Ever thought you’d hear me say that, right? Your retirement portfolio is up 10%, 20% or even 30% the last few years, you’re probably thinking, “how can I take MORE risk??”. The math is simple:
I take-a-more risk, I make a-more-money!
or maybe it’s:
I work a-less hours, I make a-more money!
I’ve been tossing ideas around with a few younger traders lately. Most of them are enamored with buying calls (eg: buying lottery tickets). In this market, the worst thing is happening to them, they’re getting paid for taking that kind of risk. Why is that a bad thing? Not all risk is equal. If I gave you the choice of working 60 hours a week for 6 weeks with a 30% chance of making $100,000 vs working 10 hours a week with a 80% chance of making $36,000 which would you chose?
Let’s break down the math. In choice 1, you have a 30% chance of making effectively $275/hr but risking “everything”. In choice 2, you have an 80% chance of making $600 / hour by only risking a fraction of your time. Not only do you have a higher probability of getting paid MORE at the end, you take less risk in doing so. In choice 1, if you’re right, you make your year, but if you’re wrong, you lose 6 weeks of income all at once (and remember, you have a 70% chance of losing).
How is this relevant? This is how just about everyone treats investing. Invest 100% of what they have into a few select strategies. This means they’re taking MORE risk to make what they feel like is MORE money. The problem is they have no idea how much risk they’re ACTUALLY taking, vs other things they could be investing in. If you had a 50/50 chance of making $5 on $100 (return on capital of 5%) but a 70/30 chance of making $5 on $50 (return on capital of 10%), which is option is better? How do you figure this out?
Return on Capital is everything. Why is this important? If you’re working harder but making less money, are you happy? If you could make $200,000 a year by working 80 hours a week vs making $150,000 working 20 hours a week, which would you chose and why? The choice is more or less obvious in real life, but that’s how we treat our long term savings accounts. For some reason, they all have to be all in 100% of the time but we don’t take into consideration of actual risk vs reward and saving something for rainy day.
This post isn’t about active trading vs passive investing. It’s meant to help you understand risk vs reward. How much risk are you taking to make smaller and smaller returns? Should you continue to blindly invest your money in the SP500 vs investing some of it in learning Amazon Web Services, which may land you a better paying job 5 years from now? Or a new laptop to help you write every week instead of every month?
In my personal life, the best trades I’ve made haven’t been in any of my cash accounts. In fact- if you were to look at the majority of my trading accounts, they’re more or less flat for the past 10 years. My biggest returns have been directly related to things where I’ve taken profits and re-invested them in myself. Buying a new laptop, investing in a coding class, buying better tools that help me write code faster. In real life, this is hard to do, but where did I learn this skill? By learning to make risk decisions more regularly and faster. In a word: Trading.
As for your retirement account the Quiet Foundation has made it trivial to spot check where you could likely make some small adjustments. This process only takes 10 minutes to run, no sales calls, no up-sells.. no bull. These small adjustments can help you adjust how much risk you’re actually taking for similar (if not higher) returns, freeing up some of your resources for other opportunities.
Think back to 1999 – 2001 and 2008 – 2009.. doesn’t everyone always suggest “it would have been awesome to [have some cash to] buy at the bottom! Well, to do so, you need to make some adjustments at the top. Take 10-20% off the table, pat yourself on the back for making some great investment decisions and save it for a rainy day.
Remember, nobody went broke taking profits.