Everyone wants to make money in the stock market so we’re going to let you in on a secret. The way to make $1 million on Wall Street is to start with $2 million. If you’ve been around the markets for a while, you likely chuckled when you read that old saw, which is as true today as it was eons ago when it was first used to illustrate one of the cardinal rules of investing: it’s a hard way to make a living.
Advisors know this perhaps better than anyone. And this is why so many advisors routinely play armchair psychiatrist with their clients, trying to keep them from making decisions sparked by the market’s only two emotions: fear and greed.
Yet, there is a pathway between those two opposing polarities that anyone can use to better navigate the market: risk management. This discipline is totally absent from most portfolios owned by individual investors, even though it is a key part of institutional portfolios. If you think that’s a crazy omission, you’re not alone, but most people do not know that they can manage risk because they don’t properly think about investing.
In a recent Barron’s interview, a Columbia University professor shared an insight that is worth pondering. The professor, when recounting his experience recommending stocks to money managers like Mario Gabelli, said that once a manager’s greed was triggered by an idea that their sense of fear kicked in. Those investors immediately began thinking how much risk they would take to make a potential return. The opposite is true for many others who usually only consider risk, if at all, when they have lost money. We think that needs to change.
Consider the lesson of Larry Fink. The Blackrock founder is reportedly “perpetually neurotic” about risk and it has served him well. His company, founded in 1988, is now the world’s largest asset management firm with almost $7 trillion under management. Many reasons contributed to the firm’s success, but risk management is widely cited as a top reason.
When Fink was a young trader at First Boston, he lost $100 million and was shortly out of work, even though he had pioneered debt securitization. As he pondered what had happened, and why, he had an epiphany. Investors, he realized, often did not understand the risks that they were taking. He lost his job, after all, because he made a mistake evaluating interest rates. So, Fink and his colleagues founded Blackrock, and bought a little computer that has since become a very big computer, to help them and their clients analyze risk.
Now, we’re not suggesting that everyone who embraces risk management will become a global market statesman and manage trillions of dollars, but we are definitely suggesting this: if you don’t manage risk, you will be managed by risk, and you won’t like it.
Bottom line: Just as Socrates said the unexamined life is not worth living, the unexamined portfolio is not worth owning. So, we ask this: do you really know what’s in your portfolio? If not, we suggest you find out before Mr. Market shows you.