More Risks Equals More Rewards
The boys and my Dad and I recently went to a Brewers game. I love that one of the stats that they’re continually showing on the big scoreboards here is the on-base percentage.
You can learn how this came about from the movie Moneyball.
It’s not about just hits, it’s just how often they are on base, a slight but real change in thinking.
So, what is your portfolio’s on-base percentage?
Do you know the saying, no guts, no glory? Do you have to take a risk to make a return?
If you have a player who’s only ever trying to get that home run, he might get a good amount of home runs, but let me tell you, he’s probably going to have a lot of strikeouts too. A lot more at-bats where he does not get on base.
Then take another player who has a much higher on-base percentage and he may rarely hit the home run, but he also rarely strikes out. It’s very consistent performance.
Let me ask you, which one of those do you want to be? How do you want your portfolio to be?
The one that’s consistent with a high on-base percentage? Or do you want your portfolio to either hit a home run or strike out?
Does More Risk Equal More Return?
More risk equals more returns. This is another piece of common portfolio wisdom that we often hear from people. But is it true?
I’m not even sure it’s a half-truth, to be honest with you.
It’s really about taking the right risk because oftentimes more risk equals more losses, not necessarily more return.
Truthfully, the key to long-term investing is to avoid big losses. If you lose 30%, you have to make 43% to get back.
If you only lost 20%, you would be ahead with the lower return.
Reminds me of just recently when I was sitting down with someone for a review of their 401k which was very aggressive. His thoughts were he had to be aggressive to make a return.
But as we dove deeper into what he really had it was surprising to him.
So ran a three-year comparison with his current portfolio against one of ours that’s managed by our team. They’re managing to provide some downside risk adjustments so they’re not going to take unnecessary risks.
The maximum downturn (loss potential) for his portfolio was 29%. The maximum downside for the one we were comparing against was 23%.
If more risk equals more returns than their upside, then the amount that they made should have been more right?
But it wasn’t. If we look at the total return over those three years, it was almost a 10% difference.
His did around 35. The portfolio we compared it to did 45%. If we break that down by year his did 11% vs 13% with the portfolio with less risk.
More risk does not equal more return.
Avoiding big losses is the key to investment success.
What Is Sharpe Ratio?
When we’re comparing these portfolios to something called the Sharpe ratio, simply said, it’s what type of return are you getting for the risk that you’re taking.
Think about it this way:
Would you risk a dollar knowing that I can easily return $2.00 or $5?
But would you risk a dollar knowing you’re only going to return a dollar?
Again, the real key is not that more risk equals more returns, it’s taking the right risk in avoiding unnecessary risk, so that we can better our return.
Because if we can lessen the downside it doesn’t matter if we make as much on the upside, we’ll be further ahead because we didn’t have to make back our losses.
Downside Risk Management
That is something we call downside risk management. Very, very few money managers or advisors employ this tactic. Why? It takes more work.
We recently talked more about this in our blog about timing the market vs time in the market.
When we look at risk-adjusted or downside risk management, there’s a little bit of work to managing a portfolio.
It takes time to watch the indicators and make moves when necessary. It’s not reliant on robot trading or rebalancing.
It’s about staying in harmony with long-term trends.
More risk often equals more losses. But avoiding the big losses is the key to investment success.
If you want to learn more and you want to see how your portfolio stacks up, are you getting the returns out of it for the risk you’re taking, then let’s do a review for you.
If what you have is good it will be obvious. But if it’s not you need to understand why.
Give us a call. We’ll go through that. So again more risk, not always more returns. More risk often leads to more losses, avoiding the big losses. Now that’s the key to invest in success.
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