not need to read every chapter to make you more confident as a stock investor, so feel free to jump around to suit your personal needs. Because every chapter is designed to be as self-contained as possible, it won’t do you any harm to cherry-pick what you really want to read. But if you’re like me, you may still want to check out every chapter, because you never know when you may come across a new tip or resource that will make a profitable difference in your portfolio.

Throughout this book, you see words like investor, speculator, and trader and also read about tactics and strategies that are long term or short term. You should understand that these terms are not interchangeable (I do my best to be precise with those terms).

One last note about this book: For the sake of the examples throughout, I don’t factor in brokerage commissions. This move keeps things tidy and makes the math easier for me!

Foolish Assumptions

My guess is that you got this book for one or more of the following reasons:

You read Stock Investing For Dummies, and you want more in-depth information and guidance.

You’re already an experienced stock investor, and you want a book that goes beyond the basics of stock investing.

You need more ideas and insights to make your stock investing strategies a little more effective, and you’re tired of hearing your Uncle Mo’s tips.

You have a financial advisor or broker already helping you, and you want to squeeze more value out of the relationship by asking the right questions and getting a better handle on the answers.

Icons Used in This Book

See those icons in the margins of this book? Here’s what each one means:

remember This icon marks a critical point I want you to store in your memory.

tip This icon flags a particular bit of advice that just may give you an edge over other investors.

warning Pay special attention to this icon because the advice can prevent headaches, heartaches, and financial aches.

TechnicalStuff The text attached to this icon isn’t crucial to your success as an investor, but it may help you talk shop with investing gurus and better understand the financial pages of your favorite business publication or website.

Beyond the Book

In addition to the material in the print or digital book you’re reading right now, High-Level Investing For Dummies comes with other great content available online. Check out the free Cheat Sheet at www.dummies.com/cheatsheet/highlevelinvesting to read about traits of successful speculators and useful investing sites and apps. You can also find free articles about option strategies, legendary investors, and more at www.dummies.com/extras/highlevelinvesting.

Where to Go from Here

You’re welcome to start at the beginning and read straight through. However, if you prefer to skip around and you already have a basic familiarity with stock investing, consider starting with Chapter 4. There, you find info on value investing, which should be at the core of most investors’ portfolios.

Next, why not read up on the great investors (Chapter 17) and speculators (Chapter 18) so you get a bird’s-eye view of those who were at the top of their game? I also cover exchange-traded funds (ETFs) for people who are bullish (Chapter 9) and those who are not (Chapter 10). Options are a fantastic way to boost your stock investing and speculating, and I devote an entire part to them (see Part III).

From there, follow your interests. You want great info to kick your stock investing up a notch? That info is in here! Check out the table of contents, use the index, or flip through the book to find what you need.

Part I

Getting Started with High-Level Investing

webextra Visit www.dummies.com for great (and free!) Dummies content online.

In this part …

Find out what you must do before you invest your first dollar in stocks. Know what steps are necessary so your stock investing is successful.

Understand the risks and how to minimize them so you’ll have more winners than losers in your portfolio.

Get the scoop on diversification and allocation so your stock investing is consistently profitable regardless of what’s happening with the economy and financial markets.

Find great companies to invest in and pay as little as possible for their stocks. Check out what successful investors look for when they analyze a company.

Use brokerage orders and services to maximize your profits while minimizing your losses.

See how markets are interrelated. Know which investments can perform well while others are doing poorly so you can choose the right stocks in the right markets.

Chapter 1

Taking Stock before You Invest at a Higher Level

In This Chapter

arrow Describing the basics of stocks

arrow Delving into stocks’ dual nature

arrow Selecting stocks and measuring their performance

arrow Moving beyond stocks with ETFs, options, and high-level techniques

The beginning stock investor does what he or she can to choose a good stock. The higher-level stock investor knows a good stock but uses tools and resources to find either a better stock (with higher earnings and the like) or a good stock with more profit potential.

In addition, beginning and intermediate stock investors usually only go long in finding a stock to buy. But a higher-level stock investor can see profit in bad stocks and choose to profit by going short. A beginning investor sees that Sector A is good while Sector B has terrible prospects, and she buys a stock in Sector A. The higher-level stock investor may buy that same stock in Sector A but also considers getting an inverse ETF for Sector B.

When you add the strategies and resources in this book, you’ll definitely have what you need to take your stock investing to greater (more profitable) heights.

remember The basics of stock investing are covered in my book Stock Investing For Dummies (published by Wiley). This chapter really serves to highlight important points as you up your gain in the world of stocks.

The Basics: Defining and Categorizing Stocks

In our economy, companies in the private sector produce goods and services. As the economy grows, the companies that do a good job of providing goods and services that the general public consumes grow along with it.

Companies may be private or public:

Private: A private company is one of the hundreds of thousands of proprietors and other business organizations that you transact with but typically cannot invest in conveniently.

Public: Public companies, on the other hand, are business entities that are organized so that you can participate as an investor without needing to participate in the daily operations of the companies.

An investor can profit along with public companies by buying and holding their stocks. In the following sections, I provide a refresher on the definition of stocks and different stock categories.

Defining stock

remember Stock is a security that indicates limited ownership of a public corporation and represents a claim on a part of that corporation’s net assets and earnings. Stock may be common or preferred:

Common: In this book, I primarily cover common stock, which entitles the stockholder (or stock owner) to vote at shareholder meetings (either in person or by mail or email communication) and receive any dividends that may be issued.

Preferred: Preferred stock usually doesn’t give the holder voting rights, but it does provide some preferential treatment over common-stock holders, such as priority treatment in receiving dividends. Additionally, in the extreme event of the company’s bankruptcy, preferred-stock holders rank ahead of common-stock holders (and after creditors) in recouping money from liquidation.

To invest, you buy shares of the stock through a stock brokerage account (find out more about brokerage tools and tactics in Chapter 5). The minimum ownership amount is one share. When you buy or sell shares of stock, you pay a transaction fee (the commission).

Obviously, you buy stock because you expect the stock to rise (appreciate) in value as the rest of the investing public is attracted to the company and subsequently buys the stock, too. If all goes to plan, you’ll eventually be able to sell your stock for a gain (referred to as capital gain). In addition, many stocks provide income in the form of dividends, which are typically paid quarterly and have the potential to grow as well.

Checking out market capitalization

You often hear about stocks being large cap, mid cap, or small cap. In the world of stock investing, size (in terms of market value) does matter. A portfolio of large-cap stocks, for example, tends to be safer than a portfolio of small-cap stocks.

Market cap, which is short for market capitalization, is a reference to a stock’s market value. Calculating the market cap is easy; you multiply the company’s total number of shares outstanding by the share price. If Company X has 2 million shares outstanding and its stock is $10 per share, then the market capitalization is $20 million (2 million times $10). Although $20 million may sound like a lot, this stock is actually a micro-cap stock.

remember Here are the five basic levels of market capitalization:

Micro cap (up to $250 million): These stocks are the smallest stocks and, all things being equal, are considered the riskiest (flip to Chapter 2 for details on assessing risk). Some of these stocks are also referred to as penny stocks.

Small cap ($250 million to $1 billion): Small-cap stocks are the bulwark for people seeking aggressive gains, especially in bull markets, but they come with greater risk. I go into detail on small-cap stocks in Chapter 7.

Mid cap ($1 billion to $10 billion): For long-term investors, this category provides great potential compromise between the small caps and the larger companies. Mid caps are less risky than small caps but have more room to grow than larger companies.

Large cap ($10 billion to $50 billion): This category is appropriate for conservative, long-term investors. This category may not have the growth potential of the lower cap levels, but these stocks are more reliable and tend to be the leaders in their marketplace.

Mega cap or ultra cap (more than $50 billion): These stocks represent pieces of the biggest companies not only in their sectors but in the world. Mega-cap stocks tend to be in most portfolios and are the most widely held. They may not hold much growth potential versus other cap levels, but they’re certainly more predictable holdings.

remember Don’t choose a stock exclusively due to its size or market valuation. Do your due diligence in terms of choosing a stock for investment, and base your decision primarily on the company’s fundamentals (sales, earnings, market potential, and so on; see Chapter 4 for details). Let market cap be a factor if you’re down to two choices and you prefer either safety (higher market cap) or growth potential (lower cap).

Investigating the Dual Nature of Stock Investing

Stocks and their underlying companies are together, yet they have different personalities:

The company: On one hand, you have the company itself. It’s the physical entity involved with sales and expenses, products, services, personnel, budgets, and a thousand other moving parts. It succeeds by providing for the wants and/or needs of customers in a competitive marketplace against other companies seeking to do the same and hopefully makes a profit doing so.

The stock: On the other hand, you have the company’s stock. The price of the stock rises or falls on a given market day based on the cumulative buying and selling of its shares in the stock market.

Here’s where the dual nature of stock investing kicks in: The performance of the company and the performance of the stock are frequently at variance. In the short term, the discrepancy can make you scratch your head. The stock may go up even though the company isn’t having a good day. Or maybe the company is doing well, yet the stock isn’t. Sometimes you see the stock of a total-loser company go up, and you see the stock of a great company go down.

remember In the short term, the stock can rise or fall seemingly without any cause-and-effect relationship with the underlying company. But over time, the reality of the company and the value of the stock tend to move in the same direction. Long term, the stock prices of good companies go up. Long term, the stock prices of bad companies go down.

Both the seasoned investor and the serious speculator understand this concept if they’re truly analyzing the company and the stock. Short-term speculators and traders play the stock for short-term moves, but long-term investors and speculators play the company, so to speak.

Investors and speculators seek to profit from the disparity between the value of the company and the price of the stock:

A low stock price for a good company: If the underlying company is valuable and the stock is not, then an investor seeking a bargain would buy the stock, knowing that he or she is getting the company at a good price. Chapter 4 goes into greater detail about value investing, which focuses on investing in quality companies.

What if the price is low but the company is new? The speculator would buy shares of that obscure company when it’s a very low-priced stock, while the investor would wait until the company has proven itself with rising sales and profits.

remember Investing is a long-term pursuit (measured in years, not days or weeks). The investor looks at the company, what it offers, and whether long-term trends (supply and demand, demographics, and so on) favor it. Investing means measure twice; cut once. If you choose a good company, you can ignore the short-term scuttlebutt from the pundits, and you have an outstanding chance of truly prospering in the future.

A high stock price for a bad company: If a speculator sees a high stock price, yet the underlying company has little or no value (or has terrible financial difficulties), then he or she sees a profitable opportunity in betting that the stock will go down (see Chapter 8 about shorting stock).

Whether speculating is long term or short term, you’re really making a calculated bet. Maybe it isn’t a pure bet, but it’s certainly an aggressive move beyond what an investor would do.

tip If you’re starting out with stocks, consider investing. Analyzing a company for the long term is easier than trying your hand at the short-term gyrations of traders and speculators. Figuring out whether a company is good is much easier than figuring out which way its stock is heading tomorrow morning. Stock prices are subject to the whims of today’s stock movers and shakers, whereas a good, profitable company will gain adherents over time, which will lift its stock price in due course.

Choosing Stocks Wisely

Stocks are a great investment vehicle, but that doesn’t mean they’re great for everyone. And just because they’re good for you now doesn’t mean they’ll be good for you at another time in your life.

remember Fortunately, stocks are a varied bunch. There are stocks for investors seeking growth, and there are different stocks for those seeking income. In this book, I help you see the difference so you can choose wisely (Chapter 3 is a great place to start looking at diversification, allocation, and fitting in your personal factors). Here are some general recommendations:

For investors in their 20s, 30s, or 40s, growth stocks (like biotech or high-tech) are a good choice. Even some speculative choices are okay to consider.

Investors in their 50s and 60s should consider dividend-paying, conservative stocks (like utilities or food stocks).

More senior investors should check with their financial advisors about the suitability of stocks and to what extent they can be in their portfolios. Generally, seniors should consider large-cap stocks in stable industries that are known as stable dividend payers (such as utilities).

Regardless of the type of stock you’re considering, understand that stocks serve a long-term purpose in your overall wealth-building strategy, which means that you can’t ignore the factors in your situation before you buy your first share.

Measuring Stock Performance with Indexes

Market indexes help you judge how the market is doing so you can compare it to the performance of your portfolio or an individual stock. With this information, you can then judge the overall growth of your stock choices (or lack thereof). In addition, everyone wants to know whether the market is doing well during difficult times, in geopolitical conflict, and sometimes just following day-to-day events so they can gauge how well the economy is performing.

These indexes are the most widely followed and reported:

The Dow Jones Industrial Average (DJIA): Nicknamed the Dow, this is a price-weighted average of 30 major mega-cap stocks traded on the New York Stock Exchange and the Nasdaq. It was invented by Charles Dow in 1896.

Today, the Dow is the most-watched single measure of general stock market performance. Money managers often use it to gauge how well their portfolios are doing by comparison. However, many criticize the Dow for not being representative enough of the market, because it tracks only 30 large stocks.

For more information on the Dow, go to the S&P Dow Jones Indices website at www.djaverages.com.

The Standard & Poor’s 500 (S&P 500): The S&P 500, which is a much broader index than the Dow, contains 500 large-cap stocks chosen for their market size, their company leadership in their respective industries, and similar factors.

Because of its popularity and the wide distribution of the 500 stocks it tracks, the S&P 500 spawned a number of financial products that investors can utilize. Many mutual funds and exchange-traded funds (ETFs) are based on the S&P 500.

For details on the S&P 500 and related indexes, go to www.us.spindices.com/indices/equity/sp-500/.

The Nasdaq Composite Index: This is a market-value weighted index of the top stocks listed on the Nasdaq. This index is primarily used to track high-tech stocks and related stocks, so it tends to be associated with aggressive growth.

As with the S&P 500, many mutual funds and ETFs are based on this index, making it easy for investors and speculators to participate in this general area without needing to find a specific growth stock.

For more on this index, head over to www.nasdaq.com.

Going beyond Stocks: Exchange-Traded Funds and Options

Exchange-traded funds (ETFs) and options (calls and puts) can greatly enhance and enrich the stock investor’s (and speculator’s) wealth-building strategies.

ETFs give the stock investor a very convenient way to play an entire industry or sector; this is great when you can’t identify a single stock that you want to invest in to take advantage of bullish developments in a particular sector. With a few clicks, you can invest in a representative bundle of stocks in a given sector. For more on bullish ETF strategies, head over to Chapter 9.

Another great aspect of ETFs is that they give the stock speculator a way to make money from an industry or sector that is doing poorly or has a bleak near-term future. These bearish opportunities can become profitable plays if you use inverse ETFs (ETFs that move opposite to the underlying group of stocks or sector). You can find out more in Chapter 10.

If you want to add creative new ways to generate gains or income from the stock market (without necessarily buying or selling stocks), then consider call and put options and the myriad creative strategies that could put some ka-ching, ka-ching profits in your portfolio. I dedicate Part III to all things options (start with Chapter 11 to get the basics of options nailed down first).

Taking Tips and Techniques from Great Investors

If you want to achieve a higher level of investing or speculating success, it pays to study the greats. You’ve heard the advice buy low, sell high, but you can see how the greats take that point up a notch.

The great investors (see Chapter 17) buy low when they see profitable companies and/or industries whose stock prices are down sharply and offer a great buying opportunity. Great speculators (see Chapter 18), on the other hand, are happy looking at extreme bullish or bearish opportunities. When they see that everyone is ebullient about a stock, a sector, or the market in general, they look to make bets that it will fall after flying too high.

Don’t forget that profitable opportunities can show up when you see how different markets affect each other (either good or bad); find out about intermarket analysis in Chapter 6.

Choosing a good stock is great, but choosing a good stock that is ready to ride a megatrend is even better; find out more about megatrends and the big picture in Chapter 19. Chapter 20 gives you some insights about insiders (corporate and political) and their stock-picking moves. And although I am into fundamentals like most value investors, technical analysis will give you an added edge so you can better time your buy and sell transactions (see Chapter 21 for this).

Now go forth and prosper! (Or at least go to the next chapter.)

Chapter 2

Assessing Risk and Volatility

In This Chapter

arrow Looking at types of risk

arrow Lessening your risk

arrow Getting the scoop on volatility

It is said that if you want a greater return on your investment (from an activity such as stock investing), you’ll have to tolerate a greater level of risk; if you don’t want to tolerate more risk, you’ll need to accept a lower level of return. Risk, one can safely say, is the flipside of successful investing. It is definitely a major part of speculating. Therefore, the more familiar you are with risk, the better your investing and speculating decisions. Given that, I consider this to be one of the most important chapters in this book.

Risk is simply the potential for loss of a part (or all) of your original investment. Volatility is merely the magnitude and speed of up or down moves of a stock (or other security or asset); it’s typically considered to be a negative, although it’s technically a neutral condition.

Delving into Different Kinds of Risk

Successful investors don’t just understand risk as a negative force or condition; they actually embrace it from a positive perspective. Remember the phrase no pain, no gain? A market or investment that is devoid of risk is frequently devoid of the potential for gain. In other words, risk is also opportunity! To start your understanding of all this opportunity, I introduce a number of types of risk in the following sections.

Risks to the value of your holdings

Your stock picks will have a batch of things swirling around them that will affect them (good or bad). You won’t worry about the good that may impact your stocks, but you should be aware of the bad.

Financial risk

Financial risk is the one investment risk everyone thinks of: I put my money into that company, and it went out of business and I lost all my money! Financial risk is tied to the individual success and financial viability of the entity itself (stock, mutual fund, and so on). How many investors lost money because they owned stock in companies that notoriously collapsed into bankruptcy, such as Enron or Bear Stearns?

You can avoid or minimize this type of risk if you just spend more time looking at the company itself and what it does (products, services, and so forth) and how it does it (are sales and profits good or rising?), among other considerations.

remember Your stock investment is safer if the fundamentals of the underlying company are strong. You can find out more about these fundamentals in Chapter 4.

Market risk

Sometimes nothing is wrong with your investment, but the market itself is having a rough time. Having the best cabin on the cruise doesn’t matter if you’re on the Titanic.

Perhaps the best and most infamous example is the 2008 financial crisis. Yes, there were plenty of bad investments that crashed and burned, but some darn good stocks went down along with the plunge. There was wholesale selling at the time on Wall Street — quality and other factors didn’t matter, and the pressure to sell was intense.

Diversification isn’t just being in different stocks; it’s also being in different markets. Sure, if the stock market is soaring and you’re 100 percent in stocks, you look like the genius at the cocktail party. However, if the stock market is tanking, you end up as the furtive, secretive one at the thrift shop. (See the later section "Minimizing Your Risk" for details on diversification.)

remember No matter how tempting it is to invest in one place, you should have money in different markets so you are never blindsided by that sudden bear market. In other words, consider putting your eggs in many baskets (or get an omelet grill).

Interest rate risk

Interest is essentially the price you pay for the use of money (going into debt). For most investors, interest rate risk occurs when a fixed-debt instrument such as a bond (corporate, municipal, U.S. government, and so on); bank certificate of deposit (CD); or other fixed-interest, long-term debt security is acquired for the investor’s portfolio and the market interest rates rise after the transaction.

For example, suppose you just bought a corporate bond that promises to pay you 3 percent interest for the next 20 years, when it will mature, and subsequently interest rates in the market rise to 4 percent, 5 percent, and beyond. Your bond — no matter the quality of the issue or the strength of the issuer (in this case, the company) — would fall in value, which could lead to a large loss. Interest rate risk is a real danger when you’re investing in a world of low interest rates (as it is in 2015) and the possibility looms that interest rates could rise.

As I write this, interest rate risk has a new wrinkle: the possibility of negative interest rates. Negative interest rates became a reality in Europe in early 2015. Not only are investors getting abysmally low rates, but they actually have to pay interest to hold debt! The bank actually charges you to hold money in the bank! It means that you have an account that pays no interest and regular bank fees for the simple act of having a bank account.

tip In the United States, consider having money in more than one financial institution as a practical matter. I keep money in a credit union, which keeps fees to a minimum, and the checking and savings accounts usually have no fees. Having both a bank account and a credit union account means that you’re diversified among financial institutions and have greater access to cash in the event of an emergency.

One of the reasons interest rates have become negative in a handful of countries is that investors want a safe haven for their money; the European Central Bank has flooded the economies of the continent with so much money that buyers of debt now have to pay to own government debt.

tip Keep an eye out for interest rates. If they do start to rise, then either put your money in investments that are variable and go up when interest rates rise (such as money market funds or variable rate bond funds) or keep a sharp eye out for bearish opportunities, as countries, industries, or companies may see their markets or stock prices plummet. The same general investing sites that track the financial markets (such as www.marketwatch.com and www.bloomberg.com) can help you watch interest rates.

Counterparty risk

Look, you got this book because you wanted access to next-level, ultra-hot information that even many financial pros don’t know, right? Well, the concept of counterparty risk is one that remarkably few financial advisors and other people with financial acumen know.

remember What is counterparty risk? It’s the risk that the value of your paper asset (stock, bond, currency, and so on) may lose its value due to the failed performance or promise of the company or governmental agency involved. Counterparty risk is associated with virtually every paper investment asset on the planet (yes, all stocks, bonds, exchange-traded funds, and regular mutual funds have this!). Believe it or not, even bank accounts and currencies (that’s right — the cash in your pocket, too) have counterparty risk. Check out these examples:

Stock: If you own stock, the value of your stock is only as good as the performance of the underlying company. If it performs well (makes a profit), your stock will be valuable. But if the company performs badly (it loses money or defaults on its liabilities), then the stock will suffer. In the worst-case scenario, the company goes bankrupt and your stock becomes worthless.

Debt instruments: How about debt instruments such as bonds and mortgages? Same here: The value of the debt is directly tied to the promise and performance of the issuing entity (corporation, government agency, and so on). The risk is that the issuing entity will default on the payment.

Bank accounts: The money you hold in the bank has counterparty risk. What if that bank fails? In the event of a bank failure, government authorities (such as the Federal Deposit Insurance Corporation, or FDIC) take over the operation of the bank and determine what needs to be done to protect the interests of depositors and other customers. Sometimes the banking authorities will engineer a purchase of the bank to another bank that is solvent, which would help the customers of the failing bank regain banking services.

Currencies: Even currencies (cash) have counterparty risk. If you hold that currency, what happens to the value of that currency if the issuing authority (the central bank) decides to excessively produce the currency? Then your cash holding would lose money. In the extreme case of hyperinflation, your cash would become worthless.

tip Because all paper assets carry counterparty risk (and you live in the age of excessive debt, financial bubbles, and expanding worldwide currencies), it makes sense to have some assets that are either not subject to counterparty risk or that may benefit from such developments. Given that, consider hard assets such as precious metals (gold, silver, and so on), collectibles, and real estate as a diversification away from paper assets. For more about precious metals, read my book Precious Metals Investing For Dummies (published by Wiley).

Keep in mind that because counterparty risk exists in virtually all paper assets, don’t fret too much about this particular risk unless there is an extreme condition involved, such as excessive debt. If you hold the currency or debt (such as government bonds) of a strong country (such as the United States circa 2015), then counterparty risk is remote. But if you hold the currency or government bonds of a troubled country (such as Greece or Venezuela in 2015), then counterparty risk is very real.

The bottom line is that counterparty risk won’t be an issue if you’re properly analyzing the underlying company or government agency of the stock or security in question, you’re doing fundamental analysis, and you’re aware of the financial strength. Find out more about this process in Chapter 4.

Political risks

As a guy who came to the United States from a faraway land, I discovered the pitfalls and land mines that come from politics and government run amok. In today’s interconnected world, the following are risks to be aware of to stay a step ahead in your wealth-building pursuits.

U.S. political and governmental risk

We’d like to think that markets in the United States are generally free of political interference or that companies need to worry only about sales and profits. However, companies can (and will) be affected by whatever is going on in the political landscape.

A company may be performing well and making great gains for its stockholders. But what if what the company does becomes politically unpopular? What if new regulations or proposed laws could have an adverse effect on either the stock or the industry?

tip Be aware of what’s going on with the country’s political and social moods and trends so you can either avoid potential risks or seize opportunities. In Appendix A, you can find some resources to track politics and other nonfinancial trends that may affect your portfolio. In addition, take a look at Chapter 21, which covers corporate and political skullduggery.

International political risk

The U.S. financial markets are not the only game in town (okay, they are the only game "in

Reviews for High Level Investing For Dummies

[Chris Barlow · Rating: 5 out of 5 stars]

Great next step, diving deeper into Investing strategies from the previous installment.