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The “Helicopter Parent” Fed and the Fatal Crash of Risk. To Succeed as an Investor, You Need to Understand These 2 Simple Concepts.

Helicopter Parents generate a perfection of moral hazard, defined as there is no incentive to hedge risk because one is protected from its consequences. Moral hazard perversely increases the incentives to take on more risk because Mommy and Daddy (the Fed) will always save me / bail me out.”

Policy settings have set off extreme circumstances. Maximum risk and allocation to equities, at the worst ever prospective long term returns.

Ever greater policy support is creating ever greater risk taking.

How do the best investors come out well in the long term in these extreme circumstances?

To Succeed as an Investor, You Need to Understand These 2 Simple Concepts

The following is adapted from Invest Like the Best.

No matter how long you’ve been an investor, you know that investing is inherently risky. There’s no guarantee that you will make money, and in fact, many people lose money investing. So how do you succeed as an investor? It’s a question worth asking, because figuring out the answer can mean the difference between financial freedom and financial failure. 

While it’s true there are no guarantees when it comes to investing, it’s also true that by studying the mindset of the best investors and seeking to understand their strategies—how and why they do what they do—you move yourself closer to investing success. As it turns out, there are two concepts the best investors understand that you should learn too if you want to succeed as an investor.

#1: Learn to Identify Your Risk and Return Priorities

Perhaps the clearest distinction between the most successful investors and everyone else is that they are not conflicted in their priorities when it comes to risk and return. As an investor, you put your money at risk because you believe that there is a good prospect of achieving an attractive return, and the risk of failure is acceptable. It is important to be clear about what drives your willingness to invest. 

If there were equal odds of winning or losing, but you made twice as much if you won, you would have a positive expected return from taking the risk. That could be attractive to you if the risk of losing was acceptable. If there were equal odds of winning or losing, but you would lose more than you would gain, then the expected return is negative. In this type of scenario, the best investors would not participate, and you should not either. This kind of trade-off will make you bankrupt over time.

To be successful as an investor, you must make this concept of assessing your priorities about risk and return a cornerstone of your investor mindset. It must be non-negotiable, and it must inform every investment decision you make.

#2: Stay Risk-Averse

Most investors are confused about return and risk and the relationship between them. Without clarity, the whole investing venture is exposed to poor decision-making, inappropriate risk, and suboptimal and potentially dangerous portfolio allocation. This whole problem starts because some “experts” prioritize high risk.

One of the most important steps in investing is for you to be clear on your investment-management decision process. If you’re working with a financial advisor, you may find that the advice is to maximize high-risk as a factor, believing that is the way to make high long-term returns. This is why the financial industry tests for an investor’s capacity to take risk, so they can maximize how much risk they take. Essentially, allocation is primarily driven by a risk-level determination according to client “suitability.” 

This approach is not followed by the most successful long term investors. The best investors focus on risk mitigation. To outperform the market over multiple decades, top investors make examining and assessing risk as their primary focus. 

As much as possible, they want “intelligent,” high reward for low risk. If they can’t find it, they default to a “safe” investment. They have no interest in high-risk per se, or taking a gamble. To simplify, the best investors take a low-risk approach with a sole focus on high return relative to risk.

Understand the Importance of Risk Management

The best investors have learned the importance of risk management for high long-term returns, so they always want to limit risk. The only way to do that and produce a high long-term return is to maximize return/risk, or alpha. 

The true test of an investor is to show they are successful in lowering or containing risk while, at the same time, increasing alpha. Just these two elements are by far the most reliable path to durable and positive long-term returns. They are relatively easy to calculate and report, so they can provide a real-time indication of whether an investor is on track for optimal results.

If risk is low and alpha is high, then not only are returns more likely positive, but they are also being produced with the highest probability of continued success! The skill of the investor’s process is clearly high. 

Allocate to Alpha, or high return relative to risk, NOT to high risk. Make your long term return a matter of consistent skill, rather than getting lucky with a bull market at the right time. You may not always be lucky.

Focus on the Process

By identifying your risk and return priorities and staying risk-averse, top investors can generate positive returns over a long period of time. This improves not only preservation of capital but also compounding. If you want to enjoy the same success—and after all, isn’t that why you’re investing in the first place?—You must understand and commit to practicing these concepts as well.

Every investment decision you make must take into account your risk and return priorities, and focus on the highest reward for the lowest risk possible. I don’t know of any successful long term investor who does not have a process aligned with this way of thinking. 

To find out what you need to do to be successful, no matter what, find out what the best investors do.

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Best Practice is a matter of your Best Interest.

Education and a Commitment to Informed Consent is an Obligation.

Chris Belchamber is an IRMAA Certified Planner

Medicare’s IRMAA impacts every retirement plan. Learning how to mitigate it is available via IRMAA Certified Planners designation.

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