The Riskiest Moment in Investing

Peter Bernstein said that “the riskiest moment in investing is when you’re right.”

On being asked how investors can avoid being shocked, or at least reduce the risk of overreacting to a surprise, Bernstein replied –

Understanding that we do not know the future is such a simple statement, but it’s so important. Investors do better where risk management is a conscious part of the process. Maximizing return is a strategy that makes sense only in very specific circumstances. In general, survival is the only road to riches. Let me say that again: Survival is the only road to riches. You should try to maximize return only if losses would not threaten your survival and if you have a compelling future need for the extra gains you might earn.

The riskiest moment is when you’re right. That’s when you’re in the most trouble, because you tend to overstay the good decisions. So, in many ways, it’s better not to be so right. That’s what diversification is for. It’s an explicit recognition of ignorance. And I view diversification not only as a survival strategy but as an aggressive strategy, because the next windfall might come from a surprising place. I want to make sure I’m exposed to it. Somebody once said that if you’re comfortable with everything you own, you’re not diversified.

Here is another article Peter Bernstein wrote for Bloomberg many years back, titled The 60/40 Solution, wherein he talked about the lessons from history –

The constant lesson of history is the dominant role played by surprise. Just when we are most comfortable with an environment and come to believe we finally understand it, the ground shifts under our feet. Surprise is the rule, not the exception. That’s a fancy way of saying we don’t know what the future holds. Even the most serious efforts to make predictions can end up so far from the mark as to be more dangerous than useless. 

All of history and all of life is stuffed full of the unexpected and the unthinkable. Survival as an investor over that famous long course depends from the very first on recognition that we do not know what is going to happen. We can speculate or calculate or estimate, but we can never be certain. Something very simple but very penetrating stems from this observation. If we never know what the future holds, we can never be right all the time. Being wrong on occasion is inescapable. As the great English economist John Maynard Keynes expressed it some 80 years ago, “A proposition is not probable because we think it so.” The most important lesson an investor can learn is to be dispassionate when confronted by unexpected and unfavorable outcomes.

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