How to Invest in the Market Without Risking your Principal

If you would like to reap a greater share of market growth without risking your principal, this article will explain the strategy that banks and insurance companies use to create indexed products. You can use the same strategy to achieve the same type of result-and keep the portion that they withold for their profit margin for yourself.

Things You'll Need

• A brokerage account
• Possibly a stockbroker

Instructions

1. The strategy for investing without risking your principal is relatively simple. The first step is to decide upon a time frame for investment, such as five years. While the length of time that you choose should match your liquidity needs, remember that the longer the time frame, the greater your chances of success.

2. The next step is to find some sort of guaranteed fixed-income investment in which to allocate the majority of your funds. For example, if you have $100,000 to invest, then you will need to find a bond with a maturity that matches your time horizon. If you are seeking a true guarantee of principal, then this will be a CD or government bond. But you could also invest in a highly-rated corporate bond, if you are willing to take a little more risk.

3. Once the bond has been chosen, you will need to calculate how much your initial investment must be in order for it to grow back to your principal. For example, how much will you have to invest in 5-year notes that pay 6% interest in order to receive $100,000 at maturity? If you are unable to calculate this yourself, a broker can help you with this.

4. Finally, you need to take the remaining intial principal balance and invest it in long-term call options on the S&P 500 Index or some other broad-based index (or the stock of single company, for that matter, if you feel certain enough that the stock price of the company will rise over your time horizon.) For example, if you need to invest $83,000 of your initial principal into bonds in order to receive your principal back, then you would invest the remaining $17,000 in call options.

5. A word of explanation about call options. Call options are derivatives that will appreciate much more quickly than the underlying security or index that determines their price. For a more complete explanation of how options work, consult your broker or the Options Industry Council.

6. The way that this works is simple: your bond investment will grow back to your original principal balance, while you reap all of the gains realized from the calls. Of course, if the underlying investment does not increase, then you will only get your principal back; there is the chance that you receive no gain from this. However, the same risk exists in all of the ready-made indexed products that are available as well. But this way, you get ALL of the gain from the calls, and not just what's left over after the bank or insurance company takes its profit.

Tips & Warnings

• If you're not an experienced investor, then using a full-service broker may be wise. A broker can help you to determine the right time horizon and invest the assets accordingly.

• This strategy will yield no gain at all if the market or underlying security does not rise in price during the investment period.