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Thoughts on Risk

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March 04, 2016 – Comments (0) | RELATED TICKERS: SWKS

Board: Saul's Investing Discussions

Author: othalan 

Thoughts on Risk


My recent investment in Patriot Nation (PN) and the discussion surrounding the price fluctuations over the past week have me thinking about risk in investing. These are my musings for the day so I thought I would write them out and share them with all of you to help clarify my own thinking on the subject.

I remember when I was first learning about investing there were two pieces of advice which have stayed with me over the years. I don't recall the exact phrasing of those conversations nearly 20 years ago, nor who said them, but to paraphrase:

"If you invest in stocks be prepared to see an investment drop 75% in value and your whole portfolio drop 50% in value. Even an index fund may loose 50% or more of its value."

"Investing done properly is not gambling. Gambling is exciting because of its unpredictability. Investing is more often boring and predictable."

Right or wrong, those statements have had a huge impact on my investing strategy, especially when combined with a bit of wisdom told to me when working as a software engineer in the aerospace industry: "Any risk can be managed and mitigated."

Thanks to these gems of wisdom I have a hard time getting worked up about PN loosing 20% of its value after my initial investment. I'm not even particularly worried about the thought of the stock going to $0. My investment in PN is small enough I would barely notice its disappearance (yet large enough that any gains can still have an effect on my portfolio). Meanwhile I have done everything I can to understand the company to the best of my limited ability and am satisfied this is more likely than not a well run and profitable business. It was boring doing hours of research into this company yet I am now satisfied I have at least some idea of what will come in their future.

At a larger level, my whole portfolio provides risk management for the individual positions.

The majority of my investments are in IRA accounts which I will likely not touch for a minimum of 22 years. That time horizon gives lets me not worry about short-term problems. Meanwhile I am learning all I can about investing in order to mitigate the risk of my own ignorance. This will decrease my risk later in life when I have a shorter investment horizon and more immediately mitigate the risk of my own ignorance for my non-retirement investments which I may withdraw money as soon as 3 months from now or maybe not for years.

My largest positions within my portfolio are a combination of those stocks with the lowest risk balanced against higher risk investments which I understand very well and thus have a high conviction in their performance (e.g. SWKS). Quite often I would like to invest more in a company I like but limit myself in order to mitigate the risks involved.

Yet I also need to keep in mind the opportunity risk: How much money does diversity cost me when a small position has very high returns? How much money am I loosing by keeping it invested in a large company with slow and steady returns?

At an even larger level I look to trends in the world to further mitigate the risks in my investments. How is technology changing the world and what companies are set to take advantage? Not only in exciting ways like IoT or 3-D Printing but also innovations to boring infrastructure. What social trends will have investment impacts?

Another risk I manage is: what do I do with money I have not yet invested? I firmly believe in remaining 100% invested because I have no faith in my own ability to time the market. Yet because of the limits in my own investing expertise I frequently find I do not yet have any company I want to invest in. So I use index funds in place of cash, a policy which has served me well these past weeks.

I consider my own ignorance my single largest source of risk, far more than any individual investment like PN. It is for this reason that I have devoted the majority of my free time to studying investing the past three months. I have a lot of money to invest and a determination to make real investments rather than uninformed gambles. It has been a race against time in order to make good investment decisions in the current market where opportunities abound yet I am confident I have succeeded more often than not thanks to the time involved mitigating this large source of risk. Looking to the future I still have thousands of posts to read on this forum and others I have found and a growing list of books to read.

So far I am satisfied with my strategy. I consider it promising that I have not been worried about my portfolio these past two months while the market has been so troubled.

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