Risk and Reward

One of the most common myths I hear people say is that you have to take more risk to get more reward.  It’s an idea preached by Wall Street Bankers, CEOs, and Financial Advisors alike that have been schooled in what’s known as the efficient market theory.  It’s a theory which states that there is no difference between price and value since the market always prices things correctly.

It’s like saying there is no such thing as a sale.  If chicken breast is $1.00 per pound cheaper, that’s just what it’s worth.  If you find a silver necklace at a goodwill store, and it’s selling for 30% of it’s normal price, well that particular necklace is still priced correctly.   But investors like Warren Buffet, Charlie Munger, David Einhorn, and Monish Prabrai are all investors that never fell for it.  And they are all investors who have spent their entire careers outperforming the market.

Benjamin Graham was Warren Buffet’s first great mentor, and set the foundation for what’s known as the “Graham-Dodd’ School of investing.  Here is what I basically boils down to.

  • “Investing is most intelligent when most business like.” –Ben Graham
  • “Price is what you pay, value is what you get.” – Warren Buffet
  • “Three most important words of investing-Margin of Safety.” -Warren Buffet

While Wall Street investors have the public convinced that the market is never wrong, investors from the school of Graham and Dodd have made exponentially greater returns consistently by understanding the concepts above.

Once we realize that the price isn’t necessarily the value of the investment, we can start to look for bargains.  Assets selling at discounted prices.  While the mediocre investor either throws money blindly, or even chases a rising market, the savvy investor will only invest when they can do so and still have a margin of safety.  If a stock is worth $10.00, and you buy if for $5.00, you can be wrong by 20% and still make a $3.00 profit.  But if you don’t wait for a sale, then you’re buying dollar for dollar.  That means you have to be 100% right just to break even, and then only hope the price goes up from there.

Understanding that assets can be cheap, reasonably priced, or even overly expensive is the foundation of what sets elite investors apart from mediocre ones.  And it doesn’t matter whether you are buying silver jewelry from a thrift store at a 70% discount, discounted gold from an estate sale, a distressed investment property, or a stock that has taken an irrational dip in price. Money is made on the buy.  Trying to capture profit on the sell is the game of the greater fool.

So the point we want to always drive home is that risk does not equal reward.  In fact, outperformance over the long-haul comes from lowering risk while increasing the potential for a superior profit.

Thanks for following.  If you’re looking for some clarity on how to make your investments more consistently profitable, we invite you to learn some of our strategies for free here.

About The Author

herbertkoehler

I am a college drop out who found my passion as an investor. I love the many facets of finance, investing, and business. But even more than that, I love sharing what I learn with others.

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