Not so long ago many people were drunk on the profits of the equities boom (2003-2008) and were thinking that the party would go on further. It’s easy to think that way when you’re making 20%+ returns p.a. for years on end. Unfortunately booms ALWAYS end and many of these same people were forced to refinance and sell down their assets in 2009 after the GFC hit.
Were they punting or investing? The answer is in the (underlying) risks they assumed. Many were listening to the hype, doubling-down through margin loans and ignoring the warning signs of an overheated market. The lure of big returns is enough for many of us to throw caution to the wind and behave with less discipline than is sensible.
The key to making money in business or investing is in understanding and managing the underlying risk(s) of any decision you take or are thinking about taking. Here are a few questions that might help:
o What are the assumptions upon which I am basing my decision?
o Are these assumptions sound? Really?
o What can go wrong? How likely is it?
o Can I survive and go on if the worst-case scenario actually occurs?
I have used these questions for many years to moderate the decisions I take. Why? Because I hate surprises and like anyone else I have a tremendous capacity to get into trouble if I make undisciplined choices. What interests me most these days is not the potential upside of any decision I make (although this is important) but rather the ability to manage the downside risks and the fall-out if things go wrong.
In practice what this approach demands is a requirement to stay flexible and nimble at all times. Changes will occur in any market but it is the ability to weigh the odds of possible outcomes that might occur and then react quickly no matter what happens that will protect you.
To do that you need to be in possession of all the important facts that matter. Listen to the “experts” (aka advisors) but examine their logic – the important thing is not their prediction but the logic that underpins it. If you can’t understand it or it makes no sense then seek out other experts to assist you or pass on the opportunity. Whatever you do don’t delegate key decisions to them to make on your behalf – it’s your money, not theirs. And always remember, they work for you, not the other way around.
Critical too is to learn from history (i.e. your own and the sector in which you operate) and to never EVER make the same mistake twice. As a final safeguard, structure your affairs to allow you to cut your losses and walk away if things go bad. A hard blow to the shins and dented pride is a lot better than a death blow.
The future is uncertain and no-one can predict it accurately. To succeed you need a deep understanding of risk – what can go wrong and how badly, weighed against the potential upside. It sounds easy but it isn’t. The outcomes you produce with this approach, however, are far more reliable than punting…
Note: I’m taking a break from writing next week. If you want a dose of the Bull click through below..