How Do We Protect Our Investment?
In our last article we covered our Renting Stocks or Shares Strategy, we mentioned that it is possible for our stock or share price to go down a little or a lot. If our stock price goes down a little, or stays relatively the same at the end of our rental term, we are quite happy with the trade, but as mentioned, our stock price can fall quite dramatically (in some cases by 100%) and these types of market crashes have been seen in the stock market during 2008. At Planet Wealth we are very aware of the current market and have recently introduced a new feature to our popular Renting Stocks and Shares Strategy…What we now do with EVERY trade is INSURE OUR STOCKS.
Since Money Does Not Grow On Trees…We Like To Insure Ours!!
Whenever we buy stocks or shares in our Renting Stocks portfolio, the first thing we do is buy insurance to protect the stock or share in case of a big fall (or even a wipeout) in price.
If you are a landlord and you buy a house and rent it out, the first thing you do is to make sure your new house is insured (in fact the bank will probably make you do it anyway). You want to make sure that if your tenants don’t pay rent, or if they damage the property, or even if they burn it to the ground, you are covered for any losses.
No-one buys a house without insurance, and we apply the same principle to our Renting stocks or shares portfolio.
Whenever we buy stocks, we spend a part of our rental premium on insurance. However, we don’t insure 100% of our stock price, because if the stock price only drops a little we can easily make this up from our rental premium.
It is only necessary to insure against a really big drop in price, therefore we only buy insurance a few dollars below the current stock price (which protects the bulk of our money, but not all of it). The reason for this is the cost of insurance is very high if you want to insure 100%, and it eats up all our profit from renting the stock in the first place.
As a general rule, we aim to spend between 20-40% of our rental premium on insurance costs.
For our example on XYZ, we buy insurance at $15, which costs us 30% of our rental premium. Our rental premium was $1500 for our 1000 stocks, so that means we spend $450 to insure our stocks at $15.
In summary, after we receive our rental ($1500) and buy our insurance ($450) we end up with $1050 of income.
Now that we have insurance, we have a guarantee we can sell our stock at $15 regardless of its current price, at any time before the rental period expires.
Let’s look at the worst case scenario: Something happened to XYZ and the share price dropped considerably, let’s say all the way down to $5. If we didn’t have insurance, we would be looking at a loss of $15.00 per stock, or $15,000 for the trade. That’s a big chunk of our initial investment, which was $20,000.
While we could live with that, it would take a long time in renting our stock out again and again before we could make up that loss.
Imagine if the absolute worst case scenario happened - the company went broke – making the stock price zero. That would mean we’ve lost ALL of our investment! That’s nothing short of a disaster. But here’s the good news…
Because we have insurance, we have a guarantee we can sell the stock at our insurance price of $15 (even if the company goes broke). That means we have only lost $5.00 per stock, or $5000 which is not too bad considering other investors who did not insure their stocks would have lost $20,000!
That’s the most we can ever lose, even if the stock price goes to zero!
Again, when we buy insurance, we have a guarantee we can always sell the stock at that price, no matter what happens. The stock could drop 50%. It could drop 90%. It could go completely broke and not exist anymore.
Regardless, we will always receive the price we insured our stock at (in this case $15).
In a balanced portfolio, we manage our risk so the most we can lose is only ever a small percentage of our total capital. So even if we are unlucky enough to be on some really big losers, the loss is still only small, and our ongoing income from keeps us well in front over a period of time.
Buying insurance is one of the key components to a successful Renting Stocks portfolio, and one that means we are not at risk from disastrous one-off events (eg. September 11) or market crashes. In summary, we ALWAYS protect our capital. That means we can sleep at night without worrying about substantial losses, even in the middle of the worst financial turmoil, bear markets or stock market crashes.
Written By
Scotty Smith - Planet Wealth
Don’t be scared by the volatility of the American stock market. Sure, we’ve all seen some disasters on the US market this past year, but there’s still wealth to be earned. Using the effective and relatively low-risk strategy of “renting” out US stock (formally known as “call options trading”), you can earn a profit from the American stock market. When Renting US Stocks, strategy is your friend, especially in a time where the stock market is so volatile.
