If you are looking at the U.S. markets, you may believe that since early March investors are waking up and pouring themselves bowls of "Risk Crispies" for breakfast -- if only Kellogg ( K) made these too. The stocks that have been rallying the hardest are the ones that have been sold down sometimes more than 90% in the past two years. Now, do note that I'm not here to recommend what I consider to be highly speculative plays, like snap, General Motors ( GM), crackle or pop, Ambac Financial ( ABK). Actually, I wrote this piece before I knew GM was becoming "Government Motors." I've been thinking of GM as the Titanic. Nobody wanted it to sink, but the ship was structured with too much optimism and it looks to be taking all the shareholders down to Davy Jones' locker. What I will say is that I believe the more you pay for the stake in a business the less likely it becomes that you will be able to sell it to someone else at a higher price. In the land of investing, risk comes from overpaying -- the winner's curse. I would say that it is certainly less risky to pay less for something if your objective is to make money by selling it off at a later date. The way I see it, there are two kinds of risk in the stock market. There's "good" risk and there's "bad" risk. More emphasis should be placed on the bad kind of risk because by being able to avoid it investors can outperform the market in the long run --- which is what most of us are interested in. Most bad risks come from people that don't understand what they are doing.
A few examples of bad, or even dumb, risk would be: picking up pennies in front of a steamroller, riding your bicycle down the Autobahn, lying under oath, drinking and driving, or deciding to fight the guy at the bar who looked at you funny. The outcome is unknown, but you are likely to not be excited about it. The examples here are the stocks listed earlier. A couple of commonly believed good, or intelligent, risks: studying for an exam that you want to pass, going to work if you want to keep your job, or exercising and eating a healthy diet to feel good. The outcome here serves more as a confirmation bias that makes these risks sound self-evident. But they aren't that obvious to everyone. I try to keep 100% of my portfolio in this category. A couple new ideas that I haven't talked about yet are Patriot Capital Funding ( PCAP) and MCG Capital ( MCGC). Also, you might want to consider the rising tide in bulk shipping with Star Bulk Carriers ( SBLK), FreeSeas ( FREE) and Danaos ( DAC). There are only a few examples of definable risk: rolling dice, most games in a casino, and flipping a coin. The outcome can be precisely calculated. There is nothing in investing that I would say has a definable future real net present value. There is so much fluctuation between stock prices, currency prices, inflation, Treasury yields, and expectations that I don't feel confident predicting anything with 100% accuracy. Believe it or not, there are examples of no risk: jumping out of a plane with no parachute, driving your car at 100 mph into a brick wall, traveling into outer space without a space suit. The outcome is, in my opinion, well-known. Unfortunately, there is no such thing as a sure thing in the stock market. Deals can always change, even after they are announced.
Some investors justify making risky decisions based on their likelihood of achieving higher returns. In times of crisis, the price of the stock market goes down. Some perfectly good stocks go down more than 90%. Wouldn't it be nice to be able to find these and pick them up for pennies on the dollar? That's what I try to do. The trick is to not step into the "fear breeds fear" market, and wait for the lower valuations to begin to appreciate across the markets and signs of early strength. Then, hop aboard the rising tide of the companies marked down 90% in price that are fundamentally set to appreciate more than anything else you can find. Some investors pay people to actively diversify their money across companies at mediocre prices. The investment vehicles here tend to be exchange-traded funds and mutual funds. This is a generalization. I know of several mutual fund companies and managers that I really like and I would even go so far as to recommend them to people who don't know how to invest themselves. In the investment world, there are two questions: Where do you put your money? And when do you do it? It's just that simple. You could put your money into high-flying stocks at market bottoms, or you could put your money into undervalued companies at market peaks. Either way, you are fighting the wrong battle. At the market bottoms, you don't want to be fighting off winner's curse. At the market peaks, you're missing the perspective of how a negative trend bludgeons most investors' risk appetites to death. Even though I've been making money since June 2008, I've been fighting the wrong battle for the majority of my tenure. I was simply trying to outperform the market. That's what I used to be interested in. Now I've refocused on not losing money and I'm doing a lot better.