What is risk?

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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”.

Posted in Books, Investment principles, Philosophy, Uncategorized, Warren Buffet | No Comments »

The biggest difference in the thought patterns of amateur investors and professionals.

Seems that a lot of people agree that professional investors are better in investing than you and me or the so called amateur investors.

While this might often be the case there is literally tons of information out there about exactly the opposite being true. If you would like to know how an ordinary person can beat the professionals in their own game I would recommend to start from reading the classic One Up On Wall Street by Peter Lynch.

But that’s not what this post was supposed to be about.

While there is no doubt that an amateur can beat a professional there is also no doubt that there are people (usually professionals) who have an amazing track record. Peter Lynch and Warren Buffett are the first to come in mind. These are the people who have shown year after year that they can beat the market. For example Warren Buffet’s portfolio has grown an average of more than 20% per year.

With a rate like that it takes a little less than 4 years to double your money. The average return of the markets is widely believed to be about 12% . With a return of 12% you would double your money in a little less than 7 years.

The key point to agree upon here is

There are people who constantly outperform the markets.

The Average Joe

Let me ask you this. Have you ever lost money in the markets? Chances are that when you have done at least a few investments in your life you have lost money.

Now let me ask you another thing – Have you ever made back what you lost – in the markets?

I bet that the answer is NO. It is no for the majority of people.

For the average investor, investing is a sideline. When he takes a loss, he usually subsidizes his portfolio from his salary, pension fund, or other assets. If the average Joe has 1000 dollars less than his goal he will simply put a little more money aside each month to get back to the desired level.

The Master Investor

For the Master Investor investing is not a sideline – it is his life. So when you take a hit and lose a portion of your portfolio – you can’t subsidize it from your salary (because you only get paid when you make money). The only way to get the money back is to make it back in the markets.

I already mentioned the fact that if you lose 50% of your portfolio you will need to get a return of 100% on the rest in order to get the money that you lost back in my post about The winning investment habit number 1 – preserve your capital.

Consider this - if you lose 50% of your investment capital and you manage to achieve the average 12 percent a year return – it will take you a little less than 7 years to get back to where you were before the loss.

With Buffett’s average return of 24.4 percent it would take 3 years and 2 months and for George Soros with an average yearly return of 28.3% it would take 2 years and 9 months.

What a waste of time!

Isn’t it simpler to just avoid the loss in the first place?

So there you have it:

The biggest difference in the thinking patterns of highly successful investors and the not so successful ones is that for professional investors losing is not an option. If you lose then it will take a lot of time to get the lost money back. So you only invest when you are absolutely certain that you won’t lose it.

If you can’t subsidize your losses then your thinking shifts from “Make profit” to “Keep what you have and after that if possible make a profit”

So here you go – Only invest when you are certain that YOU WILL NOT LOSE YOUR MONEY.

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

Posted in Books, Future value of money, Goals, Investment principles, Uncategorized, Warren Buffet | No Comments »

What is the difference between a 10% loss for Warren Buffett and an ordinary investor

When we lose money, we count the dollars we actually lost. Not Warren Buffet. His loss is what those dollars could have been. For him losing money is a gross violation of his underlying aim, which is to “watch money grow”.

Preservation of capital is an investment rule propounded by many but practiced by few.

When asking investors how it would feel to make preservation of capital, most report a sense of paralysis or a feeling that you can’t do anything because you might lose your money.

Here is a graph how most investors think about investing and risks. The conventional thinking goes like this – in order to make a 1000 dollars I need to risk to lose the 1000 dollars I already have.

Here is another graph showing the thinking behind the best investors of the world.

There are a couple of reason why the graph for the best investors in the world looks a lot better to anyone even remotely acquainted with the principles of risk versus potential profit. The second graph illustrates a proportionally smaller amount of risk with better profit.

Here is why the second graph is the right way to think about risk and reward.

1) While investing money the most you can lose is all of it but the most you can win is unlimited. If you bought the stock of Microsoft in the early 80’s you would have made more than 100 times the money you put in on your investment.

2) The second reason for this graph to look like it does is even more important. Because of the compound interest every dollar that you make on your investmet further increases the amount that you are going to make. For instance if you manage to buy a stock with a dividend yield of 10% then after the first year your 100 dollars would be 110, after the second year 121, after the third year 133,1 and so on. As you can see the first year you made 10 dollars, the second year 11 dollars and on the third year 12 dollars and 10 cents. When you have a stock that keeps rising 10% a year that doesn’t pay any dividends it is essentially the same thing – the first year your stock price will rise 10 dollars, the second year 11 dollars and the third year 12 dollars and 10 cents.

The investors that consider the second graph to tell the truth are more often focused on the investment process. They don’t view each investment to be a discrete, individual event because they know that even if you only invest for a relatively short term and make 10 per cent on your investment – it will give you 10% more to invest the next time.

Thanks to the compound interest you will potentially make more money with every passing year. Thus the longer your investment period the lower is the risk to lose all your money compared to what you can make.

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

Posted in Books, Future value of money, Investment principles, Natural law of money, Philosophy, Uncategorized, Warren Buffet | No Comments »

Winning Investment Habit No 1 – KEEP WHAT YOU HAVE. Preserve your capital

Rule No. 1: Never lose money.
Rule No. 2: Never forget Rule No. 1

Warren Buffet

„Survive first and make money afterward.”

George Soros

„If you don’t bet, you can’t win. If you lose all your chips, you can’t bet”

Larry Hite

What’s the difference between a Winning Investor and a Loosing Investor?

The winning investor – Believes that his first priority is always the preservation of capital, which is the most important cornerstone of his investment strategy.

The loosing investor – Has only one investment aim – „to make a lot of money”. As a result he often fails to keep the money he already has.

Did you know that if you have a stock that drops 20% then you would need it to grow 25% in order to get back to the same price level before the price drop. (Example: If you start with 100 dollars and lose 20% you will end up with 80 dollars. In order to go from 80$ to 100$ you need a gain of 25%).

If you lose 50% of 100 dollars you will end up with 50 dollars. But in order to get from that 50 dollars back to 100$ you need to double the 50 bucks. This means you need a growth of 100% .

It might not seem like a big deal – 50 dollars to lose is nothing catastrophic. But consider the same on a larger scale.

Let’s say that you have a pension fund that holds 1 million dollars. Because of problems in the subprime market your fund loses half of its value – now you only have 500 000 dollars left. What do you think how much time would it take to get back to the initial 1 million?

Well no one can tell for sure but the only thing that is known for sure is that it will take a lot more effort (and time) to get the money back.

Here is a chart that on the left give you the initial loss in % and on the right it shows how much you need to make afterwards in order to get the initial sum back.

This is exactly why Preservation of capital is ALWAYS the number 1 priority of any half decent investor. If you have a loss of 1 per cent you need a growth of more than 1 per cent to get the money back. The more you lose the bigger the gap between what you lost and how much you need to make to get it back will grow.

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

Posted in Books, Future value of money, Investment principles, Natural law of money, Saving money, Uncategorized, Warren Buffet | 1 Comment »

7 deadly investment habits

There are a lot of bad investing habits that cost investors all over the world millions and billions of dollars. Here is a list of 7 investment mistakes that are most common according to the book „The Winning Investment Habits of Warren Buffet & George Soros”.

DEADLY INVESTMENT SIN NO 1

Believing that you have to predict the market’s next move to make big returns

REALITY

Highly successful investors are no better at predicting the market’s next move than you or I.

One month before October 1987 stock market crash, George Soros appeared on the cover of Fortune magazine. His message:

„That [American] stocks have moved up, up and away from the fundamental measures of value does not mean they must tumble. Just because the market is overvalued does not mean it is not sustainable. If you want to know how much more overvalued American stocks can become, just look at Japan.

While Soros remained bullish on American stocks, he felt that there was a crash coming – in Japan. He repeated that outlook in an article in the Financial Times of October 14, 1987.

One week later, Soros’s Quantum Fund lost over $350 million as the US market, not the Japanese market, crashed. His entire profit for the year was wiped out in a few days.

But what does Warren Buffet – considered by some as the greatest investor ever – think about timing the market?

Well – he simply doesn’t care about what the market might do next and has no interest in predictions of any kind. To him, „forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.”

Successful investors don’t rely on predicting the market’s next move. Indeed, but Buffet and Soros would be the first to admit that if they relied on market predictions, they’d go broke.

It seems that predictions are the bread-and-butter of Wall Street analysts and mutual fund marketing – not of successful investing.

DEADLY INVESTMENT SIN NO 2

The „Guru” belief: If I can’t predict the market, there’s someone somewhere who can – and all I need to do is find him.

REALITY

If you could really predict the future, would you shout about it from the rooftops? Or would you keep your mouth shut, open a brokerage account, and make a pile of money?

There are a lot of people that have correctly predicted a bull or a bear market but this is not because they were smart or they knew something that others didn’t – it was simply because at any given moment there is always somebody predicting a crash or a boom. There are many famous market predictors but none of them have managed to predict the market correctly more than once.

DEADLY INVESTMENT SIN NO 3

Believing that „inside information” is the way to make really big money.

REALITY

Warren Buffet is the world’s richest investor (and he started from nothing). His favorite source of investment tips is usually free for the asking: company annual reports.

When Warren Buffet and George Soros started investing, they were nobodies and could expect no special welcome. What’s more – both Buffet’s and Soros’s investment returns were higher then, when they were unknown, than they are today. So if either now draws on insider information in any way, it clearly isn’t doing them much good.

There is a famous quote by Warren Buffet – „With enough inside information and million dollars you can go broke in a year”

DEADLY INVESTMENT SIN NO 4

Diversifying

REALITY

Warren Buffet’s amazing track record comes from identifying a half dozen great companies – and then taking huge positions in only those companies.

According to George Soros, what’s important is not whether you’re right or wrong about the market. What’s important is how much money you can make when you are right and how much you will loose when you are wrong. The sources of both Soros’s and Buffet’s successes are the same: a handful of positions that produce huge profits that more than offset losses on other investments.

Diversification is just the opposite: Having many small holdings assures that even a spectacular profit in one of them will make little difference to your total worth.

However it cannot be stressed enough that even Buffet and Soros do diversify – they just don’t diversify as much as many investment advisors would like them to. Successful investors keep to what they know – if it means sticking with 10-15 different stocks then be it!

DEADLY INVESTMENT SIN NO 5

Believing that you have to take big risks to make big profits

REALITY

Like entrepreneurs, successful investors are highly risk averse and do everything they can to avoid risk and minimize loss.

Just like entrepreneurs are always trying to lower their risks, so are successful investors. Avoiding risk is fundamental to accumulating wealth. Contrary to the academic myth, if you take big risks you’re more likely to end up making big losses than banking giant profits.

Remember the investing rules of Warren Buffet. Rule No.1 - Never lose money. Rule No. 2 – Never forget Rule No. 1.

Like entrepreneurs, successful investors know it’s easier to lose money than it is to make it. That’s why they pay more attention to avoiding losses than to chasing profits.

DEADLY INVESTMENT SIN NO 6

The „System” belief. Somebody somewhere has developed a system – some arcane refinement of technical analysis, fundamental analysis, computerized trading, Gann triangles, or even astrology – that will guarantee investment profits.

REALITY

This is corollary of the „Guru” belief – if an investor can just get his hands on a guru’s system, he’ll be able to make as much money as the guru says he does. The widespread susceptibility to this Deadly Investment Sin is why people selling commodity trading systems can make good money.

The root of the „Guru” and „System” beliefs is the same thing - a desire for a sure thing.

DEADLY INVESTMENT SIN NO 7

Believing that you know what the future will bring – and being certain that the market must „inevitably” prove you right.

REALITY

This belief is a regular feature of investment manias. Virtually everyone agreed with Irving Fisher when he proclaimed: „Stocks have reached a new, permanently high plateau” – just a few weeks before the stock market crash of 1929. When gold was soaring in the 1970s, it was easy to believe that hyperinflation was inevitable. With prices of Yahoo, Amazon, eBay, and hundreds of „dot-bombs” rising almost every day, it was hard to argue with the Wall Street mantra of the 1990s that „Profits don’t matter”

This is a more powerful and far more tragic variant of the first deadly investment sin. The investor who falls under the spell of the Seventh Deadly Investment Sin thinks he already knows what the future will bring. So when the madness finally comes to its end, he loses most of his capital – and sometimes his house and his shirt as well.

DEADLY INVESTMENT SIN NO 8

Don’t drink and drive - you won’t be there to enjoy your money

REALITY

Well, its not in the book, but seems like a good idea

Posted in Books, Investment principles, Warren Buffet | 3 Comments »

Why Warren Buffet doesn’t like to spend money

So you spent a 100 dollars today without even thinking twice?

We’ve all spent money that we shouldn’t have without thinking much about it. The reason is that money is relative - if you have a lot of it you tend to spend more. If you only have a little you spend little or nothing. There is a huge difference in the perceived value of 100 dollars if you only have the 100 dollars for the whole week or if you have 10 000.

The worlds wealthiest investor Warren Buffet has a secret about the way he thinks of money.

When we think about a 100 dollars we usually give value to it by thinking what we could have or do with that money. While it’s the most common way to think about money, it is also something that holds back a lot of people from becoming rich.

When Warren Buffet thinks about 100$ he doesn’t think what will he get when spending it today but he thinks what will he get from it in the future - while gaining 20% interest on the money annually.

If you decide to save 100 dollars and INVEST it with an expected annual payoff of 20%, in 5 years you would have 248 dollars and in 10 years you would have 619$. After 20 years your initial 100 bucks would be 3833 dollars.

It’s pretty tough to spend 100$ when you know that by doing that you will loose 3833$

This is an excerpt from “The Winning Investment Habits of Warren Buffet & George Soros”:

[Buffet’s wife] Susie… was a virtuoso shopper. She dropped $15,000 on a home refurnishing which “just about killed Warren,” according to Bob Billig, one of his golfing pals. Buffett griped to Billig, “Do you know how much that is if you compound it over twenty years?”

Well - it’s 575 064 dollars. (compounded with 20% which is the average pay-off of Warren Buffet’s stock portfolio)

Posted in Books, Future value of money, Saving money, Warren Buffet, getting started | 2 Comments »

A true story about how stock brokers work

This is a true story from „The Smartest Investment Book You’ll Ever Read” by Daniel R. Solin. After publishing his previous book „Does Your Broker Owe You Money?” he started to receive a lot of unbelievable stories from people who work or used to work in brokerage firms.

Here is an excerpt from the book:

One of my favorites was told by a man who had left work with a major brokerage firm in order to advise clients to invest for market returns. He told me about the training he had received a few years earlier when he started work with a major – and well-respected – brokerage firm. He and the other brokers in training were told to split their potential client list in half. They were told to call half and tell them to buy a particular stock. The other half were to receive calls telling them to sell the same stock.

In two weeks, these “financial advisor” trainees were told to see which way the stock had moved, up or down. Whichever way it had moved, half of the potential client list would think the trainee was pretty smart, to be able to pick a stock like that.

They were told to split “successful” half of their group again, and to the same thing: tell half that a stock would go up and half that the same stock would go down.

If they did this three times, and started with a call list of 120 potential clients, after three “successful stock picks” they should then have fifteen “warm leads”, people who had enough confidence in their ability to pick stocks to become clients.

Talk about a scam! This is why I prefer to take care of my stock portfolio myself.

But at least now you know how to start when you are opening your own brokerage firm one day…

Posted in Books, Scam | No Comments »

A simple way to catch up on your reading

Are you among those people who have gathered a bunch of books that are all worth reading but you simply haven’t found the time to deal with them?

If yes, then think about a quote from Charlie “Tremendous” Jones

“You will be the same person in five years as you are today except for the people you meet and the books you read”

So think about today - how many new people have you got to know?

Well… me neither.

Since most of us don’t meet a lot of new people day-to-day it leaves us with the second option - reading.

There is a lot of books I have read during my life time but there is even more books that I haven’t. Chances are that it’s the same with you.

I took a look at the books I had beside my bed and came to the conclusion that I have completely read just a few of them versus most I have only read bits and peaces or even nothing.

I am changing this.

From now on I am going to spend 30 minutes to 1 hour reading every day.

Think about this for a second:

Average person reads about 30 pages per hour. Reading for 1 hour every day for a single year means that you would read 10 950 pages. The average book being about 200 pages makes it almost 55 books a year.

What do you think - if you were to read 55 books in any given field would it give you a small edge before all the people who are not doing any reading(90% of the population)?

Well, that’s why as of today I am reading at least 30 minutes every single day.

And here is what I did to motivate myself:

By the way - Charlie Jones’s book “Life is tremendous” is one of few books that I have read in English for several times.

Posted in Books, Goals, getting started | 2 Comments »