As outlined in my last post, I’ve been taking a health-related break from trading, speculating, and any other hands-on financial activity. Well, as “hands-on” as any trading is considered to be, in any case. These days, I’ve been gardening like a maniac, in the yard, which is about as hands-on, and net-positive an activity as one can do. Gloves on, pitchfork in hand, durag firmly donned: I garden, and I think. So I’ve been meditating on the topic of risk and reward a lot, and I’d like to share some of my thoughts with you here.
Risk and Reward
To the uninitiated, allow me to explain some background. A lot of finance is about reducing risk, while trying to maximize reward. Whether you’re trading your own money (say, a small amount), by buying stocks and trying to pick the winners so that you have a safe investment, rather than letting inflation eat away at the cash in your bank account, or whether you’re trading other people’s money as a fund manager or investment advisor. People want to make money, but they don’t want to risk their initial deposit, the principal. However, what people don’t understand is that these things are intimately connected. Risk and reward are often in line with each other. Certainly, there are bad deals where there is a huge risk, and little reward. Here’s one example: buying a commercial retail property without first renting it, to see if it’s got enough foot traffic to sustain a business, means that you are taking on lots of risk, if the property doesn’t rent, then you won’t get rental income from it, and if you want to sell it, then it’s unlikely that you’ll find a buyer, since most people don’t want to buy a property unless there’s reason to believe that you can rent it out. So in this example, you’re taking on a huge risk (the entire cost of the property), but the upside (the reward) is only so-so, it’s the same reward you’d get if you were to rent any other commercial retail property. So that’s an example of a high-risk, low reward situation. Now let’s look at the fabled unicorn, a high-reward, low risk situation. There are certain scenarios where these exist, but they’re rare, and probably have either hidden or unrelated risks. Let’s say you know that a company is about to get a huge order, that will massively increase the profitability of the company, and you’re considering buying stocks in that company. It’ll only cost you a small amount of money to invest in that stock, since the price is low. The most you stand to lose financially, is that small investment in the stock, and even then, you can sell again quickly and only stand to lose a small amount of money. The potential reward is high, since you know the stock will shoot up in value, once the big order is announced. So it seems too good to be true? It probably is: depending on what country you’re trading in, this is called insider trading, and it’s often illegal. So there was a hidden risk all along. So, back to the normal case: some risk, some reward. This is the usual case in most situations, and if you want to risk more money, then you’re going to be able to get a higher reward – if – it pans out for you. So, with risk comes reward, and where you find great rewards, there’s probably a commensurate level of risk.
Life
I’ve been thinking more and more about how all my financial knowledge applies to other aspects of my life. As I’ve used these soft hands to dig holes, cut through roots, move soil, and plant seedlings, my body has been getting more and more used to the physical work. I thought it would be terrible, but I’m enjoying it. I’m finding that I’m less out of breath after a gardening session, and need to stop in the shade for less time. The occasional glass of sweet lemonade has me reflecting further. I thought that by being away from my work, my trading, my speculating this monotonous activity would turn my mind into mush. But in fact, I’ve found that as I work physically, it’s not only improved my general physical health (especially my troublesome heart), but also my mind has been able to sharply and clearly think of certain connections that were never apparent to me before. So I knew there was a risk to my mental enjoyment in life (reduced reward), but taking the leap anyway, stopping all work, immediately, to protect my physical health, I’ve found that I was actually taking a bet, taking a position, and looking at another risk-vs-reward scenario. The risk turned out to be not as bad as I thought it would be: risk was lower than I thought. I felt I was just going to benefit from the physical activity (small reward), but in fact I’ve been spending a lot of time doing some of the best thinking of my life (huge and unexpected reward). I suppose that I shouldn’t be surprised, some of the brightest minds in the world take two weeks off every year, just to do reading and relax, and not be constantly involved in their work. However, it’s been eye-opening for me.
That all said, I have noticed that my hands have been getting increasingly cut and damaged (risk) as I work in the yard, but it’s so enjoyable (reward) that I just continue anyway. I felt it was a fixed trade off: I was wrong. My wife bought me some very comfortable gloves from Home Depot and now I can work for hours without putting calluses on my calluses. Similarly, I was worried about sunburn and skin cancer (low risk), but I just couldn’t be bothered going to the hat store and picking out a straw hat (lazy reward): I instead purchased a velvet durag which helped keep the hair out of my eyes and the sun off my head while working away in the middle of the day. So, it turns out that risk and reward aren’t the whole story. It’s not a fixed game, you can do things to reduce risk AND increase reward.
Mitigating
In finance, you simply have two buttons: buy and sell. However, in real life, there are infinitely many buttons, including “take out insurance”, “buy gloves for your tired hands”, and “stop to enjoy the moment for a while”, all of which easily reduce risk or increase reward, at almost no cost. So take your time, think about your risk and your reward, but don’t forget, there’s a lot you can do to tip the odds in your favor. Humanity has been doing this for thousands of years, and traders like me would do well to remember it!