The Greedy Farmer was talking to a friend about putting together this investing service. The friend, let’s call him Ace…since his name is Ace. Ace said “I’ll bet you avoid risk when investing”. I didn’t respond, this is a long conversation meant for another time, I thought. “My returns are poor”, Ace went on to say, “let me know when you have the service up and running…”
This conversation stuck in my mind. It was not that Ace said something radical or even memorable, it is how this statement is so unlike the way Ace runs his professional life, that made the statement stick with me. Ace takes on the most demanding, technical, and risky aspect of his industry.
Because Ace is focused, knowledgeable, careful and good at what he does, he de-risks a tough job. Ace is a dirt contractor but he specializes in bridges where he makes his best profits. Because few competitors take on the inherent risks of bridge construction and focus more on general dirt moving, Ace operates where the profit opportunity is greatest; few competitors want to take on his niche. Investing, is not different. It is not really possible to make outsized profits unless you take on the risk of capital loss (stock price decline). The companies you invest in would not need your money if there was obvious and easy money to be made. Banks step up for those low-risk opportunities, after all, no independent investors needed! Ace implied that I would be making money by avoiding risk. In actuality, I make money by taking on risk AND by managing that risk effectively.
Let’s consider a few various forms of risk (there are many more than reviewed below). The risk Ace is referring to is the risk of a capital loss. In actuality there are many kinds of risk and you are never able to avoid them all. At the risk of boring you to death, let’s look at some brief examples of several types of risk: