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Tuesday, December 24, 2024
Tuesday December 24, 2024
Tuesday December 24, 2024

Embracing risk: The unavoidable ingredient in achieving investment success

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Investors should recognize that risk-taking is essential for higher returns, according to industry experts

The time-honoured adage “no risk, no reward” captures the essence of investment. Understanding and accepting risk is fundamental to achieving success in the investment world. This concept might seem straightforward—take more risk, expect higher rewards—but the real-world application is much more complex.

Investing essentially means deferring consumption today in order to have more in the future. If you invest $100 today, you forego the immediate gratification of spending that amount in hopes of obtaining greater value in the future. This expectation forms the core of investment strategies across the board. However, the risk does not simply equate to the potential of financial loss but also includes the loss of purchasing power due to inflation. For instance, if you invest at a 5% return rate during a period when inflation is at 10%, your purchasing power decreases despite the numerical growth of your investment.

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It’s important to distinguish that risk in investments does not equate to mere price volatility. While stock prices may fluctuate wildly due to short-term market sentiments, the intrinsic value of a good business does not shift as dramatically. Smart investors should not be swayed by these temporary fluctuations but should focus on the long-term value of their investments. In fact, volatility can present opportunities to purchase assets at a lower price or might compel an ill-advised sale, turning a temporary dip into a permanent loss.

Highlighting the importance of risk, Howard Marks, co-chairman of Oaktree Capital, elaborates in his memo on the essential nature of taking risks. Marks explains the investor’s dilemma: choosing between avoiding risks and earning minimal returns, accepting modest risks for modest gains, or embracing substantial risks in the hope of significant rewards. The market’s efficiency, driven by the collective understanding of its participants, often precludes the possibility of high returns without corresponding risks.

Marks points out that aiming for a portfolio without any losses is not only unrealistic but also counterproductive, as it likely leads to missed opportunities for substantial gains. True investment success, he argues, comes from understanding that losses are part of the journey and accepting them as a necessary component of overall success. This involves making numerous investments, knowing well that not all will succeed, but enough will, ensuring profitability in the long run.

The saga of ARK Investment Management, led by Cathie Wood, serves as a cautionary tale of what happens when a speculative frenzy, fueled by a fear of missing out (FOMO), takes precedence over disciplined investment strategy. ARK’s initial success attracted a flood of investors, but the lack of underlying value in overly speculative assets led to significant losses, demonstrating the dangers of chasing returns without a sound understanding of risk.

Marks concludes that while risk-taking is indispensable for earning returns, it requires a calculated and intelligent approach. The ability to manage and embrace risk, not just the willingness to take it, defines successful investing. This principle holds true whether in periods of market boom or bust. Investors must navigate these waters with a clear strategy and emotional discipline, ensuring that the risks they take are commensurate with the potential rewards.

Mickey Kim, who echoes these sentiments, is a seasoned voice in investment strategy, currently serving as the chief operating officer and chief compliance officer at Kirr Marbach & Co., and writes for the Indianapolis Business Journal. His insights continue to guide investors through the complexities of modern financial markets

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