Investing has never been so accessible. Global financial markets are at your fingertips. More and more households are investing independently and trying to achieve extra returns. However, what many people do not realize is that stock market trading is a profession that must be learned. Stock market trading therefore requires knowledge and skills. Risk management is one of the most important elements that private individuals must master.
Investing in shares. It can be done in many different ways. One makes a fortune and the other actually consistently loses his or her last savings. The possibilities for investing are endless and have expanded considerably in recent years. Banks have many options for investing and the accessibility of the internet means that everyone can participate. People are seduced by sky-high returns and low risks. People generally appear to be sensitive to high returns and do not like to delve into possible risks. That is also difficult, because how should you view risks?
Return and risk
Return and risk are related. It is often said that the higher the risk, the higher the return. If this were really the case, no one would be able to consistently make money on the stock market. So some investors are able to reduce risks or increase returns. In some cases even both. However, that does not mean that you should not question products that guarantee a 12% return on an annual basis. It just tells you that you should look for investments with relatively low risk and good potential for returns. In addition, you must be aware of when you speculate and when you invest.
Example of low risks and high returns
The KPN share is considered defensive and makes virtually no major price movements. NB! This is the situation at the time of writing. The profit is neatly paid out annually as dividend. Because the share does not make large price movements, the volatility of the share is very low. Options are therefore relatively cheap. KPN options can have a long term of up to three to four years in the future. Long term options are always cheaper than short term options. In absolute terms, long-term options cost more but have a longer term. So you get much more time value for less money. A strategy that focuses on reducing risks and with a nice return could look like this:
- Buy 100 KPN shares
- Buy 1 put option (long term 3-4 years) slightly below the current price
You can now earn money from this strategy in various ways. The price can rise and you earn from the increase in value of the share. Secondly, the dividend payment (7%) will more than offset the costs of the put option’s depreciation. Suppose the price of KPN becomes more volatile, the option premiums will rise and the put option will increase in value. A fall in the price is, albeit not synchronously, absorbed by the put option. And if KPN goes bankrupt, there is a good chance that option premiums will go through the roof due to the collapse of the price. You can then just get out and clear the entire strategy with a small profit/loss depending on the timing of this situation. Thirdly, KPN has been mentioned as a takeover candidate for years. So a takeover is also a possibility. Are there no risks at all with this strategy? Yes, if the value of KPN goes to 0 in the very short term, the put option will not make up for the entire loss in shares. T he put option has gone from ‘at the money’ to ‘in the money’, causing the expected value to evaporate. In addition, KPN could decide to no longer pay out dividends. This strategy should then be reconsidered. So in this example there are a number of aspects that reduce risks:
- Choice share (defensive)
- Making optimal use of volatility (option premiums)
- Dividend yield that makes the investment smaller and compensates for the depreciation of the put option
- A takeover candidate
- Long term investment
- You sleep peacefully as your capital is protected with a put. The chance that you sell in panic or act based on emotions decreases.
- Few transaction costs and slippage (costs due to differences between the bid and ask) because there is little need to trade
Develop strategies that suit you
There are many different strategies that can be devised. Every strategy has its pros and cons. It is therefore important to look carefully at your personal situation. In addition, it pays to invest in knowledge and in your development. But above all, the strategy must match your personality and wishes. With KPN’s strategy as described above, you sleep well, but it keeps someone else from sleeping. In other words, it is too ‘boring’ an investment for someone who does not have a long-term vision or wants higher returns. Of course you can include multiple strategies in your portfolio. Keep researching and try to learn something about ‘you’ as an investor every day. Be creative and let investing be a fun activity!