Everybody knows what financial risk is, right? Is there really a difference between financial risk and just plain ole ordinary risk? Well, first, let’s define what risk means in general. Then, dig into what it means for you. Lastly, whom should you trust with investing your hard earned $$ (i.e. where is the risk)?
Risk, like Proteus (as described by the poet John Milton in Paradise Lost), comes in various shapes. It is labeled with various names. In finance we say; systematic (market) and unsystematic (specific). One of my mentors, Jim Koch, calls it; subjective (just frightens you) & objective (can kill you). The great Elroy Dimson elegantly describes it simply as; risk means more things can happen than will happen.
What does risk mean for you? Risk is often used to imply the downside or uncertainty of one's return. Keep in mind that more risk does not always mean more money and risk is not about how many winners or losers you have. Risk is about your bottom line or what you made in the end. Your ROI (return On Investment). We see/hear lots of interesting analytics and marketing gobbledygook about how much you can save through wealth re-distribution (like spending less on strategy X versus strategy Y). Rarely, do those folks invert their pie slice (always the same size pie) and view this from their targeted customers ROI (like strategy X cost you less than strategy Y but you still end up with less money). Why? Well, heck that’s easy, whose money is at risk? Most folks have no idea where your hard earned $$ get invested. Nor do they really care because they are “neutral.” Meaning they get paid the same regardless of what direction your portfolio goes. Certainly, they have an alphabet soup of peer-reviewed source material to flood your inbox with. Ask them to withhold their fee until your MARR (Minimum Acceptable Rate of Return) is achieved? No guarantees. Always do what is in your best interest.
Another one of my mentors, Seth Klarman, teaches us that the greatest challenge in investing is maintaining the requisite patience and discipline to buy only when prices are attractive and to sell when they are not, avoiding the short-term performance frenzy that engulfs most market participants. Most investors are primarily oriented toward return, how much they can make, and pay little attention to risk, how much they can lose. Institutional investors, in particular, are usually evaluated-and therefore measure themselves--on the basis of relative performance compared to the market as a whole, to a relevant market sector, or to their peers. Those of you reading this and are invested with intuitions (like mutual funds) and are not institutional investors (maybe 99% of you?). To be blunt, those guys/gals have no idea who you are. When was the last time they called you to discuss your kids graduation, your wife’s illness, or just “I’m taking the corporate jet in your direction, let’s do lunch?” Didn’t think so.
Is there such a thing as good risk and bad risk? If you have a choice, which one should you choose? (Is this a trick question?). Hyman Minsky wrote a great thesis about how "Stability is destabilizing." For those of you that just want a simple common-sense approach to getting where you need to be financially and staying there? Glad you asked. As with anything, your ability to understand what you are doing (or whomever is investing your $$s) is directly related to the reality of the outcome.
This brings us to diversification.There are two main schools of thought about diversification:
- Don’t put all your eggs in one basket. Scatter your attention span. Act like a squirrel, love every nut and put one in every tree. Now, all you have to do is find the ones that grew from those nuts without driving you nuts.
- Put all your eggs in one basket, YOURS, and watch that basket.
As an experienced Investment Manager, my job is to eliminate risk. That's why we love #2. We use a concentrated portfolio. We hear a lot of noise about diversification. If Michael Jordan is on your team and he is scoring all the points. Should you penalize him by diversifying your portfolio (strategy)? As another one of my mentors, Warren Buffett is fond of saying; it is less important whether you know 10 businesses or 10 thousand. Stick with what you know and understand. At the Olympics, if you run the hundred meters well, you don’t have to do the shot-put.
In investing, as in life, choose good partners that you trust. Every investor relies on advice from others when making investment decisions whether they are investment advisors, brokers, newsletters, friends, or business partners. Matters not if you are a do-it-yourselfer or you hire a competent money manager.
Whatever you decide, there is a risk in every breath you take. Breathe deeply and remember to inhale the good air and exhale the bad air. Practice this enough and it becomes automatic. Enjoy your breathing.
It's not what you make; it's what you keep that determines your lifestyle.