She was so worth the risk

March 11, 2016

 

 

Amen of the Week

 

"The biggest risk is not taking any risk. In a world that's changing really quickly, the only strategy that is guaranteed to fail is not taking risks."

         

          - Mark Zuckerberg, Founder of Facebook     

 

I saw her across the room. Wow.  She was beautiful, but there was something else about her – something special in her smile. I had to meet her. As I made my way across the room, the adrenaline surged.  All of a sudden, fear and doubt took over.  Chances are she would reject me.  Hopefully, she'll be nice about it.  Surely, someone like this has a boyfriend.  (That, or she must be crazy.)  Thankfully, a rational courage came back to me. The worst thing that could happen is that this pretty stranger snubs me.  That was a risk I could handle. Who knows? Maybe, she really is special ... my perfect match in the universe. Besides, let’s face it:  I’m kinda of a catch. (Self-delusion in times of doubt does have its advantages.) With my courage regained, I walked over and met my future wife.

 

Nine years later, I still think back on that night and its powerful lesson on risk. I came so close to not meeting the most important person in my life – all due to a momentary irrational fear (or flawed risk/reward appraisal). What made the risk so worth taking was not the hindsight that it paid off so well. After all, she could have rejected me. Rather it was the high upside/downside potential that was so attractive.

 

Now here’s the weird thing: Many, if not most, investment professionals and academics seem to misunderstand this basic concept.  They’re obviously not stupid people.  Rather, they’re intellectual prisoners to a dogma that fundamentally distorts the nature of risk and reward.  The foundation of modern portfolio theory is the presumption of a “risk premium”. Translated into English, this means that assets with higher risk earn higher returns over time.  Stocks are inherently more risky than cash, so investors should be compensated with higher returns for accepting that risk. That’s their reasoning, at least.

 

Fielder rejects this framework at its foundation. Specifically, we reject the notion that taking higher risks endows one with the right to higher rewards. Yes, aiming for higher rewards requires one to accept higher risk. But it does not necessarily work the other way around.  If I get drunk, put on a blindfold, and run back and forth across Fifth Avenue at rush hour, I am not therefore entitled to good things happening to me. Just the opposite. Hazardous risk-taking (small upside, big downside) is more likely to bring bad things than good. And so it is with investing.  One of the main problems we see with traditional asset allocation is that it does not consider valuation. Rather, it presumes that past returns and volatility are indicative of what we should expect in the future. This approach leads to over-allocating to risky assets after long periods of good times and under-allocating to risky assets after long-periods of bad times. The reward/risk of internet stocks during 1999 was akin to running drunk and blindfolded across Fifth Avenue. Owning the S&P 500 in the early 1980s was more like introducing yourself to that attractive stranger.

 

Which kind of risk is your money taking today? Now is a good time to do three things:  First, try to understand how much risk is in your portfolio. This can be quantified a number of ways. Second, carefully reflect whether your personal temperament is comfortable with that risk level. Finally, explore if the mix of investments in your portfolio should be realigned to improve the odds of achieving your return needs, while remaining within your personal tolerance for risk. 

 

Yours in the Field,

 




Frank Byrd, CFA

 

 

Disclaimer:

While the information presented herein is believed to be accurate, Fielder Capital Group LLC (Fielder) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Fielder is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities.  It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Fielder makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Fielder or its employees may have an economic interest in securities mentioned herein. This information is intended only for the recipient of this email.  Under no circumstances should this report be shared with or forwarded to anyone else without the express permission of Fielder. 

Share on Facebook
Share on Twitter
Please reload

Featured Posts

Looking Backward, Thinking Forward

October 22, 2019

1/9
Please reload

Recent Posts

February 10, 2019

November 21, 2018

Please reload

Archive