Always look at the risks before looking at the rewards in your long term investing

In investing, always look at the risks before looking at the rewards.

Understand the risks you are taking and then decide for the potential rewards you can hope to get, whether this reward/risk ratio makes business or investing sense.

Also, determine what is the likelihood of the reward appearing, its quantum and when.

Remember, "a bird in the hand today is worth two or more in the bush tomorrow."



How to look at risks in investing?

Back to the teaching of Warren Buffett's 4 tenets of his investing method.

1.  Understand the business.
2.  A business having durable competitive advantage.
3.  Managed by people with integrity.
4.  Available at fair price (margin of safety).

His tenets are very simple, and yet so few are following these.


If the business is too hard to understand, avoid investing into it.  You need to be able to understand the business.  What are the products or services it is selling?  Who are its customers?  How are its revenues generated?  Its profit margins?  Who are its competitors?  Only invest into a company you understand.  This is having business sense.

A company with durable competitive advantage enjoys certain unique advantages that allow it to compete in its competitive business environment.  The company may be selling a unique product or service, protected by patents or it enjoys a brand that people like for a long time.  Perhaps, the business is the lowest cost producer, or the cost of switching by its customers to another competitor is high.  Some businesses enjoy networking effect.  Avoid businesses with no durable competitive advantage.

People with integrity can be difficult to judge with certainty.  In general, a reputation build up slowly over 30 years can disappear over 5 minutes.  Anyone whom you have even a slight suspicion of his integrity, just avoid investing into that company.

When all the above 1, 2, and 3 tenets are met, you can then determine the price to buy and how much to buy?  You need to be patient.  The market is volatile and stock prices are volatile.  These market volatility and price volatility reflect the fluctuating sentiments of the investors and players in the market.  Don't time the market, always price the market.  You buy when the price is right.  Avoid when the price is obviously too high.  Invest when a great company is available at a fair price or even a slightly above fair price.  Be greedy and invest a lot, when a great company is available rarely at a huge bargain price.



Managing risks

The above few paragraphs explore how you will manage risks as applied to each tenets of Buffett in your stock investing.  In a very general sense, risks can be managed in 4 ways:

1.  Avoid
2.  Retain or embrace
3.  Reduce
4.  Transfer.

Whenever you are prospecting a new stock, you will need to determine that this stock meets the 4 business tenets of Buffett.  At each stage, you should avoid this stock altogether if you determined its risk is too high.

• Note that not able to understand the company's business is high risk too and you will need to avoid investing into it.  
• Not able to determine what confers to it its long term durable competitive advantage, is also another investing risk that should be avoided or perhaps embraced sometimes, but you need to have a very good reason.  
• Of course, avoid counters managed by people whose integrity you doubt.  
• Not able to value the business either because it is too complex to understand or its accounting is too difficult to fathom, you are better to avoid investing into this company.

Eventually, you are left with those stocks which you understand very well.

• QUALITY OF THE COMPANY (QUALITATIVE ASSESSMENT):  You understand their businesses, their durable competitive advantages and their management.  
• VALUATION OF THE COMPANY (QUANTITATIVE ASSESSMENT):  And, you too understand how to value them and this gives you an advantage to buy and own them at a reasonable, fair or good prices.  

Every stock you own has gone through this thorough risk analysis and also the reward potential analysis.  For the stocks you have in your long term portfolio, you have retain and embrace the risks associated with investing in them and also have a very clear idea of their reward potentials.  You know their risk/reward ratios over the long term and the probability of their investing returning  predictable positive returns (driven by the durable competitive advantage possessed by these companies).

When the stocks in your portfolio are priced too high during certain market situations, you may, if you wish to, also reduce the risks or transfer the risks using various strategies.


Through managing your risks, you avoid losses or minimise your losses and the modest positive returns from the other stocks in your portfolio will translate into reasonable returns.

Investing is fun and profitable in the long run.

Good luck to all.