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Margin of Safety, Long Term Investment Strategy For Retirement


Sep 23, 2005
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While reading Benjamin Graham's book "The Intelligent Investor" he discusses the need for a "significant margin of safety" while investing. With this in mind, I consider diversification a part of the concept of developing a "margin of safety." My strategy is to minimize risk and to do risk management with my investments. Since, my employer in my 401k plan offers matching it is in one's best interest to contribute to such a plan in order to obtain the matching money, despite the fact that the 401k account is taxable upon retirement, you still come out ahead due to employer matching. When examing the mutual funds available, I investigated the mutual funds that invested in stocks that are priced under a stocks fair market value. The reason I choose value mutual funds over growth mutual funds is because by these value mutual funds buying into stocks that are priced lower than their fair market value, you are developing a better margin of safety.

I will then examine the value mutual funds long term past performances to see if every year consecutively for the long term, if that fund has made money. If that is the case, this also provides another "margin of safety." I will then turn and examine the valuation ratios of the mutual fund itself. Generally, it is ideal to buy a stock or stock mutual fund who's PE ratio is 10 or less and whose Price to Sales ratio is 1.0 or less. This is not always possible, but you want to get as close to those numbers as possible. By buying into such value stock mutual funds with such valuation ratios, you are developing more margin of safety.

I generally buy into Large Cap Core (Core is a mutual fund that has both value and some growth stocks, but I buy into a Core fund for diversification while insuring the valuation ratios are low, about 40% of portfolio is dedicated to this), Mid Cap Value Mutual fund (a mutual fund that buys stock in mid-sized companies that are priced lower than their fair market value) 30%of portfolio goes here, and Small Cap Value (fund that buys small capitalized companies that are currently priced lower than their fair market value) I will generally dedicate 15 or 10% of my portfolio to this type mutual fund, if a sector mutual fund (a mutual fund that invests in stocks only in one sector of industry) that invests in a sector of industry that is currently undervalued and priced lower than their fair market value, I will dedicate 5% to that fund and make the Small Cap Value investment allocation at 10%. I also dedicate 5% to an International Stock Indexed Fund in which I have currently invested in the MSCI EAFE indexes (Morgan Stanley Capital International, Europe, Australia, Far East). The remaining 10% will go to an income bond fund. By buying into an indexed international fund, I acknowledge the limited capacity to do research on foreign companies, so I acknowledge my lack of knowledge and therefore invest in how well these overall international indexes perform, which grants me a margin of safety. The bond fund is used for diversification and pays dividends and generally responds to interest rate risk, which also adds another margin of safety.

These are the buys that I make while investing towards retirement. I also incorporate a strategy called "dollar cost averaging" in which I take my match and my own money, that adds up to a consistent fixed amount of money every month and invest in these mutual funds with each of these mutual funds recieving the same amount of money monthly at my stated allocations of 40% Large Cap Core, 30% Mid Cap value, 15% (or 10% if you buy into a an undervalued sector fund at 5%) Small Cap Value, 5% International Index fund and 10% Bond Mutual Fund. The dollar cost averaging approach enables me to buy more shares when mutual funds are going cheap when the stock market is down and less shares when the mutual fund shares are more expensive while the stock market is up, thus enabling me to make money over the long term. This dollar cost averaging approach gives me more margin of safety. In addition to investing towards retirement, I also use a Federally tax exempt money market mutual fund to stash 6 months of living expenses, that would enable me to pay all bills, without the need of unemployment insurance or to have to take out loans or use a credit care. This emergency cash reserves provides another margin of safety and protects me from the need to go into debt or to take money out of my 401k retirement investments. This is my strategy and approach towards risk management and making money for retirment. What are some of your ideas and why?
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