Just the facts

My own personal definition of risk is: “ a permanent loss of purchasing power”.

This is a subtle variation of the above but maintains the spirit of Einstein’s “Everything should be made as simple as possible, but no simpler”. The textbook definition of purchasing power measures your returns after subtracting the impact of inflation. This is such a useful definition as inflation has been a largely dormant force since the early 1990s which encapsulates my lifetime. I also expand my definition a bit to include tax and other potentially hidden costs (such as management fees).

The origin of this note comes from just how fascinating it is to see the 2 extreme camps when it comes to risk. On the one extreme are (typically younger) investors where there is no stock or asset class too risky. Meme stocks, crypto and anything you can trade with tips from Reddit are all very much on the table. These investors have seen people online and likely people in their own social circles make money trading in these “high risk, high reward” situations. My own experience is a lot of Gen Z falls into this camp.

The other extreme is those unwilling to get off the sidelines and invest. Even purchasing a fully guaranteed money market fund is a slow process that takes time for them to get comfortable with. Many Millennials have mental scars from watching their parents suffer through the Global Financial Crisis. To them just because a bank (even a large one) is in business today is no guarantee it'll be around tomorrow.

So how to bridge the gap and get both different camps into the game in a sustainable way?

For the “risk on” group, a chat on the secret to success from motor racing legend Sir Stirling Moss “to finish first, you must first finish”. Another concepts that come to mind is Taleb’s concept of Alternative Histories.

“One can illustrate the strange concept of alternative histories as follows. Imagine an eccentric (and bored) tycoon offering you $10 million to play Russian roulette, i.e., to put a revolver containing one bullet in the six available chambers to your head and pull the trigger. Each realization would count as one history, for a total of six possible histories of equal probabilities. Five out of these six histories would lead to enrichment; one would lead to a statistic, that is, an obituary with an embarrassing (but certainly original) cause of death. The problem is that only one of the histories is observed in reality; and the winner of $10 million would elicit the admiration and praise of some fatuous journalist (the very same ones who unconditionally admire the Forbes 500 billionaires).”

For this group, it’s important to understand and fully appreciate that when the storm comes (and it always comes) you need to live to fight another day. This rules out leverage and involves discussions on position sizing and entry/exit strategies, such as setting exact price limits to either trigger a further conversation or an exit of the position. These rules need to be set well ahead of time when everyone is operating with a cooler head and strong emotions are largely kept in check.