Risk is Manageable: Reduce Risk

Risk avoidance strategy:  Reduce Risk

This is the core of Warren Buffett's entire approach to investing.

Buffett invests only in what he understands, where he has conscious and unconscious competence.

But he goes further:  his method of avoiding risk is built into his investment criteria.  He will only invest when he can buy at a price significantly below his estimate of the business's value (the intrinsic value). He calls this his "Margin of Safety."

Following this approach, almost all the work is done BEFORE an investment is made.  (As Buffett puts it:  "You make your profit when you buy.")  

This process of selection results in what Buffett calls "high probability events":  investments that approach (if not exceed) Treasury bills in their certainty of return.

Risk is Manageable: Don't Invest

Risk-avoidance strategy:  Don't Invest

This strategy is always an option.  Put all your money in Treasury bills - the "risk-free" investment - and forget about it.

It is practised by every successful investor when they can't find an investment that meet their criteria, they don't invest at all.

Even this simple rule is violated by far too many professional fund managers.  For example, in a bear market they'll shift their portfolio into "safe" stocks such as utilities, or bonds ... on the theory they'll go down less than the average stock.  After all, you can't appear on Wall Street Week and tell the waiting audience that you just don't know what to do at the moment.

Risk is Manageable: Risk-Avoidance Strategies

Master Investors use one of the four-risk avoidance strategies:
1.  Don't invest.
2.  Reduce risk (the key to Warren Buffett's approach).
3.  Actively manage risk (the strategy George Soros uses so astonishingly well).
4.  Manage risk actuarially.

There is a fifth risk-avoidance that is highly recommended by the majority of investment advisors:  diversification.  But to Master Investors, diversification is for the birds.

No successful investor restricts himself to just one of these four risk-avoidance strategies.  Some - like Soros - use them all.

High Probability Events

No matter what his personal style, the Master Investor's method is designed to find one thing only:  what Buffett calls "high probability events."  He invests in nothing else.

When you invest in a "high probability event," you are almost certain to make money.  The risk of loss is tiny - and sometimes non-existent.

When capital preservation is built into your system, these are the only kinds of investments you will make.  That's the Master Investor's secret.

He KNOWS it is possible to make very big profits with little to even no risk of loss.

The Power of Mental Habit

A habit is a learned response that has become automatic through repetition.  Once ingrained, the metnal processes by which a habit operates are primarily subconscious.

Four elements are needed to sustain a mental habit:
1.  A belief that drives your behaviour.
2.  A mental strategy - a series of internal conscious and subconscious processes.
3.  A sustaining emotion.
4.  Associated skills.

My Investing Objective

My investing objective:  
To grow my whole portfolio by 15% per year over many years, that is, doubling the portfolio value every 5 years.











For every 5 stocks, expect 3 to do averagely, 1 to do exceptionally well and 1 to underperform.  Sell the underperformer and keep the winners.  By ensuring that you do not lose or lose small (not big), the modest gains from your stocks will translate into good gains for your overall portfolio.

For every 5 years in the stock market, expect 4 bull years and 1 bear year.  If you can avoid investing in a bubble market, you will often be safe with your carefully chosen and implemented philosophy and strategy.



There are many variables affecting the returns of your investing.

Choose a long term time horizon (>10 years) for your investing.  The reasoning is as below. 



You can see here why stocks are considered a good long-term investment, but a horrible short-term investment. This chart shows that for any 25-year period within 1950-2005, the very worst you would have done was +7.9% annually while the best was +17.2%. However, for a 1-year time horizon, the possible returns vary wildly.

"Invest to increase your wealth"

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Reward-risk Chart

Everyone will fall on different parts of the below reward-risk graph.  

The goal is to get to the fourth quadrant (high reward, low risk; bottom right hand corner). 




Of course the ideal quadrant is the Low Risk, High Reward quadrant. 
Yet many times, investors end up in the High Risk, Low Reward quadrant.




Always understand the risk-reward relationship in your investments and your work.







     

The Ratio of Successful and Unsuccessful Traders

Multiple Streams of Income