“To 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

“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, either.

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 to lose?”

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.

Risk is Contextual

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.

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 recently?]


• 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, almost instantaneously.

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.

The 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 to think.

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.

Unconscious incompetence 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.

• Chapter 1:
  The Power of
  Mental Habits

• Chapter 2:
  The Seven Deadly
  Investment Sins

• Chapter 4:
  George Soros
  Doesn’t Take
  Risks?

• Chapter 26:
  Do You Need
  to be a Genius?

• Chapter 32:
  It’s Easier Than
  You Think

Add a comment

US edition:

Order from
Amazon.com
or Amazon.ca

Asian/Australian Edition:
Read excerpts
Order online

UK Edition:

Read excerpts
Order from Amazon.uk,
Amazon.fr, or, Amazon.de

Email this to a friend