Back To Basics - Investing 101
by Charles B. Carlson, CFA
Dow Theory Forecasts

Investing is one of those things, like writing a novel or coaching a professional sports team, that everyone thinks is easy. The problem is that most people who think they are "investors" haven't got a clue when it comes to even the most basic investment principles. For example:

• Are rising interest rates good for your bond investments? Some people might answer "Yes." After all, if rates rise, that means my interest payments rise, right? Not exactly. Rising interest rates cause the value of your bonds to decline. And since the coupon rate on your bonds is fixed, you don't get any more interest when rates increase. The reason many people believe rising interest rates are a good thing is that they are thinking about their bank savings account or certificates of deposit. Bonds are different animals altogether. Bottom line-If you own bonds, you don't want interest rates to rise.
  
  
• A stock that yields 10%, when the rest of the stocks are yielding 2%, must be a good buy, right? All too often investors have a tendency to chase high-yielding stocks. (A stock's yield is determined by dividing the annual dividend per share by the per-share stock price. For example, a stock with a price of $20 per share and paying out $1 per share per year in dividends has a yield of 5%.) The problem is that yield is often a proxy for risk. If you see a stock yielding three percentage points or more above other stocks in its industry, chances are Wall Street is saying that the dividend is at risk. If the yield seems too good to be true, it usually is. Avoid stocks with extremely high yields.
  
  
• A stock that goes from $50 to $5 must be a good value. Where a stock traded in the past is irrelevant to its future. What matters is how well the company will perform going forward. Stocks fall for good reasons, not the least of which is a lousy profit picture. And a "crash" stock is not going to rebound unless there is some improvement on the earnings front. Thus, don't get caught in the "value trap," buying a beaten-down stock that get cheaper and cheaper and cheaper. Base your investment decisions on what you think is going to happen, not what has already happened.
  
  
• The market can't go down in 2003 since it has already gone down three straight years, and the market never goes down four years in a row. Basing market decisions on historical tendencies can get you into a lot of trouble. The market doesn't have a memory. It doesn't know that it has gone down three years in a row. All the market cares about going forward are three things - interest rates, inflation, and corporate profits. Those three items are what ultimately drive stock prices. Thus, if those three factors - interest rates, inflation, and corporate profits -- are bullish in 2003, the market will move higher. Simple as that.

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