The stock market gets some pretty bad press. You hear about individuals losing everything. It’s scary I know, so obviously you might even think that you can lose more than you invest in the market. However, its not the full story.
Yes, you can lose more money than you invest in the stock market. But, this is only if you take on risky strategies. A single stock purchase with cash can only lose the initial investment and no more. Risky strategies include: Margin trading, call options, or shorting a stock.
Lets dive into a bit about why these strategies are risky and why maybe you shouldn’t use them if you are risk averse. Then we can talk about the safe strategies.
Risky Strategies That Can Ruin Your Bank Account
Maybe you are coming here after reading wall street bets subreddit, or maybe your just heard the story about Robin Hoods glitch that allowed you to have infinite money. Either way way you want to see how you can lose more money than you actually have.
The ways I mentioned above are:
- Margin trading
- Call Options
- Shorting a Stock
Not all of these ways will necessarily lose more money than you have in your account since some will require the rest of your account value to be used as collateral. But, as with RobinHood they didn’t have these checks and balances in place.
Margin Trading is Debt
So essentially when it comes to trading on margin you are essentially using the value of your account to take on extra debt. This can supercharge your returns if things are going well or double your losses if things don’t go well.
Either way since it is basically a loan there are limits in place. This allows the banks to stay safe and not loan out money to people who won’t pay it back.
Call Options for the Advanced Debt Trader
So to be honest I’m not entirely sure how call options work. But it is possible to lose more money than you have invested. Options are very complicated. It takes a very long time to understand. The worst part is most of the options are trading in very liquid companies so you are playing against the pros.
Check out this link to Ally bank for a simple explanation.
This sounds like a very bad deal to me, why would you want to play against pro traders and investors and have the ability to lose everything?
Shorting a Stock and Unlimited Losses
So when it comes to shorting stocks it is very dangerous if your not absolutely right. If the stock turns around and starts banking massive returns it can essentially go up infinitely.
This can’t exactly happen if you are buying a stock. Since if a stock goes to zero all you lost was your initial investment and nothing more. If a stock doubles on your shorted stock you lose everything and if it goes higher than that you lose what you don’t even have.
This does not sound like a very good trade-off to me.
Final Thoughts on Losing Your Entire Investment
While these strategies can be abused, they can also limit your risk as well. So don’t count them out entirely. If you are not sure whether a stock will go up or down you can essentially hedge your risk.
You can do this by spending a small portion of your investment on it going the other way, if the stock is unlikely to move that way you only lose a little bit, but if it does move in that direction then you will limit your losses in the other direction as well.
Check out this video from a popular YouTuber to limit your losses.
Honestly I think its a bit more trouble than its worth and you should just focus on good strategies.
Now that we know there are risky strategies and safe strategies lets dive into the safe strategies and make sure that we can actually invest, and make money in the markets.
Safe Strategies To Protect Your Principle Investment
These safe strategies of investing will guarantee that you will not lose any more money than you invest in the stock market.
This money that you invest initially, is called your principle. The principle investment can lose value and even be completely lost. But, again you will not lose more than this principle amount.
In order to invest and protect your principle there are a few different strategies that you can use for investing.
- Dividend Investing
- Value Investing
- Growth Investing
These are at their core the basic methods of investing. Now there are tons of variations and different degrees to which you could utilize and deploy these methods of investing but its safe to say that all of these methods, when properly diversified, over time will increase in value.
Dividend Investing for Retirement and Safety
Dividend stocks are probably some of the safest out there. They are typically in industries that have static and predictable revenue streams. This makes them safe, but it also makes them unlikely to move up too much in stock price.
Dividend stocks while safe can also be risky as well. Although you won’t lose your entire net worth investing in them they could move down if the dividend is cut.
One way to identify if the dividend will get cut is to look at the payout ratio. The payout ratio will show you whether or not the company is paying out more than its taking in. Anything above 100% will result in the company paying out more money than its making.
Obviously this is unsustainable and you should probably sell before the dividend gets cut. I would say anything below 60% is a more realistic and safe payout ratio.
Value Investing for Profit and Safety
Value investing is my bread and butter. I love this form of investment since it allows me to essentially buy from the bargain bin and have instant value. Now I don’t initially realize that value, but I am buying an item for less than its worth only to sell it later for a better price.
There are many ways to value invest and some of them them can get extremely complicated that’s why a small investor like me likes to invest in the following ways.
- Book value investing
- Net current assets investing
- High dividend investing
- Discounted cash flows
The above methods of investing are all considered forms of value investing but there are countless others.
Net Current Assets a Conservative Investment Technique
My favorite methods sort of blend all of these. It is net current asset and high dividend investing.
Net current asset investing focuses on a company’s assets that are either cash or very easily turned into cash. That way the company has easily identifiable value.
One of the less easily determined net current asset value is inventory. It can range a lot so beware of companies with a lot of inventory value.
I like to blend this with dividend investing by focusing on companies that have a safe dividend below 60% payout and then buying companies with more current assets that are as good as cash than the value of the stock.
Where Can These Types of Stocks be Found
Unfortunately these stocks are limited to very tiny stocks, but that’s great if you have a smaller amount of cash. There also are not many in the United States, but this ebbs and flows according to the state of the markets and economy.
Most of these stocks can currently be found internationally, A lot in Japan. Some even in South Korea. So don’t be afraid to go internationally. If your interested in what platforms you can use to invest in south Korea check out my article on how foreigners can buy stocks in South Korea.
I would also suggest using Interactive Brokers for Japanese stocks since that’s what I use.
Growth Investing for The Future
Growth investing is very popular and in times of cheap debt can be an extremely profitable way to invest. You won’t lose more than your initial investment on this one unless you are trying to juice your returns by margin trading. Which I don’t suggest.
Growth investing focuses on companies that have been growing either their revenues, profits or just overall book value quarter over quarter at a fast rate.
These type of companies tend to explode in value and are highly exciting, so a lot of times their value can get ahead of them. But the thought is that the value will eventually catch up.
But sometimes it can even go down especially in a downturn. So watch this video to prepare yourself emotionally for that eventuality.
I don’t particularly invest this way but it is still a safe way to invest and great for young people who have plenty of time to realize those values.
How should You Invest?
There is not one answer to the method of investment that you should use. It all comes back to what your risk tolerance is. But, I would say that if you choose a strategy then stick with it. Moving between strategies will cause you to lose money.
But, at least you won’t be losing more than you have in the account. Unlike those who took out margin loans to fund their gambling addiction in the stock markets.
You may not be ready to invest today but make sure you bookmark this page and website to check back when you are. Its my goal to help small retail investors invest with ease and to sidestep the corrupt areas of finance.