Safe Investing

All investing is safe investing. At least that's the intention at the outset. After all, no one invests in order to lose money.

But the question arises: Can you be both a risk-averse investor AND a successful investor?

In the end, it all depends on your definition of "safe."

Safe Investing Method #1 - Never Lose Money

When your emphasis on capital preservation trumps capital appreciation or increasing cash flows, it's actually fairly easy to put together a portfolio of financial instruments with virtually no risk to the downside.

Presumably, that would involve a lot of CD investing, money market investing, and conservative debt positions such as high-rated government and corporate bonds (not bond funds, mind you, but individual bonds held to maturity).

For the more adventurous of the extreme risk intolerant, it might also include owning preferred stock in companies with only the highest credit ratings.

Common stock? Forget it. If you want to be guaranteed that any investment you make will never lose value, you'll have to avoid owning any common stock at all.

But virtually no risk to the downside also means you've got virtually no potential to the upside.

Translation: you're not investing for profit, you're investing for stability and the status quo.

The Downside to Super Safe Investing

True, you'll know beforehand almost precisely what your returns will be.

But most likely the floor and the ceiling will be one and the same, much in the same way that salaried employees with no access to bonuses or overtime will know ahead of time exactly what their maximum (and minimum) income will be (in contrast to business owners whose prospects rise dramatically in response to the success of the underlying business).

Of course, there is another unintentional risk involved in this kind of risk-averse portfolio allocation - the risk that your returns might not be any higher than inflation itself..

Still, in the right situation, and for the right personality, this kind of super low risk investing approach has its merits.

If your net worth is already substantial enough, or if your personal cash flow is already strong enough, so that you're able to consistently sock away new funds on a regular basis, then this type of ultra conservative investing could be worth considering.

And if you have a short time horizon or if you're in some kind of career or significant emotional transition, or for some other reason not at your investing best, by all means keep your net worth in cash or near cash instruments.

But is Obsessively Safe Investing Really Investing?

And yet an opposing case can also be made. Yes, this is safe, but is it really investing? After all, with this approach, you're not actually partnering with a business or commercial endeavor as much as you're simply loaning money to it.

Obviously, bonds and preferred shares are debt instruments, but even money market and CD deposits can be considered similarly - your deposit is essentially a low-interest loan you make to a financial institution.

So despite the merits of this approach, and regardless of its undeniable safety, I just can't define this as investing. And if it's not investing, by definition then, it's not technically safe investing either.

Indeed, when the emphasis becomes so much on safety, the investing portion becomes irrelevant. Perhaps I'm biased (OK, I am biased), but I suspect that the motivation here is primarily that of fear - the fear of loss and the fear of failure. If I'm right, this is not a foundation upon which lasting success is likely to be built (at best, it's a way to maintain a success that's already been built).

Successful investing has at its core the principle of investing for profit. And you can't do that if you're consumed with the fear of losing money.

Safe Investing Method #2 - Prudent Partnerships

There's another approach to safe investing that doesn't rely on an obsessive devotion to safety. What does it rely on? It relies on a foundation of conscious, informed, and deliberate investing.

So what is investing? It's important to remind ourselves from time to time what investing really is and what it entails.

Unlike the safety-oriented creditor (see above) loaning cash to a financial institution or for a commercial endeavor, the investor is someone who partners with a business.

I don't mean simply aligning his or her interests with the interests of the company. I mean that when you invest in a business, you become part of that business. You own part of that business along with the risks that such an ownership implies.

You wouldn't start your own business, or partner with someone else on a whim or solely based on a tip heard on TV or at a party. Indeed, if investors approached the stock market with the same level of due diligence, market research, and careful consideration as an entrepreneur starting his or her own business, they would undoubtedly dramatically improve their long term investing results.

Avoiding All Risk vs. Eliminating Avoidable Risks

What I consider to be true safe investing in the stock market isn't about avoiding risk at all costs. On the contrary, it's about eliminating as many of the avoidable risks as possible to begin with.

What exactly are those avoidable risks? Whether you own your own business or whether you purchase a stake in someone else's business (i.e. investing), you should fully research and consider ahead of time what potential pitfalls you might encounter with the business.

For me, the companies I personally avoid are those with:

Lots of debt
Inconsistent, unpredictable, cyclical, or volatile earnings
Management more concerned with executive compensation than creating shareholder value
Unattractive valuations
Operations in an economically challenging industry
Significant competitive threats

Delving into the specific metrics I personally use to determine whether a business falls into any of these categories is the subject of another article (or series of articles). The important point here is to underscore the relationship between long term investing and due diligence.

And if you do your due diligence, and you invest in only the highest quality companies, guess what? You'll be engaging in safe investing without even thinking about it.

Can you be guaranteed of never losing money? Of course not, but remember this - safe investing doesn't have to be boring investing, and low risk investing doesn't have to mean low return investing.

For a unique, options-oriented, safe investing alternative, be sure to check out this site's Leveraged Investing overview section.

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