How to Manage Risk

Kim Snider  |

No one knows what will happen, but the Fed reversing a historically long period of artificially depressed interest rates is probably a good time to brush up on your risk management.

One of my favorite finance writers is Morgan Housel. I highly recommend everything he writes.

In a recent post titled, “Risk Management“, he explains what Jeff Bezos calls his “regret minimization framework.”

Jeff Bezos’ Regret Minimization Framework

In this framework, you project yourself to age 80, or 90. “Looking back on your life, you want to minimize the number of regrets you have.”

A regret, in Bezos’ framework, is not a typical challenge or even period of great hardship. There are many things that are painful today but you may not regret tomorrow.

For example, in my 20’s, a well-known Wall Street brokerage firm lost all of a windfall I had made in an IPO and entrusted to them.

And to make matters worse, I had accumulated massive amounts of debt, thinking the party would never end.

At the time, it was awful.

Today, I wouldn’t trade that experience for the world. Everything I am, everything I have, everything good about my life sprang from that awful experience.

So that was not a regret.

Can we all agree on what would cause regret?

Once you frame risk as avoiding regret, the question becomes, “Who cares what’s hard but I can recover from? Because that’s not what I’m worried about. I’m worried about, ‘What will I regret?’”

You and I may regret different things. But Housel boils them down to two things that are universal:

  1. is a decision that can’t be easily reversed and/or
  2. is a decision with a downside so severe that it prevents eventual recovery.

So, in the first category, we are talking about long-term commitments that can’t be reneged on – concentrated illiquid investments or debt that can’t be discharged, like student loan debt.

The things you can change your mind about: careers, friends, spouses, employers, liquid investments – are not necessarily long-term regrettable, even if dealing with them sucks really bad at the time.

In the other category are decisions that you really can’t move on from. Getting wiped out late in life. Getting banned. Getting convicted. Severe reputational harm.

Truth be told, the number of things that fit in this second category is becoming fewer and fewer these days. Just look at our President!

How to manage risk…

So, that leads us to understand risk management as consistently avoiding decisions that can’t be easily reversed, and/or whose downsides will destroy you… permanently.

Is there such a thing as a “good risk”?

With that as the framework, good risks are those that you will both regret not taking and won’t regret if they backfire.

This was Bezos’s point: He would always regret not trying to build Amazon  (AMZN), even if it failed.

Which dovetails perfectly with the Charlie Munger quote I am so fond of, “Risk, to us, is 1) permanent losses of capital and 2) the risk of inadequate return.”

Why bitcoin is a “good risk”…

So, with bitcoin, the fact that you have this outsized return potential gives you optionality.

If it does someday go to $100K or $1 million… I am not saying it will. But there is an argument for how it could … That would definitely be a regret of a risk not taken.

You’ll be kicking yourself for not following my advice.

On the other hand, allocating a very small portion of the portfolio to it makes sure you won’t regret it if it were to go to zero.

That, in my book, and to a professional investor, is a good risk. Not something to be afraid of. Just something to be managed.

To me, bitcoin is like a superfood for your portfolio…

It diversifies, hedges against inflation AND has returned 13,000% over the last eight years… Going from 5 cents to close to $6700 today.

No guarantee that it will do that in the future, of course. But the fact that it could makes it a MUST in my portfolio.

As always, I hope that helps.

DISCLOSURE: This article was originally published on my company's blog.


The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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Symbol Name Price Change % Volume
AMZN Amazon.com Inc. 1,512.29 -81.12 -5.09 7,983,504 Trade

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