Mickey Kim
We’ve all heard “no risk, no return” or similar pearls of wisdom. Although assuming risk is an essential part of successful investing, and it seems intuitive that the more risk you take, the greater the expected reward, the argument is more nuanced.
Investment sacrifices current consumption in order to increase future consumption. You have $100 and object A costs $100 per unit. You can buy/consume one unit of object A today, or you can invest $100 with the hope that you will be able to buy/consume one or more units of object A in the future (i.e., the investment period).
At a minimum, you want to be able to buy/consume one unit of object A in the future with the $100 you invest today. In other words, the $100 you invest must maintain your purchasing power at least up to that point.
Risk is the permanent loss of invested capital or loss of purchasing power due to inflation. If you invest in a company whose product becomes obsolete and goes out of business, you lose capital forever. If you make an investment with a return of 5% when inflation is 10%, you lose purchasing power (the investment increases to $105, but the price of object A becomes $110).
Importantly, risk is not price fluctuations. Stock prices are driven by fear and greed and are very volatile in the short term, but the value of the underlying company doesn’t change much from day to day. If your assessment of the long-term value of your business is correct, you won’t need to worry too much about price fluctuations or temporary losses of capital. In fact, volatility can create buying opportunities or force you to turn temporary losses into permanent losses by selling.
Oaktree Co-Chairman Howard Marks writes about the risks of not taking risks in his excellent recent note, “The Imperative of Risk.” “Because the future is inherently uncertain, we typically choose to (a) avoid risk with little or no return, or (b) take a moderate amount of risk and settle for a commensurately modest return. , he writes, or (c) make a profit.” Assumes high uncertainty in pursuit of significant gains, but accepts the possibility of significant permanent losses. Everyone wants to make big profits with little risk, but the “efficiency” of the market, i.e. the fact that other participants in the market are not dummies, usually eliminates this possibility. ”
Furthermore, “Most investors can achieve most of ‘a’ and ‘b’. The challenge in investing is to pursue some version of ‘c’. To earn high returns, either in absolute terms or relative to other investors in the market, you need to consider the possibility of losses when pursuing absolute gains, or the possibility of underperformance when pursuing outperformance. It requires taking serious risks, such as sex. In both cases, the two are inseparable. ”
“The goal of no losers is not useful,” Marks continued. “The only sure way to achieve that is to take no risk at all. But…risk aversion is likely to lead to return aversion. Sometimes too much risk creates risk. Most people understand this intellectually, but human nature makes it difficult for many to accept the idea that tolerating some loss is an essential part of investing success. It is.”
Investors need to understand and even embrace the paradox that failure is an essential component of success. According to Marks, “Investors must accept that there is a high probability of success by making a large number of investments, all of which are made with the expectation that they will be successful. , because you know some of it won’t succeed.” You have to let it all out. You have to take the shot. Not all efforts will be rewarded with high returns, but we hope that enough efforts will be rewarded for success in the long run. Its success is ultimately a function of the ratio of winners to losers and the magnitude of losses relative to profits. But refusing to take risks in this process will not get you to your destination. ”
The speculative madness of “YOLO” (“You Only Live Once”)/“FOMO” (“Fear of Missing Out”) has emerged in times of pandemic, and Cathy is perhaps the leading expert on “disruptive innovation.” -Exemplified by Mr. Wood’s ARK Investment Management. ARK has recorded impressive returns from 2020 to 2021. Sadly and predictably, more people are looking for returns, and ARK’s assets reached $59 billion in early 2021, making ARK the world’s largest ETF manager. Sadly, as the clock struck midnight at ARK, revenue and assets were wiped out.
As of the end of 2023, ARK has destroyed more wealth than any other investment manager over the past 10 years, with investors losing a total of $14.3 billion, according to Morningstar. Shareholders abandoned ship, and assets fell to $11.1 billion.
Marks sums up the pursuit of superior investment returns: Certainty must be sacrificed, but it must be done skillfully and intelligently, with emotional control. ”
Mickey Kim serves as Chief Operating Officer and Chief Compliance Officer at Kill Merbach, an investment advisory firm based in Columbus. Kim also writes for the Indianapolis Business Journal. 812-376-9444 or [email protected].
