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Keeping an eye on risk
The very best investors aren’t just known for their superior performance.
They are, most times, also praised for their ability to manage risks and generally avoid investing disasters.
While some may have had a bad year or two, in general they dealt as well with risk as they did with return.
In many instances, risk tends to be covert.
While loss is observable, risk tends to be hidden, especially in times of plenty (ironically, it is to an investors advantage to be most attuned to risk in good times)
In fact, loss only happens when it collides with risk and negative events.
Put differently, risk is the potential for loss if things go wrong.
To better establish this point, permit the use ofan illustration.
A house in California—a known earthquake zone—may have flaws in its construction that generally would not present themselves.
However, when an earthquake occurs—as it invariably will at some point in time, and the house collapses (the loss) those flaws (the risks) become visible.
In other words, the fact that the environment was not negative doesn’t mean that risk control wasn’t desirable.
What’s most important is the realization that risk was present even though loss didnt occur in the good, non-earthquake times.
When tough times emerge, the investors that survive are usually the ones who control risk the best.
An excellent investor therefore, may be one who, rather than reporting higher returns than others, achieves the same level of return, but does so with less risk.
Warren Buffett encapsulates it perfectly when he says: “Only when the tide goes out, can you tell which swimmers are clothed and which ones were naked.”
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