I recently wrote about one of my favorite real estate investment mentors, Coach Carson and recently ordered his book. I highly recommend the book because it offers insights not just into real estate but the human condition.
In Chapter 3 of the book, Coach Carson tells the story of Bob & Karen (minor spoilers) who had invested a lot of money in their 401k and stocks but felt uncomfortable when the stock market gyrated up and down so they ended up cashing some of the money out for real estate.
There is nothing wrong with Bob & Karen’s strategy. I do wonder however if they were aware of risk mitigation strategies with regard to the stock market.
In my post, Personal Finance & Risk Management 101, I wrote about some standard risk strategies but let me dive a little deeper.
- Risk Identification – What are the things that might happen (especially to my money/investments)?
- Risk Assessment – What is the impact? How much will I lose? How long will it take to recover?
- Risk Action Management Plan – What can I do to prevent this? What can I do if it happens?
- Risk Reporting & Monitoring – How can I make sure it doesn’t happen now or again?
For Bob & Karen, they did run through 1, 2, and 3 but for option 3 chose “stock exit” but could they have chosen something else? How can they protect their stock portfolio without just cashing out?
There are a variety of “tools” available to mitigate risks in the stock market.
First is the put option strategy. A put option allows a holder of the option to either sell stock at a pre-determined price (strike) or earn a premium. If Bob & Karen felt their stocks would go down in value they could have profited by taking put option positions.
Second strategy is call option strategy. A call option allows a holder of the option to buy a stock at a pre-determined price or be forced to sell it. If Bob & Karen felt their stocks wouldn’t go up in value they could have sold call options for a premium which then decay in value.
These are just some random examples and trading options do have their own risk but Bob & Karen clearly made the effort to learn real estate, they could have taking the time to learn options trading.
The point of the story is that every investment has some level of risk and the best thing to do is to have a risk management strategy to minimize losses and maximize opportunities. The best risk management strategy is often simply to do enough due diligence to not be caught by surprise.
If you would like to learn more about calls & puts options, YouTube has plenty of videos and The Average Joe Investor has a video on getting started with one of the safest forms of trading options: covered calls.