Productive Worrying

I recently read an excerpt from Seth Klarman’s Year End Letter that addresses the idea of worry and how it relates to investment returns. Whenever my wife starts to worry about things that I think are unimportant, the song made popular by Bobby McFerrin, “Don’t Worry, Be Happy,” comes to mind. When it comes to investing, that seems to be the mantra of the day. Don’t worry, everything is fine, this time it’s different, we’ve rounded the corner, the future is looking rosy, and every other manner of crap that comes out of Wall Street.

Almost all investment advisors, stockbrokers, and financial gurus spend their time marketing returns. In most of the advertising you will read about results. One year returns, five year returns, ten year returns, and so on. The purpose of this kind of advertising is, of course, to entice you and I into sending these folks our money. What they do not tell you is how much risk you must take on to achieve these fabulous returns.

When investment promoters do talk about risk, they typically only talk about is systematic or market risk. This is the type of risk that diversification will help to reduce. Notice that I say reduce. Market risk cannot be totally eliminated no matter how well you diversify because if the market suffers a large decline, all stocks tend to be affected to some extent.

The other type of risk is known as non-systemic or non-market risk. This type of risk is associated with individual stocks and has to do with such things as business risk, liquidity risk, and financial risk. These types of risk tend to show up when you invest in individual stocks or in sector funds that concentrate on one particular industry segment. Things that can affect non-market risk include such things as competition, new technology, and earnings shortfalls. I mention risk because in the current investment environment, decent returns have been hard to come by without taking on a tremendous amount of risk.

Investment managers are under tremendous pressure to deliver returns and as a result, take on increasing levels of risk in an attempt to beat the market. These investment managers are paid based on returns, not risk, because risk is hard to quantify. The only time we as investors concern ourselves about risk is when things are already going badly for us. This is not the time to worry. The time to worry is before things go bad.

Productive worrying allows you to identify risks and take appropriate action before you suffer lose. Concerned that a stock you hold may fall sharply? Then establish an appropriate hedge by buying puts or investing in an inverse fund.

Here’s the key…successful investing goes hand in hand with productive worrying.