Investing For Winners
So what is it that the starting quarterback of a championship football team does to win games? And more importantly for our purposes, what is it that we can take from him to become better investors?
The answer is simple: the starting quarterback on any championship team doesn't make mistakes. That's it!
When you're playing at the professional level, where the competition is extraordinarily high, all it takes to be a loser is just one big mistake. And when it comes to investing, the difference between professionals and amateurs is also not making big mistakes. But there is one key difference between winners and losers when it comes to investing...
Losers ask: "How much can I potentially make?"
Winners ask: "How much will I have at risk?"
Losing investors are wowed by returns. Winners already know that the returns will come. So they concentrate on minimizing the risks. Winning investors never talk more about returns than they do about risks. Winning investors think in these terms: for a given level of return, how much will I have to risk? It's the REWARD-TO-RISK ratio. And here's what the ratios look like over the past 50 years or so:
Stocks (including dividends):
15% a year REWARD
16% a year RISK (volatility)
0.9 REWARD-TO-RISK RATIO
Government Bonds:
6% a year REWARD
10% a year RISK (volatility)
0.6 REWARD-TO-RISK RATIO
One thing the reward-to-risk ratio ultimately tells us is that in any given year, we do have a risk of losing money. For example, in any given year, we might make a total return of 6% on government bonds. But in any given year, the likely return ranges 10% on either side of 6% - from a high of +16% down to a low of -4% return.
But the ratios above are based on putting all our eggs in the stock market or all our eggs in the bond market. However, if you take the time to crunch the numbers, you'll find that a portfolio with 50% stocks and 50% bonds, improves the reward-to-risk outlook dramatically:
50/50 Stock/Bond Mix:
10% a year REWARD
10% a year RISK (volatility)
1.0 REWARD-TO-RISK RATIO
By having 50% in stocks and 50% in bonds, your portfolio would be no more volatile than an all bond portfolio. Yet your returns would increase dramatically over that of just bonds, from 6% to 10% (a 66% increase). So by adjusting our mix, we maximize our potential returns, and yet keep our risk at a minimum. No mistakes.
In this case, with the likelihood of 10% a year in returns, and a likely range of returns between 20% and 0%, you've greatly reduced your chances of having a losing year.
So even if you lack the natural skills of the so-called professional investors, you still can succeed at the highest levels by just keeping yourself from making the big mistakes!
* * * * *
The answer is simple: the starting quarterback on any championship team doesn't make mistakes. That's it!
When you're playing at the professional level, where the competition is extraordinarily high, all it takes to be a loser is just one big mistake. And when it comes to investing, the difference between professionals and amateurs is also not making big mistakes. But there is one key difference between winners and losers when it comes to investing...
Losers ask: "How much can I potentially make?"
Winners ask: "How much will I have at risk?"
Losing investors are wowed by returns. Winners already know that the returns will come. So they concentrate on minimizing the risks. Winning investors never talk more about returns than they do about risks. Winning investors think in these terms: for a given level of return, how much will I have to risk? It's the REWARD-TO-RISK ratio. And here's what the ratios look like over the past 50 years or so:
Stocks (including dividends):
15% a year REWARD
16% a year RISK (volatility)
0.9 REWARD-TO-RISK RATIO
Government Bonds:
6% a year REWARD
10% a year RISK (volatility)
0.6 REWARD-TO-RISK RATIO
One thing the reward-to-risk ratio ultimately tells us is that in any given year, we do have a risk of losing money. For example, in any given year, we might make a total return of 6% on government bonds. But in any given year, the likely return ranges 10% on either side of 6% - from a high of +16% down to a low of -4% return.
But the ratios above are based on putting all our eggs in the stock market or all our eggs in the bond market. However, if you take the time to crunch the numbers, you'll find that a portfolio with 50% stocks and 50% bonds, improves the reward-to-risk outlook dramatically:
50/50 Stock/Bond Mix:
10% a year REWARD
10% a year RISK (volatility)
1.0 REWARD-TO-RISK RATIO
By having 50% in stocks and 50% in bonds, your portfolio would be no more volatile than an all bond portfolio. Yet your returns would increase dramatically over that of just bonds, from 6% to 10% (a 66% increase). So by adjusting our mix, we maximize our potential returns, and yet keep our risk at a minimum. No mistakes.
In this case, with the likelihood of 10% a year in returns, and a likely range of returns between 20% and 0%, you've greatly reduced your chances of having a losing year.
So even if you lack the natural skills of the so-called professional investors, you still can succeed at the highest levels by just keeping yourself from making the big mistakes!
* * * * *
posted by Bob Moser at
10:02 PM
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