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The Key Elements Of Risk Management

Mar. 02, 2020 12:23 PM ETAMZN, META, GOOG, GOOGL, SPY, DIA, QQQ, IVV19 Comments
Richard Berger profile picture
Richard Berger


  • Risk management separates the business of investing from gambling with investments in the hope of making money.
  • Here, I present the overall principles of risk management and how they work to convert a gamble into a zero probability of loss with targeted gains over 12% average annual.
  • If your goal is to make as much money as possible, I lay out a path to do so, but identify the pitfalls that go with it.
  • Looking for a helping hand in the market? Members of Engineered Income Investing get exclusive ideas and guidance to navigate any climate. Get started today »

Risk management separates gambling from business. For casino players, gambling is a risky venture. By application of principles of risk management, casinos turn risky gambling into a reliable business. To take the gambling out of your investing requires knowledge and application of the principles of risk management.

Today, I will introduce the principles of risk management for investors. Only by the application of these principles can you turn your stock market ventures from risky gambling into solid investment with 100% probability of successful returns.

First, let me discuss some important concepts in risk management generally. Risk can only effectively be managed at the portfolio level. Any given individual ticker investment is susceptible to black swan events that might take it from favorite growth to flat-busted broke. Warren Buffett is noted for saying that the key to successful investing is to "never lose any money". This may seem humorous at first, but it is truly deep wisdom.

What Mr. B. refers to is to focus on quality targets that have very low prospects of going out of business and buy them only at prices discounted from their true value. Do not confuse price for value. At any given moment, a great company may be trading at a real bargain, or an inflated bubble price, or somewhere near its fundamental fair value. If you focus on buying below fair value and the ability to hold through downturns so never forced to liquidate at prices below value, then you have very low risk of losing any money.

By doing this over a wide variety of tickers, even the occasional rare loss due to surprise fall in fundamental value will be offset by those other holdings that outperform and make up for such losses. Thus, the result at the total portfolio level with these simple rules is

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This article was written by

Richard Berger profile picture
Mr. Berger is the creator and developer of the YDP screening tool, a chart system and its analysis for screening and monitoring dividend income equity investments. The recipient of Seeking Alpha's Outstanding Performance Award, he also has been Seeking Alpha's #3 ranked Author for Income Investing Strategy & #4 for Utilities. 20 years of sitting in the board room gives me unique insights into Oil & Gas investments and corporate deal making in general. Additionally, he offers a Subscription Service  for Value & Income investors, boosting income while reducing market risk using covered option writing on a dividend income equity portfolio. Residing in Brazil gives me a local's inside view on the pulse of its economy, politics, investment climate and breaking news. A view of my front yard is available here.A former Chief Operating Officer, Director, Vice President and General Manger of Oil and Gas for Southern Pacific's Oil and Gas Operations, Business owner, geologist, and cribbage player, I've been an investor for over 48 years (started young at 13) and learned my lessons the way that makes them stick, by hard knocks and both big and little mistakes. Hopefully I can share some of those lessons with others.I am an American expatriate that decided to retire at age 57 in 2009 and now live in Brazil. As an early retiree I invest for income and manage portfolio risk by screening for strong and reliable historic data along with favorable fundamental and technical current trends.I spend 6 months/year living at home in Brazil and 6 months/year traveling the world. I have structured my financial positions so that I live virtually tax free with much of my income exempt from US tax since I live ex patriot and a lot of my US derived income over the annual ex-patriate exemptions is held in my tax free ROTH and tax deferred IRA/SIMPLE plans. This enables my tax savings to pay for my 6 months of annual traveling :) . My investing is for income and appreciation with a balance of low to moderate short term risk and low long term risk. To accomplish this I use quality dividend payors with a long track record of steady or increasing dividends along with slowly appreciating equity prices. I target a 8 to 15 % yield and almost exclusively require a minimum history of 5 years of steady/increasing dividends and no decreases in dividend ever or at least past 10 years. I diversify through sector, country and currency unit the stocks are traded in, and security type (equity, royalty trust, REIT, etf, and ADRs). I use covered call writing to enhance my portfolio yield with no added risk. In fact, it lowers the risk substantially. Once I identify a stock I want to own and an entry price for it, I write cash covered puts at or below that entry price (with a minimum of 1%/month time premium. Thus i obtain at least a 12% annualized yield before compounding just from the option premium. Likewise, I use the sale of cash covered puts to generate income and and generally get an entry point at 5 to 10% below my acceptable entry level price if/when the put stock does get presented. Thus my strategy provides a 12% pre compound yield on cash and entry into stock purchases at a 5 to 10% discount from "retail". Because I only select stocks that I am willing to hold long term for their reliable dividend yields, I am not concerned much with market volatility or short/midterm risk. Indeed, market volatility is my friend since it increases the premiums paid on the options I sell. I also selectively sell covered calls on positions I hold long so as to add to my yield that way while not taking on any additional risk.This strategy has kept me happily living off my portfolio income and traveling 1/2 the year while my portfolio has been slowly increasing in value even after my harvesting income for living expenses. As of December 2020, I am no longer writing for Seeking Alpha. If you would like to contact me with questions about my work or subscription service, please leave me a message on this site or email me at boater805@gmail.com

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SPY over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I am not a licensed securities dealer nor a certified financial advisor. The views here are solely my own and should not be considered or used for investment advice. As always, individuals should determine the suitability for their own situation and perform their own due diligence before making any investment.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (19)

Great article and insights. The article has me thinking and I hope you might take a moment to respond.

Scenario: As in your example, if one is looking for highest long term return focusing on a few etfs... irrespective of volatility to a degree and a long term outlook (30 years).

Strategy: Buy QQQ and IHI on equal weighting basis with the hopes that I can outperform the S&P over the long term. I know your article mentions spy return over longer periods, but does this hold true for qqq and ihi?

Maybe every 5 years or so, one could reallocate 10-15%% from these funds into more balanced / safe portfolios (VIG/NOBL/Bonds/Cash).

What about adding a tactical strategy overlay as well (30d/9month SMA crossover) to move from the etfs to cash when markets are unhealthy?

Do you have any thoughts on where this strategy would fail?

Thanks for your contributions on SA and any thoughts you would have.
Richard Berger profile picture

Thanks for joining our discussion.

Yes, Broad market tracking funds such as QQQ can be substituted or added to others such as SPY in such a risk management strategy. Focused sector ETFs such as IHI might also be blended in to target some areas as "overweight" to the broad market.

You thoughts about using some shorter term tactical allocations is also a good idea. I personally chose early on in the virus market swoon to add some 1 month and 3 month SPY along with my longer term SPY put positions. I have been rolling those shorter term contracts frequently as market direction and volatilty have provided opportunities to harvest additional net cash premiums at attractive double digit yields.

This is not the strategy to seek the highest long term yields. Rather it is to seek safe long term returns at targeted yield range. The more downside market protection (lower strike) prices you wish, the less yield you will generate, and vice versa. Each individual must make their own choices in yield rate target and drawdown comfort levels, etc.

For those that really want maximum return regardless of risk, I always suggest 23 Red on the roulette wheel. Take $1 thousand and simply let it ride just 4 times. If you should be so lucky as to succeed, you will then have $1,500,625,000.00 !!!! Yes, over 1.5 Billion dollars from your $1000 investment. Alas, maximum return only comes with maximum risk. I suggest that you review your opening (or periodic) amount of investment available, the time to grow it (investment horizon), and the end goal for financial independence (largely dependent on life style choices). Knowing these, it is very simply to calculate the annual yield rate needed to achieve that goal. Since risk and yield rate are largely inverse to each other, you should then opt for the MINIMUM risk path (lowest needed yield) to achieve your goal in the time available. Afterall, why take more risk than needed to reach ypropour defined goal.

Risks to the broad ETF strategy are almost all related to time. If you have to liquidate your investment early for some emergency then you may find such forced liquidation to come in the midst of a deep bear market (whereas if the long term endpoint is in a deep bear it is almost surely to be a higher level than your entry point decades early. If not, you simply roll your position forward another couple of years to walk over that bear while generating fresh cash premium income to work through that added time).

There is one more risk, but it almost moots itself. A global economic paradigm shift is likely sometime in the next 20 to 30 years. If you look at the current technology of state of additive manufacturing (3D printing), automation (robotics), AI (such as Deep Blue medical diagnosis), and genetic engineered food production (such as beyond meat), it is very likely we will reach a state where there are virtually no jobs left for 90% of the population. Even at 30% jobless, an entire new form of economy will be required to address the socio-political environment. Will it be the ultra-tax nanny state? An all powerful totalitarian regime? A utopian world of abuncance where houses and most goods are produced by 3D printing that makes it as cheap as software (expensive to develop the initial code but virtually free to duplicate)? In any scenario, private weatlh and capital may be worthless in 30 years. The good news in such a likely event is that our current investment rendered useless in such a future world will not matter at all.

When you're talking about financial goals, the end goal is: max return possible without any chance of being zero (roulette table and lottery tickets would not fit that and assuming the world/markets/society doesn't 'end'). Hence, I would not do the roulette table option.

Ultimately if EVERYONE compares their results to some extrapolation of the s&p 500, wouldn't it be prudent to just 'buy 100% of the s&p' and close your eyes? So, what investment strategy can get the same or better results than the S&P with the least amount of 'stock picking' and least number of annual trades and least amount of time involved in actively managing? In my suggested scenario, it's the qqq and ihi which I'm presuming have and will outbeat the s&p over a long investment horizon.

Ultimately I'm deciding between 1) what the typical financial advisor says - create a well diversified portfolio with equity and fixed income allocations according to one's risk profile (age/time horizon/volatility nerve etc) vs 2) Don't do that and instead take a higher risk all equity stance (spy vs qqq/ihi etc) and just adjust allocation over time to fixed income as one's appetite for risk diminishes.
Richard Berger profile picture
Whether your risk is losing it all via 23 Red or losing $1 via another strategy, the ;principle is the same. You can effectively eliminate capital risk by converting it to liquidity risk by using time horizion. If you seek only home run investments like the next FAANG, then your risk remains high of losing MOST or all of your capital. For every Google there are 1000s of startups that go broke. You would have to pick the right one and the right timing to enter and exit, avoiding false dips and dead cat bounces to come out on top. Remember, even Apple flirted with bankruptcy 2 times during its long climb to its current position. Even now it is going to take a huge hit from its reliance on many single source supply chains. Fortunately it now has the cash reserves to weather such storms.

I remain with my advice. Pick the lowest risk path to meet your goal and do not take on any added risk for more ultimate reward than needed. Otherwise you increase your risk of failure. This is why arbitrage investments are so eagerly sought and the arbitrage spread is quickly bid out of the market.
Good timing and refreshingly boring compared to the excitement of focusing on all the day-to-day turmoil in the market. Getting rich is a long and exceedingly boring endeavor ... going broke is fast and exciting. I'll take boring, thanks.
Richard Berger profile picture
Cashflow Curator,

Thanks for reading and taking the time to share your thoughts. For most of us who are not Elon Musk, taking a pass on the 23 red option is indeed the way to comfort even if not a road to untold riches. The tortoise is a wise guide to follow.

DanielHolzman profile picture
"It reveals a 100% statistical probability of achieving at least a 4% average annual return if invested for a minimum of 10 years, at least 6% if invested for 15 years, 10% for 20 year investors, and 12% or greater for investments of 25 years or more in the broad market indices such as SPY."

All the table reveals is that for the particular sample used to generate the chart, 100% of the time the returns were as shown. This does NOT demonstrate that going forward the same statistical parameters will recur. For example, the Japanese stock market has not recovered in 30 years, so obviously Japanese statistics were not included in the table. There are other stock market indexes that also exhibit long term failure to recover from losses. So it is clearly possible that a diversified portfolio in a major economy can sustain losses over longer periods of time than the table shows.

This is particularly important for individuals who are retired or near retirement, since they will almost certainly begin withdrawing principal either to live on or due to RMD likely within ten years, so protection of principal is of greater importance than someone who is say near thirty, where a long term time horizon is realistic. If you have many years ahead of your investment, assuming that a major index on the U.S. market will recover over your investment timeframe may be a prudent strategy. For those of us approaching or at retirement, maybe not such a great idea.
RetirementIsGrand profile picture
thanks Richard, very well done sir
Richard Berger profile picture
Daniel Holtzman,

Thanks for joining our dicussion. The charts shown were not a single snapshot of a period for the S&P500, rather then are a moving window (I forget if its month by month or year by year) for the entire period covered (again, its been awhile since I did that article and read the study, but covers over 100+ years into the 1990s or so).

Of course past results do not guarantee future results, but with large sampling such as for those charts, statistics are pretty good predictors. None the less, that is indeed why I cite "statistical probability" rather than simply saying 100% chance.

Many have argued that the market(s) are fundamentally different today than in the past. However, all those have been consistently proven wrong with regard to the S&P500. Japan markets are not nearly so broad or robust nor transparent as US markets. Indeed no other in the world are, perhaps excepting London and German exchanges.

The second chart showing year by year returns and drawdowns is more limited but the source material (referenced in my article here) has broader year over year returns and drawdowns supporting the rolling 5 year window for breakeven on SP&500 long term investments.

Beyond these specifics, the broad concept can be applied to other market indices and other markets with no doubt some adjustments as appropriate to their specific historical statistics. I also have methods for building a portfolio of individual ticker targets to minimize liquidation risk and generate superior yields from low risk vehicles so long as diversity of 20+ tickers are included at roughly equal weight. I discuss these in much of my historical body of work and with my EII subscribers. I will be touching on some in future public Risk Management articles also.

With regard to your observations regarding time window (long term vs approaching retirement), what you say is true to an extent, but also something traditional advisors get wrong to a great extent. Given life expediencies reaching to 100 (for 50% of those alive today), a large part of a retiree's portfolio will not be touched for 30+ years and thus has just as long a time window as a strapping 20 year old's starting the road to building investment wealth and financial independence. Thus, a large part of such portfolios should be managed as long term, not the more conservative view of needed access at retirement. Furthermore, at the 12% average annual long term returns of the S&P500, investment value doubles about ever 7 years (not even including added yearly contributions). Thus $1 invested at 18 is is $2 at 25. $4 at 32, ..., $128 at age 67. Thus a $1 lost at 18, is $128 dollar loss at age 67 retirement. It is actually more important in some ways to be low risk early than later when near retirement. $1 lost at age 66 is only $1 vs the $128 for that same $1 lost at age 18. Of course, there are a lot of over simplifications in such an analysis, but it does shed light on the need to consider all the various aspects and just how important risk management is at all phases.

Thanks for your input and view point.

life expectancy fallacy
02 Mar. 2020
Great article! Looking forward to the next installment.
Richard Berger profile picture
Thanks for the feed back. Glad you found the subject and content of interest and use. Be sure to be a real time follower for me to get email notice of each new article at the time published.

Brilliantly written!
Richard Berger profile picture

Thanks for taking the time to read and share your kind feed back.

RetirementIsGrand profile picture
Very well done sir.
Richard Berger profile picture

Thanks for the feedback. Glad you found it a worthwhile read.

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