Not What You Think

On May 7th, 2002, NBA legend Allen Iverson gave a response to a question that has since become iconic. If you haven’t watched it, you should. Iverson’s rant has since been referenced countless times all over pop culture and sports.

The 76ers had been bounced from the playoffs four days earlier—a disappointing end to an even more disappointing season. Just one year before, Iverson had won the scoring title as he led his team to the NBA Finals. Now, Iverson sat in this press conference clarifying his status with the team.

He found himself addressing questions from reporters about missing or being late to practices—something his coach, Larry Brown, brought up in public many times.

During Iverson’s rant, he says something especially interesting and insightful:

“It’s easy to talk about it. It’s easy to sum it up. We’re not even talking about the game. The actual game. The thing that matters.”

The thing that matters. Nailed it.

ESPN writer, Matt Walks, would later write:

“As time goes by, the lasting memory from that day will be Iverson’s charming incredulity. But, as has always been the case with Iverson, there are more sides to the story.”

There are always more sides to the story. That’s true of life and investing. It’s especially true when it comes to risk.

What’s the real risk?

Risk and return are forever connected. That’s true. But what risk are we talking about? Usually, risk is used interchangeably with volatility—the ups and downs of your portfolio over a given period of time.

I’d argue that’s not the risk that matters.

In his book, Against the Gods, Peter Bernstein writes,

“The essence of risk management lies in maximizing the areas where we have some control over the outcome while minimizing the areas where we have absolutely no control over the outcome and the linkage between effect and cause is hidden from us.”

Put your attention on things you can control—don’t waste your energy on things you can’t.

If you invest all of your money into one company you run the risk of your investment going to zero. That’s called business risk. If you focus your investments in one region of the world, you open yourself up to risks specific to that region. You can control these risks by spreading your money across multiple companies in different industries all across the world. You cannot control the fact that there are countless things at any one time that will move the market as a whole.

Knowing the difference and acting accordingly is the difference between success and failure in investing over time.

It’s not what you think

When it comes to investing, there are three risks you should be focused on:

1. Loss of capital
2. The risk of not reaching your goals
3. The risk of missing the point

Thinking in terms of volatility distorts your view of what matters. It pulls your attention away from the things that are actually causing the loss and/or you not reaching your goals.

For example, in terms of volatility, cash is far less risky than a portfolio of all stocks. If you put $100,000 in a savings account and came back a year later you’d still have $100,000. That means there’s no risk to cash, right? Not exactly.

Let’s say you left that $100,000 for 20 years. Let’s even assume you got a little interest out of the bank for keeping the money there. Say 1.5% each year for two decades. Inflation averages 3.5% per year during that period—meaning you are losing 2% each year you leave the cash in the bank. You just don’t see it because your balance isn’t fluctuating day-to-day.

Twenty years later you log in to your account and see $134,685 on the screen. Well, at least you didn’t lose money, right? You didn’t have to deal with the pain of market ups and downs. But what is the real value of that money two decades later? It’s $66,761 in today’s dollars. You would have lost 50% of the value of your money while thinking it was safely sitting in the bank.

Now let’s say you invested that same $100,000 in a globally diversified portfolio of stocks. You’d have to deal with the risk of ups and downs over that 20-year period. But it’s safe to say you could see somewhere around 6-7% per year on average after inflation. Let’s call it 6.5%.

Two decades later, your balance would be $352,364.

You’re scared of the wrong thing

When thinking in terms of actually losing the value of your money, what you think is safe is actually quite risky. In terms of not reaching your long-term goals, cash is far riskier than stocks.

There’s an interesting paradox that pops up in investing and in life. The paradox of fear. The thing you’re afraid of makes you act in a way that brings about the very outcome you fear.

You fear being rejected and alone so you never ask the girl out, which guarantees you’ll be alone. You coddle your child out of fear of them getting hurt–setting them up for a lifetime of pain. You’re afraid to lose money so you don’t invest, which guarantees you less money in the long run.

Remember, when it comes to risk, focus on the thing that matters. It’s not always what you think.

Here’s to making money matter!