Protecting What You Got Part 2

In the first part of protecting what you got, we talked about establishing and growing a portfolio that is basically "emergency savings". Instead of actually saving that money in cash, I suggested saving it in a food ETF, gasoline ETF in addition to other potential "core" expenses. You will need some cash to protect you against say car breaking down or whatever in that fund, which is why I suggested a full year's worth. Perhaps even more. Additionally, people talk about getting your stuff "handled" via emergency fund BEFORE investing. I simply cut right to the chase and basically "invest" in a sense that costs probably go up over time, so that's also why you can put a little bit more. You basically put a year's worth of gasoline expenses into a gasoline ETF. You put a year's worth of FOOD expenses into a food or agricultural commodity ETF. You put a year's worth of everything else into the corresponding ETF. I might just take "miscellaneous" if it isn't a major expense or isn't likely to go up into a relatively stable high income investment right away that you can use from which to use the income towards what you may need. As time goes on, the income you collect grows your actual "cash" reserves.

What do you do after you've established a core that protects you in case of emergency? That insulates you from at least a year's worth  of expenses regardless of what happens to prices of those expenses?

If you only have a very small amount, the fees and volatility of your portfolio will eat you up initially, So first, invest in "cash" until you have enough saved up. I would use a cash CD that pays interest or a "CD Ladder", then invest gradually in a dividend paying name. I don't like the risks of investing solely in ONE company, so I would use preferred shares ETF (PFF or PSK), or other high income such as HYG or corporate income CORP ETFs. Or perhaps even just the SPY or something similar that invests in the S&P.

Once your savings and capital grow, you probably want to build another income name, or continue to build a CD ladder as income comes in. It's good to get in the habit of creating the asset first, then using the interest payment from that asset to speculate. In other words, get a "CD Ladder". This is where you buy a 1 yr CD each month for 12 months and perhaps you put in whatever excess disposable income every month continuously, and then invest the principal plus interest into whatever areas you want, or start saving out of those to make the next investment. You then a year later have the income coming in each month, and from that capital you invest it while using your disposable income and putting that to replace the CD or whatever. This way if something happens and you need your normally "disposable/investable income", you still have that investing plan and have some time to adjust, and if your income grows you are still protecting the excess earnings first, and investing it second.

You earn money every month, you put that into a savings account, you build up that nest, you put it into a dividend account for higher yield. Then you go to work saving again, but now have some dividends from which to draw from in addition. The thing about dividend investing and long term investing is, if you have very little, you don't want to have a lot of transactions that cost you. Instead, you have capital being sold via dividends and transition into cash again and can build another position with the cash you accumulate without having to sell and then buy again.

After you have your core CD ladder, your income investment (dividend ETF), then I would start saving some liquid cash, and THEN once you match that cash, you invest half of it into dividend investments and/or long term trades. You then continue to save and repeat and then add some bonds and then some short term trades, then you add some currency trades and then a stock index, then some commodities, and some short term trades.

If you already have saved all the capital to invest, I would do something like this. If you don't, you progress your account to eventually develop towards this, with the idea in mind that you start out with a "riskless investment" (such as CD), followed by one that has some risk, but you basically progress from the least risky investments to the more risky as you alternate from riskless (CD) to risk (long term dividend paying investments). This way your account is built with stability first and so that you eventually have enough where fees aren't an issue so that you can actually make "shorter term trades" in the account.

As a non leveraged investor you do something like this.
10% investments (dividend paying, hold "forever" type of "Buffett" names)
10% long term trades
10% short term trades
10% bonds
10% commodities
10% Stock index
10% currency
10% liquid cash
10% illiquid income paying cash (CDs)
10% income

The strategy will be explained in more detail later. For now look at it. You really have 40% exposure to the stock market through trades, investments, indices. You have 40% exposure to cash via bonds, currency, liquid cash, cash CDs. Then you have 10% income which provides stability through capital flowing into account regularly. You have 10% commodities which can go up in a "risk on" type of environment, but also will help protect against price inflation that could potentially hurt some companies and slow long term growth. The portfolio is really "balanced" and really protects around half of your capital.

This strategy certainly has room for some shifting around. What you should be looking for is your "bias", and shift accordingly, but not too much. This is roughly a 50/50 strategy meaning it should be your allocation if you have no determined bias or think market has 50% chance of going up or down. If you think it has a 60%/40% you might have more trades, investments, and into a stock index. Perhaps there is one currency trade you really believe in for the long term and put more into it.

If you are a leverage investor seeking aggressive growth and speculation:

17.25% Non Leveraged Income (PFF,CORP,HYG,TLT)
4% Commodities LEAPS
4% stock indices LEAPS
4% currency bets LEAPS
10% hedging/cash for hedging
25% liquid cash for rebalancing
20% cash CD
2% highly leveraged short term plays "lottos"
11% 4 "core positions" long term. 2.75% each (position trades and investments using LEAPS options as stock replacement)
2.75% 2 half positions " non core" 1.375% each (swing trades and position trades using 3 month out options as stock replacements)

Even if you are aggressively leveraged, notice how you still have a very important goal of protecting yourself. To paraphrase SPDR... I mean the movie Spider Man, "With great [leverage], comes great responsibilities". Since you are using more leverage for the allocation/rebalancing area than other strategies, you need more cash for rebalancing, but you also need more cash to protect yourself from making mistakes especially since you have less income coming in. Since you have more core positions and half positions, you also need more cash and/or hedges in case those core positions and half positions grow to unhealthy levels since you don't want to be forced to sell them.

The goal of putting so much cash in a CD, cash, hedging, income, etc is not a return on investment, but a return OF investment. You are protecting yourself from going nuts and wanting to invest all the capital you have, as 20% is tied up in a cash CD, 17.25% is tied up in income, and then you tie up 12% capital in stock indices and currency LEAPS and commodity LEAPs which work together along with your cash and income to produce a very low correlation with the market overall, but still produce a return, and tie up capital that you won't be tempted to use elsewhere. If you are tempted to use excess capital you can use your hedging capital to hedge for every additional position if you must, but that is not the intention. Even your "core" positions and half positions protect a decent amount of capital as you buy much more time on the contract than they are worth, and you still leave some room for some highly leveraged short term plays or "lotto".

Once you really grow your account and produce enough income, you might put more capital to "lotto" trades, but this portfolio is already really aggressive.

Moderate leveraged investor
15% Non Leveraged Income (PFF,CORP,HYG,TLT)
10% long term individual DRIP/dividend investments
3% Commodities LEAPS
3% stock indices LEAPS
3% currency bets LEAPS
3% treasury bonds
5% hedging/cash for hedging
17% liquid cash for rebalancing
30% cash CD
1% highly leveraged short term plays "lottos"
8% 4 "core positions" long term. 2% each (position trades and investments using LEAPS options as stock replacement)
2% 2 half positions " non core" 1% each (swing trades and position trades using 3 month out options as stock replacements)

Conservative leveraged investor
35% Income
22% DRIP/dividends
2% commodities
2% stock indicies
2% currency bets
4% treasury bonds
2% hedging/cash for hedging
10% liquid cash for rebalancing
15% cash CD
3% 2 core positions of 1.5%
3% 4 half positions of .75%

As a conservative leveraged investor, you are using leverage to reduce risk and replace stock with options. In other words, if you were to buy 100 shares of stock, you would buy 1 call. The capital freed up allows for dividends investment. Because you have so much more tied up into dividend investments, there is less of a need to have cash. The cash will come in through dividends when you need it mostly. You will use less on your allocation models, and thus need less liquid cash for rebalancing. You will use smaller amounts on your allocation models, because your core and half positions will be smaller, and as a result, you need less cash for hedging those positions. Since you have smaller positions, you don't need as much cash and as a result, you have lots of cash, but since you aren't using those in more positions, you should be putting them in safe and stable income and dividend income.

Really, depending on your skill you might structure this differently. Perhaps your skill areas are in currencies and commodities, and would put more capital there instead of building core leveraged positions that you aren't skilled enough to use. If your skill is dividend income, perhaps you would be more drawn to the conservative strategy naturally. so it all really depends. Also, the market may dictate slightly different allocations. If commodities are cheap, oversold, and ready to go higher, you may put a more aggressive allocation towards them. Perhaps you trade very short term in currency and thus have a very low correlation with all your other accounts and can put more towards it and still trade it successfully with ability to maintain that balance by taking capital out and distributing it among other positions.

More on this later