survive in the financial markets sometimes means beating a hasty
retreat.” — George Soros
“It’s not risky to buy securities at a fraction of what
they are worth.” — Warren Buffett
Passionately Avoid Risk
|As a result [of Habit #1], is risk-averse.
||Thinks that big profits can only be made by taking
“What’s your risk profile?”
After discovering that Master Investors such as
Warren Buffett and George Soros avoid risk like the plague, I hope
this sounds like a pretty dumb question. Because it is.
But let’s suspend disbelief for a moment
to investigate what it means.
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,
If a client is willing to take risks he’ll
probably be advised to invest in a portfolio full of so-called growth
stocks, all with great promise but no guarantees.
This counsel 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...the Fifth
Deadly Investment Sin.
When someone asks you “What is your risk
profile?” or “What’s your appetite for risk?”
what they’re really asking you is:
“How much money are you willing
Fancy phraseology like “risk profile”
merely disguises the belief that you must be willing to take the
chance of losing a bundle of money in order to have the chance
of making any.
Yet the practical application of making preservation
of capital your first priority (Habit #1) is to be risk-averse.
If, like Buffett and Soros, you can be risk-averse and
make far-above-average profits, there must be something severely
wrong with the conventional wisdom.
Unsurprisingly, the Master Investor has a very
different perspective on risk than the average investment professional.
For example, Buffett puts “a heavy weight on certainty. If
you do that, the whole idea of a risk factor doesn’t make
any sense to me.”
To the Master Investor, risk is contextual, measurable,
and manageable and/or avoidable.
Is the construction worker who walks along a plank
60 floors up in an unfinished skyscraper without a safety harness
taking a risk? What about the expert skier who zooms down the almost
vertical double-black diamond slope at 60 miles an hour? Or the
experienced rock-climber, whose fingers are the only things holding
him 100 feet up a vertical cliff-face?
You would probably say, “Yes!” But
what you really mean is: “Yes — if it was me.”
Risk is related to knowledge, understanding, experience
and competence. Risk is contextual.
While we can’t be certain that the construction
worker, the skier and the rock-climber are taking no risks,
intuitively we know they are taking less risk than we would, if
we did what they did. The difference is unconscious competence.
If you’re an experienced driver, you have
the ability to make instantaneous judgments — whether to slow
down, speed up, turn right or left — to avoid a potential
accident or a pothole in the road.
You can probably recall times when you have hit
the brakes or swerved to avoid an accident — yet not been
fully aware, consciously, of the nature of the danger until
after you’d taken evasive action. The decision was
made entirely at the subconscious level of your mind.
Such automatic reactions come as the result of
years of experience.
Think about it for a moment and you’ll realize
that driving a car is quite a complicated activity. Think of all
the things you’re monitoring at the same time:
- Is that kid going to run onto the road?
- Is that idiot going to swerve in front of me?
- Is that car behind me too close?
- Will that car stop at the corner? [Has he had his brakes checked
- Is there enough space between me and the car in front in case
he brakes hard — unexpectedly?
...and I’m barely scratching the surface of all the things
you’re monitoring as you drive. [Next time you get behind
the wheel of a car, take a moment to become aware of all the things
you’re doing that you weren’t consciously aware of doing.]
Even an apparently simple thing like changing lanes
on the freeway is what’s called a multi-body problem in physics.
You have to monitor your speed, the speed of the traffic, the speed
of the cars behind you and in front of you on the lane you’re
in and the lane you want to move into; while maintaining awareness
of traffic in the other lanes just in case. And you also
have to make a judgment as to whether or not the drivers in the
other lane are going to let you in.
And you do all this at the same time,
Multi-body problems often stump the physicist.
That’s even though the physicist has a great advantage over
you, the driver: the particles he’s studying don’t have
free will. If they’re moving in a certain direction at a certain
speed, they don’t suddenly swerve right or left or speed up
or slow down. And nor do they drink and drive.
In a state of unconscious competence, you solve
the multi-body problem automatically — and just change lanes.
While your subconscious mind directs your driving,
your conscious mind is free to carry on a conversation, be aware
of the sights, or listen to the radio.
But for someone who has never driven before and
has no experience or competence, just getting behind the wheel of
a car is a high-risk, life-threatening activity. Like you...before
you’d learnt to drive.
Four Stages of Learning
The Master Investor acts apparently effortlessly
and instantaneously in a way that, to the outsider, seems risky
— especially when the Master doesn’t even seem to pause
Warren Buffett can decide to buy a multi-million
dollar company in 10 minutes or less, doing all the calculations
in his head. He doesn’t even need the back of an envelope.
What’s more, most of the decisions he’s made so quickly
have proven to be the right ones.
That’s only possible for someone who has
gone through the four stages of learning:
- Unconscious incompetence: doesn’t
know that he doesn’t know.
- Conscious incompetence: knows that he doesn’t know.
- Conscious competence: knows what he knows and knows what
he doesn’t know.
- Unconscious competence: knows that he knows.
is the state where you don’t even know that you don’t
know: the state of mind so many young drivers are in when they begin
to learn to drive. That’s why young drivers have many more
accidents than older, more experienced drivers: they fail (or refuse)
to recognize their limited knowledge, skill and experience.
People in this state are highly likely
to take risks — expose themselves to danger or loss —
for the simple reason they’re totally unaware that that’s
what they’re doing.
Investors who subscribe to any or all of the Seven
Deadly Investment Sins are in this state. They think they
know what they’re doing; and they fail to recognize the reality
of their ignorance.