Safe but steady returns 9/3/12

A past associate of mine who has a Master’s degree in Science and also in Business asked me the following question:

“I was trying to find out, if you know a source or person who could invest on your behalf (not 401k) and charge a fee but be relatively safe bet in picking stocks etc?”

What is “a relatively safe bet”? Money magazine gives us as their cover, 101 ways to build wealth. Everyone seems to have a great solution. Then why is it so difficult for me to answer my friend’s question simply without giving him a feel for the risks involved in trading? The only safe place to park your money and reduce risk is a money market fund delivering some awful 0.2% return. Even that is open to currency valuation risks down the road. Gone are the days a retiree could live off the interest when the banks were paying 5-6%. Of course inflation was much higher then, and we easily forget the net value of out holdings. Is too much knowledge a dangerous thing?

If my friend invests his money with an advisor who puts him in a basket of stocks balanced with a basket of bond funds, in a real recession, he is still likely to see a drop of 20-30%. That is completely unacceptable to him/me.

If he were to put all his money in SPY (S&P500) then he would see a loss potential of 30-40% in terrible down years. Unacceptable for sure.

Alternately Taleb suggests a less risky strategy is to only take very high risk with a small portion of your portfolio and leave the rest in a safer haven.

Most people go off their investment plan when they lose a lot of money. The first and most important question is not how much you want to make but how much you can afford to lose. I had a rich consortium of investors approach me to manage their money if I could generate 50-60% return per month and safely in the Forex markets. The reward potential for me was huge. But can you really separate risk from reward? I don’t think so. It would certainly be worthy of a PhD paper if one could actually dissociate the two in the investing world. Wall Street is littered with genius’ who thought they could.

I have asked my friend how much money he wants to invest, how much he can afford to lose, and what return % he is looking for. I am a conservative investor and don’t like to lose money. I find it safest to hedge my transactions, to lop off the high loss potential with put options. Next I diversify and also use stocks and also different trading systems. Finally I also sell near month options to generate a credit against my synthetic call position when I have a long signal. All sounds quite complicated, and so it is. It takes time to manage these positions as they are all end-of-day. I have hesitated to manage other people’s money because of lack of time. With my job that keeps me out for long hours, it is difficult. I have friends who have successfully made money through selling out-of-the-money options over shorter trading periods. But in every case, there is a risk and reward equation that cannot be ignored. Reduce risk and you reduce your reward.

Confucius said  “Real knowledge is to know the extent of one's ignorance.”