How Risky is Too Risky? A Tale of 3 Investors

Are you finding it difficult to sleep at night?

Do you find yourself staying up until the wee hours?

Do you worry about the state of your wealth?

Source: Harvard Health

Well, if you are finding it difficult to get some shut-eye, rest assured, you’re alone:

• Health statistics suggest that one in three people will suffer from brief insomnia at some point in their lives. And for one in 10 of us, our symptoms may be more chronic and lasting.

• It’s not hard to understand why. Unlike our forefathers, we now live in an age of 24/7 media. There’s no pause. No reprieve. Just a constant stream of gobbledygook hitting us from the multiple devices we surround ourselves with.

• We engage in doomscrolling. We spend a lot of our time following negative news stories. This is bad for our mental health — but we can’t seem to help ourselves.

• Media statistics suggest that a negative headline will get 60% more clicks than a positive headline. And astonishingly enough, each additional scary word will increase the click-through rate by 2.3%.

• ‘If it bleeds, it leads.’ Scandalous and violent stories are given priority. No surprise there.

Now, as an investor, it goes without saying that the quality of your sleep is directly related to your perception of risk:

• According to the Cambridge Dictionary, risk can be defined as ‘the possibility of something bad happening’.

• How true. But here’s the thing: risk isn’t a binary choice. It’s not an on/off switch.

• Instead, risk actually exists on a sliding scale. 1 to 10.

• So, where exactly do you sit on this scale in terms of your investment choices?

If you want an accurate picture, you may actually need to ask yourself some honest questions:

• Are you an optimist or a pessimist?

• What is your tolerance for uncertainty?

• How well do you function under stress?

• What is your ultimate destination?

• Do you know what it takes to get there?

Now, obviously, I can’t give you personal financial advice. Nor should you treat what I say as such. But maybe I can clarify your thinking in a general way:

• I want to give you three different imaginary scenarios to consider.

• They involve three different levels of risk.

• They involve three different investment personalities.

• What kind of lessons can you learn from them?

• Well, here goes…

Investor #1 — Mark

Mark is an IT expert who invests heavily in cryptocurrency. He’s a true believer, and he’s absolutely committed to this path.

He has a deep and abiding distrust of the traditional banking system. So he’s looking for a libertarian alternative. He believes that he’s found the answer: blockchain technology. He is convinced that it will grow exponentially in the years ahead.

However, Mark understands that the road ahead won’t be a straight one. And he accepts that extreme volatility is the name of the game.

In 2022, Bitcoin fell around 65%, while Ethereum fell around 72%. Cryptocurrency-related companies such as FTX, Celsius, and Voyager collapsed.

Investors panicked and ran for the hills.

Reportedly, over $2 trillion worth of wealth was wiped out.

Source: One Click Crypto

During this crypto winter, Mark wasn’t spared. He saw the value of his investments plunge by hundreds of thousands overnight.

By any measure, this is terrifying — but Mark isn’t shaken.

He hasn’t lost sleep. He will continue to hold. He has diamond hands.

He’s bullish for a blockchain future — even if he isn’t quite sure what that final destination will look like.

So, on a scale of 1 to 10, Mark’s tolerance for risk is probably 10.

Investor #2 — Paul

Paul is a fairly new investor. He only started investing in shares in 2021.

Paul is not particularly ideological. Nor is he particularly ambitious. In fact, he’s your typical everyman. The regular bloke you might meet on the street. His tolerance for volatility is about average.

Paul’s goal is simple: he just wants to cast a wide net. He wants to capture a slice of every sector, every industry. He is aiming to diversify his wealth globally without too much technical knowledge or physical effort.

When he first started, Paul was attracted to the buoyancy of the stock market. From 2009 to 2021, it experienced the longest bull run since the Second World War.

Everyone seemed to be making money easily during this economic boom — so why not him?

So Paul made a snap decision and dived in.

Source: Zipmex

Uh-oh. Unfortunately for Paul, he came in at the tail end of the economic cycle. In 2022, the bull became the bear. The S&P 500 index fell over 19%, and the Nasdaq fell over 33%.

When this happened, Paul was caught off-guard.

He became depressed. He moped. He lost a few nights of sleep.

Fortunately, Paul didn’t stay down for very long. He soon picked himself up. He started doing his research.

He found a quote that he liked from Warren Buffett:

‘Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.’

Paul feels encouraged by this. And he’s now using this bear market as a chance to stock-pick for value. He aims to buy into dividend-paying companies that will give him an income yield of between 5% to 7% annually.

Paul plans to hold for the long-term. He’s not a daredevil, but he is comfortable with taking measured risk. He cautiously optimistic that the economic cycle will turn again at some point.

So, on a scale of 1 to 10, Paul’s tolerance for risk is probably 5.

Investor #3 — Thomas

Thomas doesn’t invest in the stock market at all.

His chosen vehicle for wealth is New Zealand property.

In fact, his money is highly concentrated in Auckland housing. Several real-estate agents have told him that prices would only go up and would never come down. Auckland housing was as good as gold.

Thomas believed them. So he took up two large mortgages in 2020 and 2021. He was eager to exploit the ultra-low interest rates. He made a bet that soaring capital gains would propel him to the next level of wealth.

This logic felt sound to him. After all, it was the bank’s money he was playing with. It was practically risk-free, wasn’t it?

Source: Stuff

Unfortunately, it hasn’t turned out that way.

In 2022, mortgage rates started climbing. Suddenly. Sharply.

It’s the perfect storm.

Thomas is losing lots of sleep now. He has seen the value of his properties slide around 20%. And he’s only getting a rental net yield of around 1% annually.

He is struggling with his mortgage payments — and his optimism has turned into pessimism. He’s terrified that New Zealand could experience something similar to the Irish property bubble.

In 2013, house prices in Dublin fell an astonishing 54% from their peak.

His deepest fear: could this happen in Auckland?

Up until now, Thomas assumed that investing in housing was risk-free. He also assumed that his journey would be a smooth ride. But he was wrong on both counts. This economic turbulence is causing him to question his own judgement. He’s starting to experience some buyer’s remorse now.

So, on a scale of 1 to 10, Thomas’ tolerance for risk (at least in his own mind) was probably 1.

It’s time for wisdom

‘Gnōthi seauton.’

That’s Greek — ‘Know thyself.’

Legend has it that this proverb was inscribed on the ancient Temple of Apollo at Delphi.

It’s simple but profound. ‘Know thyself.’

So, you need to consider this:

• Some people are optimistic by nature. Some people are pessimistic by the nature.

• But the razor’s edge between bravado and distress may be slimmer than you think. Because you never really know what someone is made of until you put them under pressure.

• Indeed, pressure has a way of revealing a person’s character.

In the Bible, in the book of Genesis, you will find an interesting metaphor:

• The Pharoah of Egypt dreams about seven fat cows being devoured by seven lean cows.

• Joseph translates the meaning of the dream: seven years of bountiful harvest will be followed by seven years of crop famine.

• In other words, cycles of plenty will be followed by cycles of scarcity.

• Mathematically, this has become known as the Joseph Effect.

Source: Capital Group

Today, the modern economic cycle displays a similar ebb and flow:

• Five-year tides of greed tend to be followed by one-year tides of fear.

• Lather, rinse, repeat.

• How you successfully navigate any cycle may come down to your tolerance for stress — as well as your capacity to sleep well at night.

• Preparation is key. Risk-management is critical. Only then will you be able to figure out the Goldilocks temperature that works for you. Not too hot. Not too cold. Just right.

So, are you looking at the big picture? Well, here are some words of wisdom from a few legendary investors. Take your time to ponder them:

• Shelby M.C. Davis: ‘Invest for the long haul. Don’t get too greedy and don’t get too scared.’

• Benjamin Graham: ‘In the short run, the market is a voting machine. In the long run, it is a weighing machine.’

• George Soros: ‘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.’

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(This article is general in nature and should not be construed as any financial or investment advice.)