What a time to be an investor!
The S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) is up almost 8% over the last 12 months and many blue chips like CSL Limited (ASX: CSL), Cochlear Limited (ASX: COH) and BHP Billiton Limited (ASX: BHP) are up much, much more.
Perhaps the last thing you want to think about now is risk. But the investing weather can quickly change and often for reasons completely beyond our horizons.
The way I think about risk and return has been significantly shaped by legendary investor Howard Marks and I think much of it can be distilled into three of his best quotes:
1. You can't predict. You can prepare.
This was the title of Marks' superb 2001 memo in which he highlighted how futile it can be to rely on economic forecasts.
The line was borrowed, fittingly, from a Life Insurance Company tagline and I think it should be the founding principle of every investment plan.
The reality is you need to be prepared for things to go wrong.
Interest rates can go up, customers can jump ship, or your carefully selected investment may turn out to harbor unexpected surprises like Big Un Limited (ASX: BIG) or Blue Sky Alternative Investments Ltd (ASX: BLA).
Being prepared will help you keep steady nerves when others are panicking, positioning you to take advantage of changing tides.
2. 'If we avoid the losers the winners take care of themselves'
This is the mantra of Marks' investment company Oaktree Capital, one which encourages putting the time into thorough due-diligence while avoiding specific risks which are outside of our control as investors.
Ian Schapiro, one of Oaktree Capital's portfolio managers, says there are five risks he won't go near:
- Commodity risk
- Turnaround risk
- Technology/start-up risk
- Returns based on financial leverage
- Public policy risk
3. "For investing to be reliably successful, an accurate estimate of intrinsic value is the indispensable starting point. Without it, any hope for consistent success as an investor is just that: hope."
This requires little explanation, but it is a sage reminder on one of the most challenging and important aspects of investing. Without a way to assess value, you're flying blind, with no compass for when to buy and when to sell.
Thinking a bit about risk today and making small tweaks to prepare for the unknown can help you better navigate rough investment seas to come.
