- The Advisor's Playbook
- Posts
- What is Risk?
What is Risk?
Quote from Morgan Housel
What is Risk?
A Guide to Seeing the Unforeseen
A Money Question
Quote
“Risk is what is left over when you think you’ve thought of everything.” - Morgan Housel
This is simply gold. The biggest risks we face in our lives are the ones we have no idea are coming and can be hard to prepare for. If they were easy or we could see them there would be no risk.
What is Risk?
One of the most dangerous times for a pitcher is with two outs and the bases empty. As a pitcher, you have a laser focus on getting the lead-off batter out each inning. If you can do that the chances of a team scoring a run drop to just 16%. If you can get the next guy out the chances of a run crossing home plate drop to less than 7%.
That breath you just took thinking, oh I see the big inning isn’t going to happen is when risk comes in.
I can remember having two outs and two strikes on a batter only to find myself in a bases-loaded jam within a handful of pitches. While I had done nearly everything right and kept my focus there was still a chance of the big inning.
That is the weird part about risk, we know it is out there but we typically only account for the obvious. We wear a seatbelt to protect against an accident. Yet we might not put it on if we are only going thirty seconds in the car. We get an education to make sure we get a good job. Yet we don’t consider that a sweeping layoff could be around the corner. We get regular checkups for our health. Yet we often make unhealthy choices thinking, “That outcome won’t happen to me”.
Risk is as much a part of life as it is money management. Today, I want to talk to you about what I have learned about risk, how I approach it today and three things you can do to reduce it in your financial life.
Let’s dive in!
A Guide to Seeing the Unforeseen
I have been investing for 15 years. In that time, I have seen the market crash and rebound. I have seen real estate plummet and rebound. I have seen the world shut down and rebound. You see the theme ~ a crash followed by a rebound.
The thing you won’t see a theme with is the reason for the crash and the rebound. From the subprime mortgage debacle to a housing bubble to Covid, the results are the same but the reasoning is far different. The only thing in common among these three events is no one saw them coming in advance.
Each one of those situations planted a seed that has helped me better understand risk. It has shifted both my mindset on risk and my tactical approach to reducing it.
My Approach to Risk
My approach to risk is both simple and complex. My starting point is the same as it is for my clients. It is a combination of my desire for risk multiplied by my need to take risks.
Here is an example:
If you have $20,000,000 and are living a lifestyle that costs $300,000 to maintain, your desire to risk might be a 10 but your need to take risks might be a 1.
If you have $1,000,000 and are living a lifestyle that costs $300,000 to maintain, your desire to risk might be a 1 but your need to take risks might be a 10.
You see risk should look different for everyone. It is a combination of art and science.
Today my need to take risk has shifted down but my desire to take risk has shifted up. This has happened for a few reasons. Today, I have a clearer vision of my future money moves. I have also become better educated in the spaces that I play thus increasing my desire to take risks.
Yet the thing that has helped me the most is understanding to accept risk as part of my life. The clearest example of this has been my desire to build up a war chest. A war chest is the term I use for my safe bucket of money. This is the money that will be there no matter what comes my way. The downside (and thing that kills me internally) is that money will never earn the rates of return my other buckets will earn. Yet it is equally as important if not more important than those other buckets.
In summary, my approach to risk is somewhat simple. The thing that anchors this simple philosophy is having someone to keep me accountable. For me, my brother and business partner serves as my financial advisor. He gets the great pleasure of telling me, “That aligns with your risk or that is a shiny object to avoid.”
While I don’t always want to hear it, that second set of eyes has been invaluable.
3 Tactical Steps to Take
There is no way to remove all risks from your financial life. Stuff money under your mattress and your house could still go down in a blaze of glory. Yet there are tactical steps you can take to reduce risk and increase your odds of staying in the game.
Remember, the ultimate goal of investing is not great one-year returns it is staying in the game long enough to let compounding take effect.
Build Your War Chest
The money you place here gives the rest of your portfolio the ability to compound. It allows you to stick with your investments through those inevitable crashes and find traction on the rebound. It gives you the peace of mind needed to sleep at night when the train is seemingly off the tracks.
Diversify
The only free lunch in investing is diversification. The best part of diversification is you will drastically increase your odds of staying in the game and capturing a fair rate of return. The worst part of diversification is that it will always leave you wanting more. Your portfolio will be littered with things you want more of and stuff you want less of.
Know the Game
The number of ways to make money and invest money is endless. While the best investors may choose a different asset class they all have one thing in common. They focus on what they know. They are not playing someone else’s game. They are playing the game that tilts the odds heaviest in their favor. For the record, for most people that is a diversified portfolio tilted towards stocks.
Risk is weird. We all know it is there but we often think it won’t happen to us. That my friends is a dangerous mindset. Building and protecting wealth is as much about protecting your downside as it is maximizing your upside.
Until next time my friends!
A Money Question
Where are you taking too much risk?
Rarely do we take time to think through where we are taking on too much risk. Yet I have found it to be a useful exercise. To understand what is working, what I should double down on, and what I should pull back on.
Work with Jacob
I help athletes, entrepreneurs, and executives pay less in taxes, simplify their financial lives, and invest in the long run.
Until Next Time, My Friends
Moment Private Wealth, LLC is a Registered Investment Advisor, located in the State of Missouri. Moment Private Wealth provides investment advisory and related services for clients nationally. Moment Private Wealth will maintain all applicable registrations and licenses as required by the various states in which Moment Private Wealth conducts business, as applicable. Moment Private Wealth renders individualized responses to persons in a particular state only after complying with all regulatory requirements, or under an applicable state exemption or exclusion. Nothing in this content is intended to be, and you should not consider anything in this content to be, investment, accounting, tax, or legal advice.