High Return Investments

(50% Annual Returns?)

On the subject of high return investments, the website Motley Fool published an article in September 2007 entitled, "Why Aren't You Earning 50% Annual Returns?"

The article and provocative title was in reference to Warren Buffett statements about the difficulty of compounding large amounts of money (such as all the billions of dollars Berkshire Hathaway has to invest). In contrast, Buffett expressed confidence that he could compound 50% annual returns on a smaller amount of investing capital, such as $1 million or less.

The Motley Fool article was essentially a promo piece for their small cap advisory newsletter, Hidden Gems.

Of course, in hindsight, September 2007 (i.e. the calm before the nightmare) wasn't the ideal time to advocate any strategy in pursuit of high return investments.

In October 2009, Motley Fool published an update to the article entitled, "The Only Way to Earn 50% Annual Returns." This time the article promoted a different Motley Fool advisory newsletter, Global Gains, that focuses on international investing.

As the article readily admits, the problem with targeting 50% annual gains via small cap value investing is that volatility and losses can be extreme, to say the least. So the new idea then is to scale back and target 50% gains on only a portion of your portfolio, say 5%.

Wow.

50% gains on 5% of your portfolio is . . . hardly worth doing the math.

So what the article is actually suggesting is that the "only" way to successfully achieve high return investments is to keep score on just 5% of your portfolio and expose it to a lot of risk.

Honestly, I used to have a lot of respect for The Motley Fool, but in recent years, the marketing arm of the organization has seemingly taken over just about everything else, including in this case, basic common sense.

Other Ways to Earn 50% Annual Returns

Although I do believe that Warren Buffett and other proven, savvy investors and money managers probably could compound at 50% a year given a small enough portfolio, I don't believe I myself could do the same with a stock-only approach.

But once options are introduced, the landscape changes dramatically. Many others have made the analogy: trading stocks is like playing checkers and trading options is like playing chess. The complexity increases, but so do the potential rewards.

Options have their own set of risks, of course, but if you're serious about high return investments, I think you really must consider adopting some kind of options-oriented approach.

Briefly then, here are three such approaches where I believe that 50% annual gains can be an achievable target (but by no means a guarantee):

Covered Calls - Admittedly, earning 50% annual returns writing covered calls falls into the perfect storm category. But it can be done in a nice, steady bull market where you write out of the money calls on rising stocks so that you're gaining both from the premium received as well as capital appreciation. But you're going to have to be a proficient market timer and stay out of the market altogether during strong downtrends. Warning: it sounds a lot easier than it really is.
Calendar Spread Trading - If you're willing to assume a little more risk and complexity, calendar spreads can give you a much better shot at 50% annual returns. Although I consider myself more investor than trader, if I were a trader, these would be my favorite trades. Calendar spreads can be ideal high return investments as long as the market isn't exhibiting excessive volatility. I honestly can't understand why more traders don't absolutely fall in love with calendar spreads.
Iron Condors - Iron condors are comprised of two credit spreads - a bull put spread and a bear call spread that can generate very lucrative profits as long as a stock or index remains within the trading range defined by the trade. Iron condors have grown in popularity in recent years because, quite simply, in range bound and well behaved markets, you can make a killing. And as far as high return investments, these are fairly straightforward and easy to understand. Of course, the flip side is also true - in markets where support and resistance are little more than wishful thinking, you can also suffer big losses.

But Do You Really Need 50% Annual Returns?

If The Motley Fool can be provocative with their headlines, so can I (although I doubt I can match them in the "misleading" category).

Who in their right mind would pass up 50% annual returns? Obviously, there is no trading strategy that can guarantee those kind of gains, but such high investment returns are still possible. It's just that, as the updated Motley Fool article points out, those lofty targets often come with lots of volatility and risks of significant losses.

In the end, it really comes down to your own personality type. I firmly believe whether you're a trader or an investor, the very best approach is the one that best matches your own personality.

So, in that regard, allow me to present an alternative approach to high investment returns, one that doesn't seek 50% annual gains in the first place.

My own investing personality (and I know I'm not alone) is that I'm more strategic than tactical and I truly "get" the incredible structural advantages of long term investing. At the same time, I also recognize that "default" investing (i.e. buying and holding indexes, ETFs, or mutual funds) pretty much guarantees substandard results.

I want to own great companies (i.e. companies that make a lot of money pretty much no matter what) because I know that true, long term investing in great companies produces enviable results: earnings that are largely automatic and increasing over time and which I typically benefit from in the form of ever growing dividend streams.

But I'm not an entirely passive investor because I have found that through the strategic and conservative use of options, I can give myself a further edge, which I call Leveraged Investing.

I've used different analogies to describe the Leveraged Investing process: perpetually lowering my cost basis, receiving endless rebates on my stock purchases, and buying and holding and cheating.

However you prefer to conceive of it, the bottom line is that long term investing in high quality companies works, and Leveraged Investing attempts to significantly speed up the process. Whether I calculate in terms of adjusted cost basis or in terms of dividend income, I expect to earn noticeably more money each and every year.

That's how I define high return investments, and that's also why I'm not particularly interested in pursuing 50% annual returns in the near term.

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