For example, when the stock market goes up, most stocks go up in price, including those with less-thanspectacular sales, growth, and earnings. Similarly, if a sell-off occurs in the stock market, stocks with better than average sales, growth, and earnings will be included in the downslide. External events that move security prices (stocks, bonds, and other assets such as real estate) are unpredictable. Such an event could be a terrorist incident or news of a war, death of a prominent leader of a foreign nation, changes in inflation rate, labor strikes, or floods in the Midwest. Investors cannot do much to avoid these volatile short-term fluctuations in stock, bond, and real estate prices. Over long periods of time, however, stock prices tend to appreciate in relation to their intrinsic value (their growth and earnings).

In other words, a stock's long-term returns are determined by a company's investment fundamentals. Market risk highlights the dangers for investors who invest short-term money in the stock market. If you need cash when the market has declined, you will need to sell your stocks, which may have produced losses. For stock investments, you should have a long time horizon so that you are not forced to sell in down markets. The same long time horizon applies to investments in real estate.

Suppose that instead of investing the entire $1 million in Intel stock for the one-year period, you decided to divide the money equally into 10 stocks. At the end of the oneyear period, your diversified portfolio would have increased by 6 percent as opposed to the loss of 25 percent from investing the entire amount in Intel. The gains in the portfolio came from aerospace, pharmaceutical, beverage, oil, and conglomerate stocks (Boeing, Johnson & Johnson, Pepsi Cola, ExxonMobil, and Tyco). The losses were due to Mattel in the recreational sector of the economy, Washington Mutual in the financial sector of the economy, Intel and Applied Materials in the technology sector, and Wal-Mart in the retail sector.

The importance of diversification can be looked at in another way. With a portfolio consisting of one stock, a 50 percent decline in that stock results in a 50 percent decline in the total value. In a portfolio of 10 stocks with equal amounts invested in each stock, a decline of 50 percent in one stock's value results in a 5 percent decline in the total value. Thus too few stocks in a portfolio means that you have too much risk placed on each stock. Too many stocks in a portfolio dilutes the potential upside appreciation in the total value of the portfolio.

By investing in a number of stocks from different sectors of the economy rather than investing in one stock, we have reduced our risk of loss. The returns on stocks from different sectors of the economy are not perfectly correlated, thereby reducing the variability in the returns. For example, the two technology stocks in the portfolio, Intel and Applied Materials, have returns that generally move together, a high correlation. Stocks from different sectors of the economy have returns that are not related, which means a low or negative correlation. By increasing the number of stocks in your portfolio to 30 or 40 that have low or negative correlations you can effectively eliminate all company-related risks. Thus, of the total risk, you can reduce unsystematic risk (operating, business, and financial risks) through diversification.

Monetary Risk

Is it worth the price?

Perceived monetary risk is simply the chance that the purchase won't prove to be worth the price the buyer paid. The amount of monetary risk depends on the degree of uncertainty about the value of the goods and on the size of the purchase price. Expensive gourmet foods, jewelry, and high-tech gadgetry are types of products that might be perceived as having high monetary risk.

Functional Risk

Will its performance fulfill my expectations?

The risk here is whether the product is effective and functions as anticipated by the consumer. The degree of perceived functional risk depends in part on the nature of the product and partly on the amount of functional risk capital the prospective buyer possesses. “Risk capital” here is similar to the way I used it in Chapter IV (Principle #2: Take Risks). More specifically, risk capital can be defined in terms of the degree of need (how important is it to you?) and the availability of substitute goods (are there alternative choices that might perform better?). A camera, computer software, or one of those cool gizmos advertised on late-night television are examples of products with a high functional risk.

Physical Risk

Could it endanger my health and well-being?

Products and services that are likely to have a high physical risk include those directly associated with health and safety, as well as products that could injure users. The degree of physical risk capital depends on how frail the consumer is. Examples of products with high perceived physical risk include snow skis, skateboards, and hang gliders.

Social Risk

Will this impact my social status?

Any consumer product that is socially visible is prone to perceived social risk. Specifically, social risk is the chance that buyers will lose social affiliation or status as the result of the purchase. These kinds of products include unfashionable clothing, plastic pink flamingo yard art, or anything else that is beneath one's social stature.

Psychological Risk

Can this threaten my self-esteem?

Perceived psychological risk is present when prospective buyers recognize there is a chance the purchase might jeopardize their self-image or threaten their self-esteem. This form of risk differs from “social risk” because there is no consideration of what others might think or do. The more positive the individual's self-image and self-esteem, the less psychological risk is perceived. An example is someone with strong moral convictions purchasing pornography or a vegetarian purchasing a steak.

Once you have determined which form of perceived risk your prospect will most strongly encounter when considering the purchase of your product or service, try rating the level of that risk. On a scale of one to five (five being highest), how high would you rate the perceived risk the purchase of your product/service represents?

Low Risk   1 - 2 - 3 - 4 - 5   High Risk

The final phase of knowing your prospect is to compile all the bits and pieces of information you have accumulated into a single composite profile. This composite profile is a “picture” of your best prospect. And with that picture firmly in mind, you can begin creating advertising that is, in effect, a personal “love letter” from you to your best prospect.

The traditional avenues for stock trading are stock exchanges where stocks and bonds are sold using the auction method. The three major stock markets are the New York Stock Exchange (NYSE), which lists over 3,500 stocks; the American Stock Exchange (AMEX), which lists 1,000 stocks; and the National Association of Securities Dealers Automated Quotation (NASDAQ), which lists 4,000 stocks. NYSE and AMEX have a trading floor, and all buy and sell order are routed electronically or brought in person to the exchange floor.

The NASDAQ is a different type of market. There is no trading floor, and it operates entirely through a massive computer network. It is an immense electronic dealer quote board. It is an open market with multiple dealers making a market for a given stock. Each dealer posts a bid price and an offer price. If you are selling stock, you look for the dealer making the highest bid; if you are buying stock, you look for the dealer posting the lowest offer. The current price for stock is the best bid and the lowest offer. Unless you are involved in “day trading,” your broker will route your orders to the dealer with the best price. Stocks will be quoted at the last traded price and at the best quoted current bid and offer. You can find these prices in most newspapers and on the internet.

Stock prices move according to supply and demand. If there are more buyers than sellers, the price goes up. If there are more sellers than buyers, the price goes down. Individual stock prices are quoted every day. To observe the market's performance, you can follow the major market indexes-Dow Jones Industrial, NASDAQ, and S&P 500. The Dow, created back in the 19th Century, tracks 30 United States companies in different sectors of the economy. NASDAQ tracks technology companies. The Standard & Poor 500 tracks 500 of the largest companies. It is the broadest and the most reliable indicator of market performance.

Stock markets are divided into sectors that represent major industries or groups of companies. New emerging companies and most technology companies are growth companies. Growth stocks appreciate in value but pay little or no dividends. They have a potential tax advantage for investors, particularly long-term investors. The increase in the value of the stock is not taxable until the investor sells it and receives a capital gain. If the investor holds the stock for more than a year, the capital gain is taxed at a favorable long-term rate.

High growth, however, is usually associated with high risk. One of the fundamental rules of investing is that risk and return are directly related. The higher the potential returns from an investment, the greater the risk of losing money. Investments with low risks have lower returns than higher risk securities. Although common stocks had outperformed other types of investments over the long term, they also tend to be more volatile than other investments. This means that the prices of common stocks will fluctuate more than bonds or other types of securities. Some types of common stocks such as small-caps will also tend to be more volatile than other types like large-cap stocks.

Steady companies, such as electric utilities, are cash-generating. Most profits are paid to investors as dividends instead of being retained in the business. Dividends are a benefit of owning stocks for investors who need income. However, for the investors in high tax brackets, dividend income, which is taxed at ordinary income rates, could be a disadvantage. These investors might prefer grow stocks that do not pay dividends in order to avoid increasing their taxable income.

Blue chip companies are large, solid companies with established reputations. There are usually few risks with blue chips. You are most likely to grow at the pace of the economy with fewer risks than with most other stocks.

Preferred stocks offer a fixed return. Investors with this type of stock get a piece of the profits first. Whether the company suffers a loss or gain, these investors usually are not affected. Most companies, however, do not offer preferred stock.

By purchasing stocks from a particular company, you invest in the company as an owner. In return, you expect a share of the profits. If a company does well-if the market for its goods or services is expanding and its earnings are increasing-then its shareholders can expect to see the value of their shares increase. If the company does not prosper, however, if it goes bankrupt-then its shareholders can easily lose their entire investment.

The prices of individual stocks are influenced by the overall performance of the stock market. If the market suffers a general decline, then the prices of most common stocks are likely to decline as well.

All investments involve risk. Though most types of risks are common to all securities, other risks may only relate to one type of security. You may not be able to sell a security quickly at a reasonable price. This type of risk tends to increase as the amount of trading in a security decreases. Small over-the-counter stocks are illiquid. Another risk is that, due to inflation, the value of the dollar will decline over time and cause a decline in purchasing power. Historically, equity securities and variable annuities provide the best protection against this type of risk since their returns tend to increase with inflation.

Before you buy stock, do your homework. Is the management frank with its shareholders? Is it simply trying to create buzz for the stock? How do you feel about taking risks? What if you lose all your investment? Could you survive such a loss? Are you prepared to stay for the long haul? The most common mistake investors make is pulling out of a fund too soon. When you decide which stock you wish to purchase, check out its performance. A stock's past will not guarantee its future, but you can get an idea of its performance for the last few years. And always remember-your investment is at risk. Nothing is guaranteed!

Consider the following before starting a business:

• Business Has an Investment: Before you go ahead and invest your retirement account, take a second mortgage and steel from your children's education account make sure that you have a good chance at success. Cover your entire basis, complete your business plan and make sure you have the skills necessary.
• Long-Hours: You may have dreams of going golfing every morning, spending more time with your kids or enjoying your summers more. This may happen if you are truly one of the most successful. Before this can happen you have to be able to set your business up to run independently. This may mean hiring other people. That takes years and possibly decades of 12 hour days.
• Income: Once you cut the job purse strings you will find that you are completely on your own. This means that you no longer have the advantage of a steady income, pay checks and medical benefits. If you have a family you have to worry that you may not make enough to suit their needs. When your kids start bugging you for money it isn't easy to ignore them.
• You Could Damage Your Psychological Health: Once you have invested your life savings, spent all those years ignoring your family and have tied your mental health to your business you might fail. As a matter of fact there is a higher likelihood you will fail than win. Once you have been beaten it is very hard to go back to work for someone else.

My first thought when I emerged on the other side of the road was: this time my decisiveness didn’t work. Which prompted the question: what went wrong? As I thought about this, I realised that there are three steps in decisiveness.

The first step is knowing what is happening. It’s wholly perception. When I looked to the incoming car, I thought it would turn left. But, on hindsight, I realise that its blinkers were not flashing and it was on the right lane. So, it couldn’t be turning left. I just misunderstood the facts.

The second step, once you perceived the facts right, is projection. You imagine what will follow from a particular situation. I thought the car was going to turn left, so I also thought I could safely cross the road. A mistaken perception drove me to a wrong projection.

The third thing is that there is a window of time for action once you know what is happening and what is going to happen next. The only thing to do in this window of time is to move quickly into action. In fact, it’s here that the fast decider shows up. In my case above, after I made a wrong judgement, I didn’t move fast and run into danger.

There is, though, more to decisiveness, which is a clear set of values. This I have learned a long time ago. If you know what you stand for, you know what you must do at any time. If safety were a value of mine, I would have waited to cross that road when the lights were green for me. That would have saved the whole episode.

The final thing about decisiveness is an ability to run risks. This is so because, when you take decisions, and if you do be honest with me, you cannot always guarantee the results. Sometimes, something can go wrong and you are the responsible person, you answer for it.

This shows up especially when the situation you have to take a decision on is out of the ordinary. There you have to be creative and sometimes the results may not be what were anticipated. You, then, are required to have the courage to run a risk.