I am still young and can take big risks when investing. Or at least I like to think so. But hey, I’m also still of the opinion that I haven’t hit middle age.
The point is that from an investing standpoint, most people who are younger than forty should be focusing their portfolio on growth and that means taking measured risks.
Risk is something that I have always loved. I’ve always been interested in snowboarding, skateboarding, biking, and all types of extreme sports.
I like taking big risks and have done so in the past
When I was younger (and yes I know that saying “when I was younger” makes me sound old: but I am still young!) I took a lot risks. And I still like to take a lot of risks. But I have always been really careful too! That’s something that a lot of people who don’t do extreme sports don’t understand. You can take risks but still be safe.
Someone might look at the picture below for instance and think, “wow that is too risky for me – I would never do that!” But to me that looks fun! I love being outdoors, swimming, and jumping from cliffs into water.
This picture is in fact a picture of me when I was a little younger. Ok I was a lot younger.
Here is what happened when I jumped off of an eighty-five foot waterfall at Cane Creek Falls in the Falls Creek Falls state park in Tennessee. I know that is a mouth full but I didn’t name it; I just jumped off of it. If you go to the link there is a great picture and near the bottom of the page and a really interesting video as well.
I want to talk about taking risks and I think jumping off the waterfall is a good example of taking measured risks just like you do when investing.
Cane Creek Falls Jump
In the summers I used to go to a week-long camp in Tennessee. It was one of the highlights of my youth! We also played a lot of basketball and did some interesting excursions.
One of the activities was to visit a local state park and go swimming. So we went out to this state park with a bunch of people that we had just met started exploring.
When we got there it was absolutely amazing! The trail to get down to the swimming area was a challenge in itself. If you look at the short video you will see that the descent to the base of the falls involves navigating a steep rocky slope while holding a metal cable. I don’t think you would see anything like this in the highly litigious mid-atlantic region where I live. They would probably put a huge fence up with barbed wire to keep people out so that no one would get a scrape or hangnail. Babies!
But back to the story. As we were swimming below the falls, one of my friends said, “hey – do you guys want to jump off the waterfall?”
I immediately said, “No way, that is a horrible idea and someone could get killed.”
So they started swimming around under the falls and going 8-10 feet deep under water to make sure there were no rocks or logs and to see if it was safe to jump.
They finally decided to go up to the top of the falls “just to look” and I figured it wouldn’t hurt to go up with them. Who knows, someone might actually jump and it would be interesting to see what would happen.
But I told them there was absolutely no way I would jump. It was too risky.
When we got to the top I was even more sure that jumping would be unwise. I felt like I was standing on top of a skyscraper and looking down at a street below. The people swimming below us looked like little specks and we couldn’t hear more than a faint noise when they yelled up to us.
So my friend said, “I’m going to jump.” And I couldn’t believe it. I tried to reason with him. It would only take one awkward slip and he could get off-balance and hit the water at a funny angle. That would be it: neck broken.
But he is a HUGE risk taker. So he jumped!
It was crazy. He gently pushed off from the edge as us, and several other onlookers, gasped. It was great though! He dropped into the water, came up a few seconds later, and gave us the thumbs up.
So now I knew that it could be done. The test had been performed. There was solid proof right in front of me that on this day, in these conditions, at this water level, the jump could be completed safely.
But there was still a huge risk. I could still slip. I could still hit the water at a bad angle. Maybe I would land in a slightly different location where a rock or log was hiding.
But it was now a measured risk. It was now a risk that had been tested. So what did I do? I did what any young man looking to have fun would do: I jumped!
It was incredible. I felt like I was in the air for minutes and I was trying to figure out when to take the final big breath before impact.
Upon impact, I went 10-15 feet underwater. It was great. The reward was well worth it. But I didn’t run up to the top and do it again. Once was enough.
Investing is personal and should reflect your personality. You should do the wise thing and understand the fundamentals. But you should also do things that reflect who you are. (I hate Bonds by the way.)
And that is why I take a lot of risk as an investor. I am extreme and I love excitement. Taking risks and reacting to new situations is what makes me feel alive. I like a challenge and I like to see some volatility and change from day-to-day.
So I have a huge position in my portfolio in a highly leveraged ETF. I think it is a wise move but I know that it is a risky one. It is a measured risk.
Could anything go wrong? Definitely. But I am taking the risk now because I am younger and have some years of investing to make up for any losses.
This is Extreme Investing. I invest in a 3x the DJIA ETF. What this means is that the ETF returns three times the DJIA. So if the DJIA drops by 10% then my ETF will drop by 30% – or more! This is a couple steps farther than a 100% allocation to stocks. This is like a 300% allocation to stocks and it could blow up in my face.
Its the investing equivalent of jumping off of an eighty-five foot waterfall.
But I don’t actually plan to sell the ETF. If the market takes a dive and my ETF absolutely tanks, I plan to keep investing in it. Eventually it should come back.
But the other thing I am doing is hedging. The idea behind hedging is that you have one position that makes money if the stock market goes up. But you have another position that makes money if the stock market goes down too much. Its is a little bit like insurance.
I keep open orders on index futures so that if the Dow Jones Industrial Average (DJIA) drops to a certain level, then my orders are filled and I own futures contracts which make money as the stock market declines. It’s a little complicated but it is worth the peace of mind.
Hedging isn’t something I see a lot of people writing about or that I hear a lot of people are doing. But it is a very important way to reduce risk. It’s basically like portfolio insurance. You pay a premium to insure against a certain level of loss. To continue the analogy, you set the insurance contract at a level which will let you take some loss and that is like your deductible.
So if the DJIA is at 18,200, I may set my open orders to automatically hedge my position if the DJIA goes below 17,495. The 705 point decline that I do not have insurance for is like my deductible. I am willing to cover the loss on the 705 point drop myself, but I am covered with insurance for anything more than that.
Using futures contracts to do this is very effective because you don’t have to pay anything up front. Using index options can accomplish a similar thing but then you have to pay a premium up front and the value of the insurance declines over time and eventually the options contract expires and you have to buy another one.
And just like insurance the option contract premium is gone forever if you don’t use it. Most option contracts expire with zero value just like most insurance contracts don’t result in claims.
What do you think? I love extreme investing but it requires a lot of effort, research, practice, and risk mitigation. It’s just like when you are snowboarding and about to go into a big jump. You better know where the landing is, practice your technique, and have good health insurance if something goes wrong!
What do you think – are you up for taking big risks?