Motley Fool Money - 4 Ways to Manage Risk

Episode Date: January 25, 2022

Will the consumer spending American Express saw in the 4th quarter translate to other companies like Visa and Mastercard? Why will it take Johnson & Johnson two full years to split its company? Bill Mann answers those questions and shares his perspective on the market's recent volatility. Plus, Alison Southwick and Robert Brokamp (and some surprise guests!) discuss ways to manage risk. If you're looking for stocks to add to your own watchlist, we've got 15 in our free Investing Starter Kit. For a copy just go to www.fool.com/StarterKit Stocks: SHOP, NVDA, JNJ, GSK, BRK-B, BRK-A, AXP, COST, V, MA, PYPL Host: Chris Hill Guests: Bill Mann, Alison Southwick, Robert Brokamp Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

Hi everyone, I'm Charlie Cox. Join us on Disney Plus as we talk with the cast and crew of Marvel Television's Daredevil Born Again. What haven't you gotten to do as Daredevil? Being the Avengers. Charlie and Vincent came to play. I get emotional when I think about it. One of the great finale of any episode we've ever done. We are going to play Truth or Daredevil.

What? Oh boy. Fantastic. You guys go hard, man. Daredevil Born Again, official podcast Tuesdays, and stream season two of Marvel Television's Daredevil Born Again on Disney Plus. Today on Motley Fool money, we're going to take your pulse, your investing pulse. We want to see how your risk tolerance measures.

So roll up your sleeve. This won't hurt a bit. I'm Chris Hill joined by Motley Fool Senior Analyst Billman. Thanks for being here. How are we doing, Chris? We're going to find out how we're doing in just a minute. We've also got some consumer spending data as well as some health care that we're going to get to. But why don't we start with the fact that today is looking a lot.

like yesterday. And by that, I mean, it's the middle of the trading day. You and I are recording this. Jason Moser and I yesterday recorded what apparently was the low for the day yesterday, because at the end of the trading day, everything was sunshine and rainbows. Hopefully today ends up the same way. It was a nevermind market. Never mind. As you were. You pointed this out earlier today. on the morning show that you do for Motleyfoam members. Let's just take one stock, Shopify. You look at Shopify's stock price yesterday. It dropped 5.5% and from there, it rose 20%.

The range for Shopify. The range was 24%. That's insane. 24%. And then to put some real brackets around that, this is about $40 billion. A $40 billion. billion-dollar presumed change in the value of Shopify from the low yesterday to the high yesterday.

And I know $40 billion is a big number. But in all ways, it's too big of a number. There is no way that Shopify's actual value changed that much. It's just a matter of sentiment. And we always talk about on the morning show that a stock price equals, how's the company doing, times, how are people feeling right now? And in times of extreme fear, which I think yesterday was, and I think today probably applies as well, the amount of benefit of the doubt that the average investor is going to give any company is negative. It's at best zero. And these are things that happen from time to time, and they are the wages of owning stocks. in the stock market. Is it just me or is the speed getting faster? I mean, we've seen this type,

is it just me? Next question, Chris. No, it really is. Yeah. I think it is. So this is just something like this is an additional cost of doing business that we didn't really, look, we've always had volatility at various points in time, but it seems like an additional cost of being a stock investor right now is the speed with which this happens is going to increase. Just get used to a little faster speed. I think that that's probably at least partially true, but it bears remembering if you want just to sort of take your feeling from right now,

and we have had, depending on how you measure it, we have had somewhere between 10 months and two weeks of pain, depending if you are a gross stock investor, it's been somewhat longer, but for the S&P 500, it's roughly been two weeks. Just go and look at any chart. Like, for example, take the company NVIDIA, which was down from its high for a 14-year period. 14 years, it never made it back to a high that it had in early 2000s. I think things are happening faster.

I also think that there was a trillion dollars added into equities in 2021, more than the 19 previous years combined. And I think that a lot of that money was hot FOMO money. And there's not a whole lot we can do about hot FOMO money turning into the process of being either more patient money or zeroed out. And those are kind of the routes that that that money is going to go. So, yeah, there's a process involved, and I think it probably does happen faster. And it makes me wonder, you know, back in the day, you know, we thought, hey, with the internet, we're going to have so much more access to information. I don't know that that information as it comes to the stock market has made us as a collective

any better or smarter at stock picking. Yeah, because if you just happen to blissfully miss the entire trading day yesterday and you just looked at the headline at the end of the day, you thought, oh, this was a nice day. You would have no idea. It was a complete roller coaster. Yeah, I got on a plane yesterday afternoon yesterday at the lows and got back and it landed it right at 4 o'clock and the market was flat. And I was thinking, why couldn't it have been a longer flight? Right? Like, we have to get you back on a plane. Let's move on. We talk about allocation all the time. importance of investors having at least 25 stocks. And I think for a lot of people, myself included

having a stock like Johnson and Johnson, the prototypical stable blue chip business, you look at their fourth quarter, I get that it was mixed, but they wrapped up the fiscal year with 94 billion in overall sales. It seems like this has been, while an eventful year, they are wrapping up. It seems like they are in a good position for the year ahead. And then obviously, into 2023 when they expect to complete the splitting off of the consumer products business. Right. This joke's probably been made, but they're going to go from being Johnson and Johnson to Johnson and Johnson at some point. I mean, the split-off is coming from their drug discovery business and their medical devices business. It makes a lot of sense. And there are other

companies like Glaxo that are doing the same thing. Because you're talking about an industry that is so highly regulated at every step along the way, it is a somewhat more difficult surgery than it would be, say, if you two retail concepts suddenly wanted to go their own way. So some of that time is just going through the legal, you know, the legal process of making sure that they don't trip up on any regulatory issue. So I get why that would take as long as it did. This was a great quarter for Johnson and Johnson. And the cynics amongst us would say, well, yeah, that's because they're selling a vaccine for COVID. And that's kind of been a bull market. That actually was not a huge component of their revenues. It was about 5%. Other areas for Johnson and Johnson,

were, I mean, really just incredibly, incredibly successful. And this was the first time that their new CEO, Joseph Duotto, was joining in the role of CEO. And, you know, they had a lot of great things to say for what Johnson & Johnson is doing, Johnson and Johnson and Johnson. I'm glad you touched on sort of the hows and wise of the split, because it did, when the news first broke mid-November that this was happening and it made perfect sense at the time. It still makes sense. I did have a little bit of difficulty wrapping my head around the fact that it was going to take by their own projections two full years. And I just thought, okay, I get this is a

$435 billion. I know it's a big company. That still seems like a long time. But am I correct in interpreting what you said is like, look, you always want to be. careful when you're doing something like this, you want to be especially careful when you're dealing with something as highly regulated as parts of their healthcare business. Right. Just think about, think about, and rightfully so. I don't know how to say this without sounding negative. I think that this is a strength of the system. Think about how touchy the FDA is about swapping out like chocolate chips that go into chips-ahoy. I mean, every tiny bit of, you know, of this industry is regulated. On the pharmaceuticals, you know, from the drug discovery to the building of the building of

any types of trials, there isn't a step along the way that is not really, really heavily controlled by regulators. And so they're asking, they're asking permission every single step that they make. So it's a, it's a tremendously complex legal process. Last thing. And then we'll move on. Did the people at Mondalese change the chocolate chips at chips at Chips Ahoy? Did that happen under my nose and I didn't, I wasn't bring attention? I'm sorry, it was a, that was a, that was a little bit of a drive by mention. No, but, but, but in any, what I was saying was that in, in, in any situation, even something that's seen, that's, that innocuous. The FDA is involved. So you can imagine what it's like when you're talking

about drug discovery. Fair point. American Express saw record spending on its card in the fourth quarter, and I don't want to get too excited about this. I understand why American Express shareholders are excited today. They should be. But I'm not one of those shareholders. I am, however, someone who cares a great deal about consumer spending in this country. We did it. Well, it's a positive sign, but is this something where it's like, great, now let's wait and see what we hear out of MasterCard and PayPal and Visa and other people transacting? Yeah, I think that that's the case.

I would point out that basically this episode so far has been the Berkshire Hathaway portfolio since both Johnson and Johnson and American Express are very big Berkshire holdings. Yeah, it was a really big, great quarter for Amex. And let's go in the wayback machine just a little bit to a few years ago. When Amex seemed like the also ran, when Costco decided that it was going to end its relationship with Amex. So they have done an incredible, incredible job coming back to a steady state. They did say in the call that they're achieving, they're hoping to achieve 10, percent earnings per share growth, or excuse me, revenues and mid-teens earnings per share growth.

This is a compounding company. And it's just not one that people who, you know, in an age in which we want the shiny new thing, people don't think American Express, but American Express has been one of the best performing stocks in the market over the last year. And they very, very much are looking at the changes in spending and fintech as being things that American Express, and also Visa and also MasterCard, these aren't things that are going to compete them away. They are looking to take advantage of. Stocks up 40% over the past year. And I'm glad you mentioned the break with Costco, because that really was the start of

sort of a rough patch for them. do, I would say, in small part anyway, to the color that we got behind the scenes. I think it was a Bloomberg story about sort of essentially what went into that breakup. And there was no way to read that story and come away with any thought other than, boy, American Express really thinks very highly of itself. That's right. Exactly. And so the fact that they've been able to sort of turn around that business, it was this great legacy brand, but at some point, the legacy just became another word for old,

stayed. Right. Card Blanche is a legacy card brand too, right? And that's not, you know, a diners club. It really did feel like it was going that way. But American Express acted the entire time like they had a rabbit in the hat. And the rabbit in the hat for American Express has been doubling down on marketing. I mean, they have a huge.

marketing spend and doubling down on shareholder perks and tie-ins, nearly 50% of their of their revenues go into those two segments alone. So they have very much doubled down on on American Express being a, you know, being an exclusive high-end product in, you know, in the financial segment with excellent customer service and excellent perks for their sharehold. I mean, excuse me, for their card holders. I'm glad you mentioned the marketing because I like seemingly based on the data, most people in the United States of America watched a lot of playoff football over the weekend and noticed a bunch of American Express commercials.

And I did have the thought, like, is this working for them? I mean, they're spending a lot on marketing. I don't have an Amex card. I'm not necessarily looking at good get one. I wonder if this is working. And based on the results that we're seeing, yeah, it seems like it's working. It seems like it's working. And working to the point where they are a company where everything that they do, they track, right? They are a data-driven company. And the CEO came out and said, yeah, we're going to keep, we're going to keep increasing our marketing spend. So it is something

that has absolutely been working for them. Bill, man, great talking with you. Thanks for being here. Thank you, Chris. The investor who needed it this month has been a good reminder that risk tolerance is a very personal thing. With some thoughts on risk and how to manage it, there's Robert Brokamp and Alison Southwick. At the on of investors speak, right up there is risk versus reward. Whether you're a trader on Wall Street or an individual investor on Main Street, you probably spend some amount of time thinking about how to minimize your risk while maximizing your possible rewards. Sounds simple enough. For some of us, we don't like the idea of losing money. Or maybe we

We can't afford to lose money, so we like less risky investments. But what if by being too risk-averse, you actually risk losing purchasing power due to inflation? See? Not so simple. Now, this week, we're going to explore what risk is and give you the foolish take for managing it. There are many ways to define risk. Bro will offer four ways to think about it, but interspersed among Bro's ramblings,

we'll hear from other full investment analysts on how they approach risk. Let's hear from Emily Flippen first. Classic sense, investment risk is just the risk that an investment has returns other than what you expect. So why are we talking about risk now? Well, it's been the best of times and it's been the worst of times, huh? Well, indeed, Allison, the last several years have been a great time to be an investor. The S.P. 500 earned more than 15 percent a year on average over the past decade, well above

its 10 percent long-term average annual return since the 1920s. And in 2021, the index returned more than 28 percent, which was high-term. outstanding. But if you look below the surface, you can see the many stocks are not doing nearly as well. So nowadays, about a fifth of the stocks in the S&P 500 are down 20% or more from their all-time highs, and well more than half the stocks of the NASDAQ and the Russell 2000 are down that much. In fact, almost half of the stocks and the NASDAQ are down more than 50% from their all-time highs. Our resident Pollyanna and Motley Fool analyst Bill Mann thinks this volatility is actually something you should be a little bit thankful for.

It doesn't feel like a gift, but it's actually a gift because right now, you as an investor, can determine exactly what your risk profile is. It's impossible to do it when things are going up. While there are many risks investors face, let's talk through four of them today. And first up, we have short-term volatility. In 2020, the market dropped more than 30% in about a month, and that was an extraordinarily fast drop. And it was followed by, by unastoundingly fast recovery. Yeah, this sort of very quick up and down is measured by academics, as well as just folks in the financial industry, by something called standard deviation.

The higher the number for a particular investment, the more you can expect that the returns of that investment in any given year will be higher or lower than its historical average. Stocks have a high standard deviation because even though their long-term average is that 10% a year, we could expect anywhere from like 40% gain. or a 40% loss in any calendar year. And that's the entire stock market. Individual stocks can be up or down even more, sometimes at a single day. Bonds, on the other hand, have a much lower standard deviation because in any given

year, their returns will be within a pretty narrow range. I would say these days around a 2% decline and a 5% gain given today's interest rates. So basically, no huge surprises from bonds, but every year in stocks is full of surprises. Practically speaking, myself and many other investors actually associate investment risk with the volatility in those returns. So, how often those investments rise or fall dramatically over time? Now, I keep talking in terms of a single year, but when it comes to major declines in the stock market, they actually can stay down for more than a year and take a while to get back

to where they were. On average, it takes three years for the stock market to recover from a bare market, and it took around five years after the dot-com crash of the early 2000s. But in investing terms, that's still generally considered short-term or at least short-ish term. So, bro, what's the foolish take on short-term volatility? Well, it's never fun, but fools try to ignore it. And really, accept it as part of investing in stocks. You can't avoid it if you're going to be a part owner of a company, which is what you are when you buy that company's stock.

It's also why we say that any money you need in the next three or five years should not be in stocks. Put it in cash, CDs, short-term bonds. something safer. What I'm ultimately thinking about is how much emotional pressure do I have to make a bad decision at the wrong period of time? Now, the next risk an investor faces is permanent or seemingly nearly so loss, a painful lesson for everyone to learn. Isn't that right, Jason Moser? Yeah, so I look at risk a couple of ways. I think in regard to the investment itself, it's really the degree to which a given investment will result in a loss, ultimately a permanent loss, right? I mean, we invest to make money.

Any individual stock you invest in can go to zero. Enron, WorldCom all collapsed and investors lost at all. And when you sell a stock like, oh, say, Peloton, which is down 80%, then that becomes a permanent loss, something I'm trying to avoid. So, bro, what's the foolish take on mitigating the risk of permanent loss? Well, also, when you weighed into the world of investing in individual stocks, you have to accept that, actually, most stocks do not outperform. Many studies have established this, including a recent analysis that was published last year by Morning Stars John Reckenthaler. So what he did was, he identified the 5,000 largest U.S. stocks as of January 2011 and calculated their returns through December 2020. And this was a time of extraordinarily good performance for

American equities. Here's what he found. 42% of the stocks earned a positive return, but 36% lost money. Twenty-two percent of the stocks are no longer publicly traded, and based on his previous research, Reck and Thaler estimated that about half of those were likely acquired and probably realized decent returns. But only 13 percent of the stocks outperform the Morning Star U.S. stock market index. The takeaway here is that it's important to be diversified. We have the fool think you should own at least 25 stocks, and I personally like even more, at least until you've established yourself as an exceptional stock picker. And throw in the full, some index funds for good measure. The Motley Fool provides an allocator tool for our premium members,

and it recommends an allocation to total market index funds in addition to individual stocks. And I'm on the Fool's 401k committee, and I can tell you that the total stock market index fund is the biggest holding in the full 401K. We all know that it's hard to beat the index, so why not have at least some of your money join it? And with an index fund, your chances of permanent loss are very, very, very small, as long as you hold on during the tough times. And if the SB 500 ever goes to zero, which would mean that the largest companies in America have become worthless, we'll all have bigger problems than our portfolios. We've covered the risk of volatility and the market taking a hit. We're talking about the good times, the bad times. But what about the risk number three of the boring times? Extended flat returns.

The Dow ended 1964 at 874 points. And 17 years later ended 1981 at 870. Five points. Yes, one point higher. The S&P 500 crossed 1,000 and 2000. Then came the dot-com crash and then the Great Recession. It didn't cross 1500 for good until 13 years later. It took the NASDAQ longer to recover from the first two bare markets of the 2000s. It didn't exceed its dot-com peak until 2016. Oof. Most people would think a decade as longer term, yet it's still possible to be underwater after investing in stocks for 10 years or longer. So what's the foolish take on that? Well, those extended flat returns were just for U.S. large-cap stocks. But other types of stocks did better. For example, small-cap stocks, real estate investment trusts, even international stocks,

depending on which time frame you look at. Even cash outperformed the S&P 500 over the 10-year holding period of 1999 to 2008. And that wasn't that long ago. This is why asset allocation is important. You don't want your financial future writing on just one stock, one industry, one sector, or one asset class. All right. The last risk we're going to talk about today is the odds that you won't reach your financial goals. You're not just investing to see a bigger number on your brokerage statement.

You're investing to pay for something in the future. Most people, that something is retirement, but it could also be your kids' college bills, a vacation fund, world domination. Wait, what? Bro? Wait, whose goal is that? So whatever your goal, or if you're already retired, your goal is to make sure your money lasts as long as you do. So, bro, how do I make sure my portfolio can pay for my lofty goals of living it up in La Jolla?

Well, it sounds very nice. And Allison, unless you've inherited all your wealth, your ability to accomplishes goals really will depend on your ability to earn money, which in turn determines how much you can save, and then the returns you earn on those savings. So in other words, it's going to be a mixture of your human capital and your investment capital. So throughout your career, you regularly have to see whether your savings rate and your investment returns are sufficiently teaming up to accomplish your goals. It can be done with a good online calculator, and I emphasize good because some are better than others, or with the help of a competent financial professional just to run the numbers for you. There will be times when your returns are so good, you may not have to save as much.

But during the times when your portfolio returns are not moving you closer to your goals, you may need to get more from your human capital by saving more. In fact, managing your finances really in a way that empowers you to save a lot of money is one of the most surefire investments you could make. And this all brings me to my final point. You can't avoid risk. You can only choose the ones you're willing to take. Doing something to avoid one type of risk usually means taking on another, right?

So you could avoid the risk of the stock market volatility and the uncertainty by just investing in cash. But then you assume the risk of not being able to meet your financial goals because you're essentially, investing in something that yields nothing. So you have to ask yourself, which risks do I most want to avoid and which am I comfortable taking? Well, next week, we'll be back with more advice and thoughts on risk, including portfolio allocation and mindset. So we'll see you back here next week. In the meantime, let's close with some parting words from Jason Moser. Ultimately, I think while many feel investing is too risky, clearly a greater risk is not investing at all.

That's all for today, but coming up tomorrow, how are three healthcare companies investing the money they've earned from sales related to COVID-19? And what will Microsoft have to say about their plans for Activision Blizzard and the Metaverse? As always, people on the program may have interest in the stocks they talk about, and the Mountain Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.