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Risk comes from not knowing what you are doing

Warren Buffett

The average investment advisor’s recommended portfolio will vary depending on his client’s “appetite for risk”. If the client wants to avoid risk he will be offered a well-diversified portfolio of “safe” stocks and bonds that theoretically won’t lose money - or make much, either.

If a client is willing to take risks he is probably advised to invest in so-called growth stocks which all have great promise but no guarantees.
This idea makes sense to the advisor and the client who both believe it’s impossible to make above-average profits without exposing yourself to the risk of loss.

But this is not the case.

A great investor understands that risk is contextual, measurable and manageable or even avoidable.

What is risky for me might not be risky for you

Is the experienced rock climber, whose fingers are the only things holding him a hundred feet up a vertical cliff taking a risk?

Or is the expert skier who zooms down the almost vertical double black diamond slope at sixty miles an hour taking a risk?

You would probably answer “Yes!” But what you actually mean is “Yes, if it was me doing it”.

Risk is related to knowledge, understanding, experience and competence. Risk is contextual.

While we can’t be sure that the rock climber or the skier are taking no risk we intuitively understand that they are taking less risk than we would in the same situation.

Even when we observe something that feels very high risk we can assume that for somebody else it might not be risky at all.

To even better understand the concept, think about driving a car. Chances are that you are an experienced driver and you have the ability to make instant judgments while driving - You can even listen to the radio and switch lanes at the same time.

When you first started driving it was not as easy as it is now. When switching a lane you actually have to consider several things:
Is my speed OK compared to the speed of the other cars to switch lanes?

What’s the speed of the cars in front and behind me?

Will the drivers in the other lane let me in?

…and so on.

The more you practice driving the better you get at it - to the point that you will be able to do it unconsciously leaving your conscious mind to be able to listen to the radio.

The more you practice something the better you get at it - until at one point it becomes a habit where you do what you do unconsciously.

This is the case with the death defying rock climber and the skier but it is also the case with professional investors.

There is a story of George Soros interrupting a meeting to place orders worth hundreds of millions of dollars. A person who was attending the meeting told later:

“I would shake in my boots, I wouldn’t sleep. He was playing with such high stakes. You had to have nerves of steel for that”

For this person it looked like George Soros was taking a huge risk but in fact he didn’t. In order to be able to make fast decisions concerning hundreds of millions of dollars like this we would have to know what Soros knows and it would not look like such a huge risk any more. We would simply have to learn to drive the “trading car” as well as George Soros is doing it.

Remember:

Risk declines with experience

How can we embrace risk as a winning investment habit?

Restrict your investments to the areas of life where you can make competent decisions. If you don’t know anything about computer chip makers don’t invest in them even if a stock has an attractive price. If you know about construction find a company that does just that. It will be so much easier for you to understand what they are doing.

Warren Buffett:

It’s not risky to buy securities at a fraction of what they are worth.

The ideas from this post are derived from the book „The Winning Investment Habits of Warren Buffet & George Soros”.