The individual investor
The best defense is a good offense
In this post I will look at the kind of risk tolerance you need to be a successful investor.
It’s a difficult subject to write about because everyone is so different. What to me may look like ordinary business risk-taking may to someone else seem almost foolhardy. So, I’ll largely stick to my own experience.
Let’s be clear about what I mean by ‘successful investor’. There are basically two investing paths. Ben Graham explains: “To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.” (Graham, The Intelligent Investor, fourth revised edition.1973) p. 287.
To achieve satisfactory results, all you have to do is put your retirement savings into index funds. This blog is not about satisfactory results. It is strictly about achieving superior results.
I have convinced myself that my approach to investing, aimed at achieving superior results, requires only a modest level of risk taking. I say that because after almost 50 years of investing I am now satisfied that stock market volatility, even of the market crash variety, is not an investment risk. I say that because true investors are in it for the long haul, which necessarily involves lots of ups and downs along the way. It comes with the turf. Price volatility does not change the intrinsic value of one’s holdings.
You can be too conservative
My bias is obvious. Some investors give the impression that investing in common stocks is like handling a bag of scorpions. I had a conversation with a legal friend many years ago. He was about 15 years older than I. He was thinking about retirement in about 5 years. We talked about investing. He told me that the biggest mistake he had made was to be too conservative in his investing. He had almost all of his savings in bonds, certificates of deposit and other fixed income. By being risk averse he had risked his retirement.
My point is that even what may seem like the most conservative investing can entail risks. So the question that needs to be addressed is the level of risk appetite needed to not only invest in common stocks but also to follow a program designed to beat the market. Does one have to be a big time risk taker to be a successful investor?
We can start with this. Different people do have different tolerances for risk. It is fascinating to reflect on what causes people to have different comforts zones. I have read that some psychologists believe there is a relationship between self-control and risk taking along the lines that those with higher levels of self-control are more willing to take risks. This makes little sense to me. I am more inclined to believe there is a relationship between optimistic personalities and risk taking.
It might be thought that optimists are more willing to take risks because they are more impulsive or fail to see the downside of risks they take. I disagree with this.
I suspect that investors who are by nature or nurture more optimistic are more willing to take risks because they are more resilient in the face of adversity and also because they are less likely to be fearful and defensive in times of general despondency, times when the intelligent investors should be taking advantage of depressed prices. Daniel Kahneman tells us that some people, by their nature, are more optimistic than other. (Kahneman, Thinking, Fast and Slow. 2011) p.256. And also see below.
Adept at the avoidance of failure
Another side to risk taking is fear of failure. This presents itself in different ways. There can be a fear of financial loss. There is also a fear of loss self-esteem, which is internal, and also fear of loss of face or loss of status amongst friends and colleagues, which is external. There is a certain mental toughness or intellectual courage required to combat fear of failure.
Combatting fear of failure is a topic I have discussed with my children many times over the years, although never in the context of investing. Life is full of challenges. Some you will win and some you will lose. One should never be afraid of losing a non-life-threatening battle.
I recently read Lampedusa, a semi-fictional biography of Giuseppe Tomasi di Lampedusa, written by Stephen King. Lampedusa was, in turn, the author of The Leopard, one of the most famous books in Italian literature. The book The Leopard is a novel that chronicles the changes in Sicilian life and society during the Risorgimento in the 19th century. It was made into a bad movie. King develops the character of his subject beautifully and describes Lampedusa as being “adept at the avoidance of failure’. I love that expression. One way to be adept at avoiding failure is to avoid attempting anything you might fail at.
There was a similar thought captured in the brilliant 2019 Korean movie Parasite. The line was: “with no plan, nothing can go wrong”. You get the idea. It’s the flip side of the theme of ‘nothing ventured, nothing gained’.
Fear of losing money
People are fond of quoting Warren Buffett who is supposed to have said: “The first rule of an investment is don’t lose [money]. And the second rule of an investment is don’t forget the first rule.” I don’t know the source of the quote. I don’t know what it is supposed to mean. The truth is that I have lost money on some investments. You win some and you lose some. That doesn’t bother me. The trick is to sell stock you hold in companies that are losing their way. And, hold onto your winners.
My general philosophy has been that the best defense is a good offense.
Flip sides of the same coin
Fear of failure and risk taking are flip sides of the same coin. I suspect that fear of failure is a major factor that causes many people to be unwilling to take risks even if the odds are much in their favor.
I will admit that buying stocks with a margin of safety or at the point of maximum pessimism required some courage. This is ironic since readers will know that this is the point of least risk.
Both Benjamin Graham and Warren Buffett have made it clear that buying a stock when its price is depressed by negative sentiment reduces risk. Holding a balanced and diversified portfolio of the shares of superb companies bought at very attractive prices is not an overly risky thing to do.
With study and experience investors will come to realize this. It does get easier.
Let me close with a warning. It is all well and good to have the confidence to buy when others are desperately selling, but there are always dangers of overconfidence and its cousin, hubris.
Overconfidence can get you into trouble. Hubris is more dangerous than overconfidence. It can bring on ruin. For examples of hubris we need only look at the ‘masters of the universe’ who inhabit Wall Street. They are the ones who periodically crash and burn. Until that point they strut with supreme self-confidence.
John Templeton was a humble man. The most successful business people attribute their success to luck or providence. They attribute their failings to their own shortcomings. The less successful attribute their success to their own brilliance and their failures to bad luck.
To read further on what it takes to succeed in investing check out these posts:
The personal qualities successful investors need to cultivate
Do optimists make better or worse investors?
What it takes to be a successful investor
To dig a bit deeper into the whole notion of risk, take a look at:
The joy of higher return with no more risk
Many investors just don’t understand the risk/reward trade-off
You can reach me by email at firstname.lastname@example.org
I’m also on Twitter @rodneylksmith
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