I wrote about an investor’s greatest fear in my first Green Bison blog post in January 2019 (13 months ago). An investor’s greatest fear is simply losing their money. I wanted to dig into this topic more now because it is so important to keep top-of-mind. What are some investment strategies to reduce your risk of losing money?

How do you preserve your capital and protect against the extreme downside such as a stock market crash, a natural disaster or a man-made mistake (e.g., a massive fire caused by carelessness)? A typical strategy is to diversify your investments such that if one investment performs poorly, it doesn’t have a material effect on the performance of a group of investments. This is certainly prudent….the ‘ol adage of “don’t put all your eggs in one basket”. But what about when considering a single investment? If you had a single investment and wanted to isolate your investment risk from a major downturn in the stock market, then you should invest in something that is not correlated with the stock market.  Investments such as direct ownership in real estate, precious metals, and private businesses are not correlated with the stock market.  But what about a natural disaster or an accidental, man-made fire?…

Insurance. Another strategy to protect against the downside is to have insurance. For real estate, we are talking about property (hazard) insurance and flood insurance if the property is in a flood zone. You can even insure for loss of rent if something happens to the property. Suppose there was a fire in your property, and it became uninhabitable for three months.  Insurance will cover you not only to fix the property but also for the loss of rent for those three months. Your insurance policy may also pay for the tenant’s accommodation for those three months. For investing in a business, you can get insurance on principal owners/managers to protect the company should the principal become disabled or deceased. This is known as “key man” insurance, and I have firsthand experience with this downside protection in business. Unfortunately, stocks and 401k plans do not have insurance to protect these investments against a market downturn.

Cash Flows. Another way to help preserve invested capital is to return some of it as cash flow during the investment hold period.  This helps because the overall return on investment is not 100% dependent upon when you sell the investment.  Green Bison looks for investments that distribute cash flow on a monthly basis, and these cash flow distributions would be an average of 8% per year over a 5 year period.  This totals to returning about 40% of the invested capital as cash flow.  You can certainly get cash flow from stocks if they pay dividends. The highest dividend yield paying stocks return about 4 to 5% per year.  Dividend yield is how much a company pays out in dividends each year relative to its share price, and is usually expressed as a percentage.  With direct investment in real estate, you can significantly reduce and potentially eliminate the taxes you would pay on this cash flow with business expenses and depreciation.  Therefore, the after-tax cash flows from direct investing in real estate would be more than twice the after-tax cash flows from stock investing. This tax shield on monthly cash distributions is additional protection against the downside that you don’t get by investing in high dividend yield stocks.

Forced Appreciation.  I wrote about forced appreciation and the commercial value formula in my blog post in June 2019.  In order to preserve capital, Green Bison looks for investments that have a business plan where value is added to the property in a number of ways.  This will be through increasing rents or other income streams and /or decreasing operating expenses through better management.  The result is increasing the net operating income (NOI), and this typically translates to an increase in the market value of the asset.  Therefore, the appreciation of the asset is forced.  This allows the operator to do a number of things to preserve capital.  Capital can be returned to investors through refinancing or adding a supplemental loan due to a higher asset value. Or, the operator can simply sell the asset for a profit.