Thursday, January 18, 2007

Thoughts on Risk

Non-sports junkies: This is not a sports post!

In the recent few days, many a sports column has criticized the coach of the San Diego Chargers, Marty Schottenheimer for choosing to go for it on 4th and 11, rather than making the more conservative choices to punt or try to kick a field goal. Never mind if the Chargers had pulled the play off, he would have probably been hailed about a genius!

All of this got me to thinking about something I've been pondering a lot recently - risk. Risk is an essential element of our lives, but do we truly understand risk? The daily exhibition of this is stock pickers, who brag about how wonderfully their stock picks did, often doubling in value after they picked it. And yet, they achieve that by picking a speculative issue that may have no profits and no prospects beyond hype and hope. And yet, the lay person doesn't seem to understand that it is quite possible to make superior returns if you are willing to accept sufficient risk. Even the popular Motley Fool website joins in this game, egging its readers to find the "next Microsoft or Apple", even if in this pursuit, substantial money could be lost.

Mutual fund fund managers face it all the time - what GMO's Jeremy Grantham calls 'career risk'. If you want to be a brilliant stock picker, be prepared to have clients leave you by the drove when you deviate too far below the average, as happened to some of the most brilliant fund managers in the late 90s when they refused to buy into bubblevision.

But this isn't simply an issue in investing or sports. Every inspirational book or article you read is full of urges to follow your dreams, to believe in yourself. Don't take the safe route to a stable job; take risks and seek out your destiny. You'll read plenty of portraits of moguls who did that! Except Hollywood is full of washed-up wannabes, and the streets of America are lined with people who tried to make money with the next big idea.

To be fair, I'm not suggesting that we avoid risk. After all, risk avoidance presents its own risk, that of mediocrity. Bill Gates, Warren Buffet, Bill Bellichek and Morgan Freeman didn't get where they are today by risk avoidance. And risk avoidance can be detrimental - ask manufacturing workers who chose not to further their skills only to find their work outsourced to China. Or retirees who chose not to accept equity exposure only to find their savings corroded by inflation.

Nevertheless, it does strike me as odd that we persistently talk about success stories without talking about risk. That's like a group of gamblers talking about the one guy who hit the jackpot on the roulette!

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