Investment Skill is About Risk and Return

When you see people claiming to have insane returns, 40%, 100%, 200% in a short amount of time, sometimes, its hard to not be depressed about your state of affairs when you see that you only made a profit of say 5% or 10%. This is normal. As people seem to attach their happiness for how good people are doing in relative to them. Envy is a real problem and it can be hard not to be affected by envy when investing.

Envy can tempt you to make investment decisions the same way the other risky investors play the game.

But I want to offer a slight contemplation with this matter. Having a 100% return on your investment in a short period of time, does not mean the investor or trader is skillful. Also, having return 5% or even a negative return does not mean you are unskillful.

Let’s take a scenario of two people. Both of them earned P10 million in one year. Does it matter where the money comes from? Or how they earned it? If you’re buying from a department store, the store may not mind where your money comes from. But if you’re an investor, you should take into account how you get the money.

Let’s say Person A got his P10 million pesos from working hard as an employee. Saved his money and got promoted, became the top dog and the owners of the company gave him a bonus of P10 million for the year. Now, Person B on the other hand, made his money by playing Russian Roulette.

Now, does it matter where the money comes from?

Of course it does. You should take into account how you got the money. A person who made 100% on his investment in stocks may look like a genius. Just like the person who won by Russian Roulette. But it does not make him smart when you know how he got his money. And if you have a time machine, repeat the same day for 100 times, how many times did that person die? 1 out of 6.

While Person A even if his life is repeated again and again, he will earn that P10 million with a high certainty. In contrast with Person B where he can die earning that 10 million. You should also think about the scenario that did not happen.

People seem to believe that having more returns is the only game in investing. No… You also have to account for the risk taken. Because even though the possibility is unlikely, you don’t want to go bust when that happens. Same thing as, even if there’s 5 out of 6 (83%) chance that you won’t die in Russian Roulette, that 1 out of 6 (17%) chance is enough to render anything you won useless.

And that’s what we are trying to do when value investing. There should be enough probabilities for profit and looking at the downside how much are we going to lose and the chances of those happening. Even if the best possible scenario didn’t happen and you end up only earning mediocre, you made a good decision, even if the outcome does not reflect that decision. If the market drops and you only lost little (still a loss), your decision becomes a stroke of genius. But if the same strategy in times of bull market returns a little lower than the market, people may seem to disregard your strategy and thought of you as a fool. But in reality, your strategy and decision-making is sound.

The quality of the outcome does not define the quality of the decision. You will have to take into account a long number of years for a strategy to be judged as good.

Investing in risky assets or stocks is like running through a dynamite factory with a burning match. You may live, but you’re still an idiot.

So don’t be an idiot. Even if others got 100% in one year, remember you did not went running around a dynamite factory just to get that 100%. 5% while doing nothing is probably the best there is.

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