Is the market going up or down … how to invest when you don’t have a crystal ball … the tweak to your market approach that can help you get pro-level returns
10% shaved off the Nasdaq from Thursday through yesterday …
From one perspective, this is a preview of more exaggerated downside to come.
Driving a potential market collapse are historically high valuations … a pandemic that still has much of the nation on lockdown … a presidential election that could be the most contentious in U.S. history … and continued weakness in the economy, despite recent signs of recovery.
From a different perspective, this 10% correction — while unpleasant to go through — is normal volatility.
It’s nothing more than an overdue breather in a larger bull market that’s growing into its high valuations … all while the economy — though badly bruised — continues to recover and strengthen.
If you side with “more downside to come,” get out of the market, yet are proved wrong as stocks turn north again, you miss out on what could be double-digit percentage gains.
If you side with “normal volatility,” yet are proved wrong as stocks and the economy collapse, you could suffer double-digit percentage losses.
***Today, let’s show you how the pros handle this dilemma
This topic isn’t sexy — but it has the ability to transform your long-term gains in a way that no single, high-flying stock could ever do.
It’s the blocking and tackling of investing … the fundamentals that, unfortunately, most investors never learn.
But fundamentals are what win championships — and create championship portfolio-returns.
Today, let’s look at how to do this with the help of our CEO, Brian Hunt.
Beyond helming InvestorPlace, Brian is an accomplished investor, trader, and teacher, having penned a series of classic investment essays which you can read here.
Recently, Brian added to his collection of writings, authoring a powerful, mini e-book titled, The Risk Vs Reward Manifesto.
Above, I’ve hyperlinked to the complete e-book because Brian chose to make it available to all readers, free of charge.
Though I strongly encourage you to read the entire piece as your schedule allows, today, we’re going to cover it from a 30,000-foot perspective.
When you get a sense of what’s in the Manifesto, you’ll see that the dilemma that began this Digest isn’t really a dilemma at all.
You’ll know how to remain in the market to benefit from potential upside, while having a system in place to protect you from potential downside.
Enough intro. Let’s dig into The Risk Vs Reward Manifesto.
***The one thing that various traders and investors have in common
Brian begins the Manifesto by establishing some context …
… whether you’re a short-term trader, a buy-and-hold investor, a venture capitalist, a commodities trader, or a financial “mutt,” we all have one thing in common …
One thing unites us all …
That’s Risk Vs. Reward.
How you manage Risk Vs. Reward — how much money you risk on investments, short-term trades, and business deals relative to how much money they can make you — determines the long-term success of everyone in business or the markets.
It determines your success.
That’s why the mastery of Risk Vs. Reward is the most important investment and business skill you’ll ever learn.
Now, notice something …
What did Brian not write is the most important investment skill you’ll ever learn?
“Picking winning stocks.”
This is critical to understand because so many investors miss this fundamental of investing.
***Your long-term investment success, and long-term returns, are far-more related to how you handle the risk vs. reward tradeoff than by picking winning stocks
Don’t believe me?
Well, ask yourself, what exactly is a “winning” stock anyway?
Most investors would probably say the answer looks something like this …
Now, while this is a wonderful chart, here’s what immediately followed the upward march of this specific “winning stock” …
If you didn’t properly handle the risk vs. reward tradeoff of this investment, the collapse of this winning stock either gave back a huge chunk of your profits, or it even turned into a full-on “losing” stock, depending on where you bought and sold.
To further this point, what if you had been a short-seller, who initiated a short-trade against this stock near its peak on the second chart above?
In that case, this “losing” stock was actually a huge winner.
***The reality that many investors miss is that stocks aren’t fundamentally “winners” or “losers”
They’re merely tools that we use for wealth creation. Yesterday’s “winner” can quickly become today’s “loser” and vice versa.
What that means is the most important variable in our wealth-creation process is not the tool itself, but rather, how we handle the tool.
Back to Brian:
In every business deal, every investment, every short-term trade, and every situation that involves the potential for you to earn or lose money, you want to MAXIMIZE your POTENTIAL UPSIDE while MINIMISING your POTENTIAL DOWNSIDE …
Now, risk and reward are topics most people are familiar with.
However, the way most think about Risk Vs. Reward is ALL WRONG.
They spend all their time focusing on the wrong side of it the equation. Most people spend 100% of their time as an investor thinking about how much they can win … which is why they lose …
They don’t think for a second about how much they stand to lose if things don’t work out as planned or if the best-case scenario doesn’t play out.
On the other hand, the intelligent investor or trader — the pro — is always focused on how much money he could potentially lose on a stock, a private deal, a trade, a bond, or a piece of property.
He is always focused on risk.
Brian goes on to note how two of the greatest financial minds in history — Warren Buffett and Paul Tudor Jones — think the same way.
He references Buffett’s old saying that the first rule of investing is “never lose money,” and the second rule is “never forget rule one.”
Jones has been quoted as saying … “don’t focus on making money. Focus on protecting what you have” … “risk control is the most important thing in trading” … and “I am always thinking about losing money as opposed to making money.”
***So, how do we do this? What are the nuts-and-bolts of mastering risk vs. reward?
In Brian’s
Manifesto, he lays out five pillars of risk vs. reward investing:
Asset allocation … Position-sizing … Stop-losses … Bargain-hunting … and Asymmetric bets.
I strongly encourage you to read the entire piece for the details, but let’s hit the high points now.
Below, we excerpt from Brian. We present it without block-italics (which we usually use when quoting someone), to make it easier for you to read.
Asset Allocation:
Asset allocation is the part of your investment strategy that dictates how much of your money you place in broad asset classes like stocks, bonds, cash, cryptocurrencies, precious metals, and real estate.
Over the course of your career as an investor, asset allocation will have a MUCH greater impact on your wealth than stock picking will have. The ratio will be at least 100 to 1 …
The most important aspect of asset allocation is using it to diversify your holdings across private businesses, public stocks, real estate, precious metals, cash, insurance, and other financial vehicles …
Whatever asset allocation mix you choose, just make sure you’re not at risk of being wiped out by a crash in a single business or asset class.
Position-sizing:
Position sizing is the part of your investment strategy that dictates how much of your investable assets you will place in an investment or a trade …
Many folks think of position size in terms of how many shares they own of a particular stock or investment.
But smart investors think in terms of what percentage of their net worth is in a particular holding.
Position sizing is one of most important ways you can protect yourself from what is known as a “catastrophic loss” …
Most world-class investors say to never put more than 10% of your portfolio into any one position. Some professionals won’t put more than 5% in one position.
When in doubt, always dial down your position size. It will help you follow Warren Buffett’s most important rule (don’t lose money) … and it will help you avoid catastrophic losses.
Stop-losses:
When it comes to limiting risk, the powerful tool known as “stop losses” can work hand in glove with position sizing to greatly increase your odds of success in the markets.
A stop loss is a predetermined price at which you will exit a position if it moves against you. It’s your “say ‘uncle'” point.
It’s when you say, “Well, I’m wrong about this one, time to cut my losses and move on” …
Combining intelligent position sizing with stop losses will ensure you a lifetime of investing success …
If you’re trading a riskier, more volatile asset, the stop-loss percentage should typically increase and the position size should decrease.
If you’re investing in a safer, less volatile asset, the stop-loss percentage should decrease and the position size should increase.
To be clear, you DON’T have to use stop losses with your investments. You can simply use no stops but small position sizes.
Bargain-hunting:
The average guy gets excited about a stock story he reads in a magazine … or hears how much his brother-in-law is making in a stock … and he just buys it.
He doesn’t pay any attention to the price he is paying or the value he is getting for his investment dollar.
It’s a shame … because the price you pay is a critical part of mastering Risk Vs. Reward.
In your quest to master Risk Vs. Reward and limit your downside, your goal is to buy assets at bargain prices … and to avoid buying assets at bloated, expensive prices.
It’s vitally important to know that buying a stake in a great business can turn out to be a terrible move if you pay the wrong price …
Don’t be a sucker and overpay.
Make sure you get good value for your investment dollar.
Asymmetric bets:
When it comes to Risk Vs. Reward mastery, symmetry is the opposite of what we are looking for in our portfolios.
Expert investors and speculators seek asymmetry in virtually all the positions they take.
An asymmetric “bet” is when the potential upside of a position is much greater than its potential downside.
If you risk $5,000 for the chance of making $100,000, you make an asymmetrical bet.
Although this concept is common sense, the vast majority of investors fall into the trap of making symmetrical bets in the stock market.
Many investors routinely risk 100% of their money in the pursuit of 100% returns.
The world’s best traders and investors almost never touch positions with symmetrical risk/reward profiles.
***Putting it all together
Jeff here again.
As Brian wraps up his Manifesto, he points toward the investing legend, George Soros. Over the course of his multi-decade career, Soros made more than $20 billion from the financial markets.
Brian notes that there’s a simple mindset that’s more responsible for Soros’ success than just about anything else.
Soros once summed it up like this:
It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.
That’s the essence of risk vs. reward.
If you’ve been thinking that “winning stocks” is how you grow wealth through investing, please, please make time to thoughtfully read Brian’s Manifesto.
Frankly, it’s the keys to the kingdom … the “X-marks-the-spot” treasure map … the paint-by-numbers guide to financial freedom and abundance.
It’s how you stay in today’s market without fearing your wealth will be destroyed if you’re wrong.
If you master and then implement the content, I’m certain you’ll watch it transform your investment returns.
Have a good evening,
Jeff Remsburg
