Speech by SEC Chairman:
Investing With Your Eyes Open
by Chairman Arthur Levitt
U.S. Securities & Exchange Commission
The Washington Post Investors Town Meeting
September 16, 2000
Thank you for that introduction. And I want to thank you as well [Jill Dutt] for your own efforts in putting together todayís event.
Iím here to talk about todayís marketplace and review some of the basic principles of sound investing. Of course, the SEC canít recommend or endorse any particular companies, trading strategies, or financial products, but we can help you get the facts you need to achieve financial security.
We are amidst the longest period of economic expansion in our nationís history. A new, heightened optimism is fueling an almost unbridled culture of entrepreneurship, innovation, and investing.
Our markets are more a part of America's consciousness than ever before. Standing in line at the supermarket or the hardware store, you're as likely to hear people talking about the Nasdaq's performance as you are people discussing whether or not Deion was worth the money.
Even truck and beer commercials seem to be outnumbered by advertisements for on-line trading and investment advice. Just a few years ago, that would have been as unthinkable as the end of the fiscal year arriving without talk of a government shut-down.
But, Iím concerned that some of the basic but important fundamentals of investing are being lost on investors. Unless investors truly understand both the opportunities and the risks of todayís market, too many may fall victim to their own wishful thinking.
These times demand an even greater commitment to staying disciplined and understanding risk. More than ever, investors must remain focused on what makes sound investing sense for their families, for themselves, and for a more financially stable future.
We must not fall prey to an urge that tells us itís okay to suspend good judgment and invest with our eyes closed and our fingers crossed. This means researching your investments and understanding what you are investing your hard earned dollars in.
Letís start with the age-old question "How do I figure out what a companyís worth?" Most analysts and investors refer to a P/E ratio -- that is, the stock price and the earnings per share -- to gauge growth potential. But in todayís market, does it even make sense anymore to look at a P/E ratio -- are some of todayís companies really worth 1000 times nothing?
Consider how todayís multiple stock splits have helped drive up the market value for many of these companies. If, for example, a stock splits two-for-one, while the number of shares has doubled, the companyís total market value has stayed the same. If more investors dive back in and the stock shoots back up to where it was, the companyís valuation is now worth twice what it was.
Todayís increased activity in buying and selling stocks highlights an important difference between trading and investing. Trading is buying on the hunch that the stock price will rise -- regardless of what the buyer actually thinks itís worth.
Studies show that the more times you trade the less profit you make. Thereís nothing wrong with such a strategy as long as you understand the risks.
Investing for the long term means focusing on the fundamentals that make up a solid company. Does the company have a vision, a business model that works, a strong management team, or a quality product? Is it well-positioned to embrace new technology or innovation? Does it use its resources to become a better company?
Another common practice today that can also be risky for investors is buying stocks on margin. In too many cases, investors are focusing on the upside -- without carefully considering the downside. When you buy on margin, you can double your money, but you can also double your losses.
Some investors have been shocked to find out that the brokerage firm has the right to sell their securities that were bought on margin -- without any notification and potentially at a substantial loss to the investor. Many investors are stuck paying principal and interest for stock they no longer own.
If youíre margined, and the market moves against you, and you canít get a hold of your broker -- you might be in some trouble.
More generally, you should also understand how your overall portfolio is tailored for risk. There is no better way -- over the long term -- to distribute risk than to diversify your investments.
Now, some years or some markets will outperform a diversified investment strategy in the short term. Thatís just a fact. But donít forget that investors who boast of fantastic returns by investing in a single stock or one sector have also assumed the higher risks of a more narrow investing strategy.
But remember, if a one-stock or one-sector portfolio starts to spiral downward, thereís no other gain to offset the loss. Youíre also less likely to hear them boasting "Hey, I just lost my entire portfolio by buying only 3 stocks."
One way that some investors have looked to lower their risk profile is to consider CDís. But CDs are no longer the safe, boring investment vehicle they once were.
- "Brokered" CDs now can have 20 year terms, and are often "callable" meaning the bank can redeem them if interest rates fall. Weíve seen an increase in complaints from elderly citizens who have been sold long-term CDs.
- Investors confuse the statement "callable in one year" with the maturity date. When they try to cash in the CD after a year -- for example, to meet an unexpected medical expense -- they discover the maturity date exceeds their probable life span.
- CDís have new features, and investors need to read the fine print to understand what they are buying. CDís now may have variable rates and hefty fees for early withdrawal. Or they may have no fee for early withdrawal, but you have to sell them for a big loss if you want to get out.
Another way to diversify your risk profile is to consider mutual funds. But like any investment, before choosing a fund, do your homework.
Today, it seems you canít open a newspaper or read a magazine without seeing ads promoting the stellar performance of "hot" mutual funds --some boasting returns of over 100 percent.
Past performance is not as important as you may think. Maybe a fund invested early in a few successful IPO's giving the fund unusually high returns. Or maybe a fund had an extraordinary year or two, but over the longer term, has not done as well as recent returns suggest.
Scrutinize the fundís fees and expenses. Over time, expenses and fees can really make a difference. On an investment held for 20 years, a 1 percent annual fee will reduce the ending account balance by 18 percent.
Know the effect that taxes will have on your mutual fund returns. Our web site also has a Mutual Fund Cost Calculator to help you estimate and compare the costs of owning mutual funds. Youíll find the calculator in the Investor Assistance section of WWW.SEC.GOV. Iíve known people to spend more time comparison shopping for paper towels than they do for their investments. There is just no excuse for that.
Ask yourself some fundamental questions about your investment goals. What is my time frame for investing? What happens to my overall portfolio if a certain investment doesnít do well? Ultimately, maintaining a diversified and balanced portfolio is key to maintaining an acceptable level of risk and reaching your financial goals.
As you do your research, ask specific questions about products and ask questions about those who sell them. For example, letís look at money market funds. I have a few of their prospectuses here with me now. When I look at some of their names, I see reassuring words like "Trust" -- "Liquid" -- "Government" -- "Cash" -- "U.S." -- "Ready Assets."
Well, I donít care if a fund is named "The Rock-Solid Honestly Safe U.S. Government Guaranty Trust Savings Fund." In any market investment, you stand a chance of losing your principal. Let me underscore that last point. Itís a fundamental fact of investing. You might even write it down, and remember it whenever you invest: With any investment, you stand a chance of losing your money.
Managing risk also means researching what you read and hear about potential investments. Unfortunately, itís not always just separating good information from the bad -- often, itís a question of gauging objectivity or bias, or salesmanship from honest advice.
How many of you have seen analysts from Wall Street firms on television talking about one company or another? Iím willing to bet that not many of you have thought twice about that personís recommendation to buy or sell a particular stock. But you should.
A lot of analysts work for firms that have business relationships with the same companies these analysts cover. Some analystsí paychecks are tied to the performance of their employers.
You can imagine how unpopular an analyst would be who downgrades his firmís best client. Is it any wonder that today, a "sell" recommendation from an analyst is as rare as finding a weekend parking space on the Mall?
Whatís more, the Internet -- with its low cost, anonymity, and large number of innocent investors -- makes it ripe for out-and-out fraud. Be wary of illusions of easy money, or fancy web sites promising youíll make a fortune with one quick gamble.
Be wary of "hot" press releases -- donít react before researching. Iím sure most of you read about the EMULEX case a few weeks ago. A former employee launched a phony press release that sent the stock plummeting -- costing investors billions of dollars. Luckily, he was apprehend shortly after. But those who sold their stock on the way down lost out. Always, research even the most "authentic" looking press releases.
Chat rooms increasingly have become a source of information -- and mis-information -- for many investors. I wonder how many chat room participants realize that if someone is waxing poetic about a certain companyís stock, that person could well have been paid to do it.
Now, I donít want to make it sound like the Internet is bad for investors -- Nothing could be further from the truth. Itís empowered investors -- giving them timely access to financial information like never before. And it now serves as a way for companies to communicate with investors more quickly and efficiently.
Some companies even hold "virtual" annual shareholder meetings on-line. And thatís a good thing -- but only as a supplement. I believe these virtual meetings should not be held in lieu of real, live, face-to-face meetings -- as recently passed legislation in Delaware now permits. In-person meetings are the surest way to keep corporate management accountable, and we must not exclude those shareholders without access to the Internet.
To research a company, visit the SECís Internet website, again thatís WWW.SEC.GOV and click on EDGAR, the SECís electronic database. You can retrieve every report a public company has filed with the SEC in the past five years.
The SEC requires that the annual reports filed by companies be certified by independent auditors. Auditor independence is a covenant between auditor and investor that says the auditor works in the interests of shareholders, not on behalf of management. This covenant says the auditor must steer clear of having financial interests in the companies he or she audits. The auditorís work must stand separate and apart from the clientsí business.
Weíre seeing ever more complicated audit engagements and interwoven business relationships. It's become abundantly clear that a more modern and effective approach to self-regulation in the accounting profession today is an absolute necessity.
Next Wednesday we will hold our third public hearing on an SEC rule proposal that addresses two aspects of the auditor independence issue: stock ownership by auditors and the types of services that auditors provide to their audit clients. I invite you to visit our website, read about the proposed rule, and tell us what you think.
I also encourage you to visit the Investor Assistance section of our site. A more informed investor stands a better chance of avoiding the pitfalls of investing in todayís market.
And finally, the SEC is proud to be a member of the National Partners for Financial Empowerment. This exciting public-private effort was launched last April by Treasury Secretary Lawrence Summers. The partnership has a website, WWW.NPFE.ORG, where you can learn about financial planning, saving, investing, and credit management. Our goal is to promote financial literacy among Americans of every age and income.
Iíve been involved with our markets, in one way or another, for over four decades ó almost as long as Strom Thurmond has been in the Senate. Iíve seen markets go up, and Iíve seen them go down and stay down for extended periods. In that time, Iíve learned one incontrovertible fact: successful investors, through good times and bad, focus a vigilant eye on managing risk.
Periods of promise and prosperity are not an excuse to let your guard down. In fact, itís times like these when you need to raise it even higher.
In todayís environment, with all the financial information, advertisements, and advice being fed to us, it is even more important -- not less -- for investors to focus on the fundamentals of investing. The ease of todayís technology isnít an excuse to do less. Itís an opportunity and a mandate to do more; to learn more; to be aware of more; to be informed of more and to achieve more -- as individuals and as a nation.
Thank you very much.