Are You Taking Enough Risk Trading Stocks

Taking Risks

I had lunch with a fund manager friend of mine on Tuesday. It was his shout and after we’d finished he paid. The waitress left with his credit card to process the bill.

I then said my retirement account was invested purely in index funds. Naturally, as an active fund manager, he was offended and he pretended to ask for the bill back so I could pay for my own f-ing lunch.

I explained my rationale: over a 30-year period (about when I’ll be retiring) it’s almost impossible to beat the market. My retirement fund and paying down my mortgage would mean I’d have a very comfortable retirement.

Moonshots

I then said that, outside of my retirement account, I would make “shoot for the moon” investments. I called them “moonshots”.

Moonshots?

Basically, investments that have potential for massive returns: investments that could turn $5,000, into $50,000 or even $500,000; investments that could make a material difference to your medium-term wealth.

A moonshot has limited downside, but huge upside. It’s a stock where you risk $1 a share but could earn $100 or more.

Moonshots provide spice, and hope, if your income potential is limited and most of your portfolio is conservatively invested.

Made $30 million and retired

My friend was sceptical when I mentioned moonshots.

Then he remembered what he described as ‘coterie’ of London-based Australian brokers who had done exactly that – bought moonshots.

They bought into an Australian resources company at around 5c a share. It was later bought out for over $5 a share. They made around 100 times their initial investment. One broker pulled out a million; the other made close to $30 million and retired for life.

I got the idea for moonshots from the late Peter Bernstein, the highly respected economist, money manager and author of books like ‘Against the Gods’.

Berstein was one of those wise old guys that I increasingly listen to.

Advice for youngsters

In an interview Bernstein talked about shooting for the moon.

He was asked this question:

Is there any specific advice you can offer to financial advisors that manage assets for younger clients?

His answer:

I learned from managing individual money that investors with small portfolios, relative to other assets, take too little risk. Their overriding criterion is the consequences of loss. But when you are young you can afford a loss. Shooting the moon and losing is not terrible. But making a killing makes an enormous difference. The fear of regret is weighted too highly. Investors can take risk through higher equity allocations, exposure to small cap and international stocks, and by being less diversified.

A long time ago I gave a talk at the New School of Social Research. A man – not too well dressed – came up afterwards and asked if we were looking for a new client. I said “sure, send us your portfolio.” He owned only three stocks, like U.S. Steel, that he had bought on margin and now had big profits – on the order of $150,000. He was doing very well, so we asked him why needed us. He was a reporter with the Brooklyn Eagle, and he was losing his job because it was going out of business. Had only $15,000 in the bank and was going to be broke in a year. But, with his investment success, he had a comfortable amount. He took the right risks at the right time, and it paid off. I learned a lot from that person, and I think about it often.

Frustratingly, Bernstein didn’t really go into too much detail. But his point is this: sometimes we take too little risk. Steve Cohen’s coach Ari Kiev used to say too little risk for traders is as big a problem as too much risk.

Context of lives

I need to put moonshots principle in the context of people’s lives. Some people have limited capacity to earn big bucks. Some people are not business people — they will never start a business, grow it and cash out.

So for them, they look ahead and see a reasonably good income, then after 30 years of disciplined savings and investing a comfortable or affluent retirement.

That’s comforting, but also kind of depressing – where is the upside in the meantime, at 40, 50, 55?

I’m convinced that almost all men need to pursue the accumulation of a modest fortune. Psychologists and socialists will tell you that’s crap and that there’s more to life.

There is (which is why I’m a self-employed writer!), but the material impulse in man is also powerful and dangerous. Crush it and deny it and it can warp you.

The most jealous people I meet are often school teachers and public servants with limited monetary upside who become embittered with the world because all they see around them are rich people; rich people who have what they never will.

Money makes you more satisfied

Psychologists are also revising the notion that money doesn’t make you happy. Yes, they’ve found that money does make you happier up to about $US75,000, then it tails off. But they’re also finding that the more money people have, the more satisfied they are with their lives: when people look back at their life and achievements, the more money they’ve earned the more satisfied they are.

My point is that having some kind of medium-term financial upside potential – call it hope – is extremely important.

But if you can’t earn a big income or are not suited to business, then you need moonshots for that – you need a portion of your income at risk in the hope of making a big enough return in the next five to ten years to make a substantial boost to your wealth.

Buying penny dreadfuls?

So am I going to go out and start buying penny dreadfuls and hope to make 100 times my money?

No.

But what the ‘shooting for the moon’ principle does is reinforce my belief in the aggressive-growth, momentum trading style and where it fits in my portfolio: it is the portion where you go for it, and which could deliver a significant windfall in the medium-term – it gives you hope that something will change for the better as you plod towards retirement.

As usual, there is a caveat. Moonshots, as mentioned, need to have limited and defined downside and virtually unlimited upside. It’s like the Aussie brokers inLondon. The worst that could have happened is they’d lose 5c a share (unless they were using margin). If the resources company failed they weren’t going to end up in debt.

Sensible people

Momentum stocks are similar: a well-placed stop limits the downside, but the companies have huge potential to earn big returns in a relatively short time-frame. They have moonshot potential.

Sensible people will tut tut and frown at all this. For the most part sensible people are right and I certainly listen to them. But as I’m learning, life is more complicated than sensible people lead you to believe – we all need a bit of hope in all aspects of our lives, including financial.

NO COMMENTS

LEAVE A REPLY