Friday, April 11, 2008

Capital Protection (Dollar Risk Free) Risk Management Scheme

The capital-protection scheme simply means that by the end of the performance period, even in the worst case scenario that you lose EVERY SINGLE TRADE (Murphy’s freaking Law, where ‘if anything could go wrong, it will go wrong.’), your original capital remains preserved. Yes it is possible, practical, and easy to pull off once you understand the numbers.

Basic Run-Down

Allocate majority of capital into an interest collecting instrument, and trade with only the remaining amount. By the end of the investment period, even if the trading resources become lost, the original amount becomes regained from the interest gained on the investment.

Execution Details

First you need to find a low risk investment. In today’s financial environment that means government or bank backed savings account or bonds. Here in NZ, the average banks here offer rates as high as 8.9% a year for these debt instruments that comes to roughly 6.5% after tax.

Let’s say you have $100k of capital to start with, and you want to have at least that amount by the end of a 1 year investment period in the worst case scenario. All the while you find a bank that provides 5% interest rate for a CD or Term-Deposit (termed here in NZ). Next step lies in tweaking the numbers to find the amount assigned for trading.

x= Risked Amount for Trading

$100k-x= Interest Bearing Investment

0.05= 5% interest over 1 year

($100k-x)0.05= x



So, this means out of $100k, you can invest $95,238.10 into an account for 5% return, and apply $4,761.90 for risk involved trading. By the end of the year, even if you blow the $4,761.90 entirely, you’ll still have $100k.

Of course if you lengthen the investment period to 3 or 5 years, the amount available to trading becomes much larger due to compounding of invested capital. This is how the “capital-protection” investment funds operate.

Risk had become averted from dollar to time value. Pretty easy right?

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