Have you ever noticed
Have you noticed that posters on finance messages boards almost exclusively post bullish views? Worse yet they shout down anyone sensible enough to venture a fearful scenario.
I wish there were more bearish views.
Fear greed spectrum
For every company there are multiple possible outcomes. Multiple scenarios across the fear-greed spectrum.
When investing it’s good to know and weight at least 3 alternatives. You could go crazy and use a Monte Carlo simulator. But 3 weighted outcomes will do.
So tell me, how many do you consider before buying part ownership in a company? And more importantly what’s your risk return hurdle?
Mine’s 3 to 1. But that’s simply to pique my interest ;-).
For every dollar I consider at risk I look for at least $3 in return. And get excited when I see over $5.
For example, if my fearful scenario for a company is a 50% loss, then the conservatively optimistic scenario has to be a 150% gain. However, these days I prefer lower risk, around 20-30% downside.
I currently have one large position that doesn’t meet my 1 to 3 hurdle. That makes me uncomfortable. Very uncomfortable, so I watch the company closely.
Risk return investing example
I used the following graph to highlight the attractiveness of Telstra Corporation (ASX: TLS) in January 2011. That opportunity had a 1 to 8 risk return!
Telstra was especially attractive due to multiple payoff windows that made it both an excellent short and long time frame investment. Just the type of investment I love, and suggest you look for — excellent risk return profile and multiple payoff time frames.
Using a risk return framework forces me to consider multiple outcomes and to look forward. It provides a rationale mechanism to overcome the noise of fear and greed. It would butter my toast if I let it! Most importantly, it forces me to consider what could go wrong.
Long live the bear.