Capital protection is no guarantee


Capital protection does not mean you can't lose money. If markets decline such that you need to exercise the put option, you will lose the money paid for borrowing costs and the put option premium. This limits the downside to a known amount but does not eliminate loss altogether. If you want to eliminate losses due to sharemarket falls altogether, then stay with term deposits.

Near or at-the-money put options for high-dividend shares over the medium term being considered in this article, particularly given current market volatility, are generally expensive. The additional costs can erode the potential gains that were the initial purpose of the strategy.

Protection strategies became topical after some investors experienced difficult margin calls during the GFC. This may be an overreaction. The yield strategy outlined in this article is based on a modestly geared, reasonably diversified portfolio of blue chips with a record of earnings and dividends. Even precipitous falls similar to those in 2009 are unlikely to result in a margin call for this style of share portfolio.

More importantly, all investment strategies, whether term deposits or shares, should not be "set and forget". Certain strategies require more monitoring and adjusting. In a gearing strategy, a margin call is an "automatic adjustment" of last resort. Investors should consider setting portfolio review points.

As gearing drifts from the 50 per cent target up to 60 per cent, for example, a review is triggered, potentially resulting in a decision to reduce the loan by selling shares. A fall to 40 per cent gearing would trigger a similar review.

Competition for term deposits has created some very attractive safe havens for investors' cash. Financial markets have moved on, interest rates are down, and dividend yields may again be attractive.

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