Are you asking the right questions? Risk and reward in the stock market

“To ask the 'right' question is far more important than to receive the answer. The solution of a problem lies in the understanding of the problem; the answer is not outside the problem, it is in the problem.” ~ Jiddu Krishnamurti


Growing up, Krishnamurti was one of my favorite philosophers. If you haven’t been exposed to him, I’m happy to be able to introduce you to each other here, in the context of something close to home – investments.

I’ve found that most people approach investments with the wrong question in mind. And the wrong question leads at best to a misunderstanding of the purpose of money, which can lead to an unfulfilling relationship with money, and at worst suffering in the stock market.

What question do you approach investments with?

The most dangerous leading question I find many people ask is: How can I get more money as fast as possible?

What’s wrong with this question?

There are a few things I don’t like about this question:

A misunderstanding of where returns come from. When investing, it’s important to understand that higher returns are possible, but there is a fundamental relationship between risk and reward. In short, in order to get higher returns, you need to take on higher risk.

This relationship is so strong, that any time you hear someone say that they have a “guaranteed way to become rich,” you should immediately expect a scam.

Back in 2008, people thought that real estate was a guaranteed investment, and that led to some of the biggest banks shutting down! Nothing can hide from risk.

It is absolutely possible to make loads of money in a short amount of time, but those investments are so risky that it’s also possible to completely lose your investment. You might as well bet your life savings on a roll of dice.

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A lack of clarity about the impact risk has on daily life. Even when people say they understand the risks (usually these people identify as an “aggressive investor”), they don’t think through the impact that risks will have on their lifestyle, or their emotional reaction.

Right now, the stock market is experiencing the results of risk. As of the writing of this article on May 13, 2022, since the beginning of the year, the S&P 500 is down 16.3%! $1000 invested in the S&P 500 would have lost $163 in just a few months.

And if you’re close to retirement, expecting to live off a nest egg of $500,000 invested in the S&P 500, you’re looking at a loss of $81,500. That’s potentially years of retirement income that have vanished in just a few months.

If you had invested $100,000 for your child’s college tuition, you would have lost $16,300.

None of these scenarios would feel good. And that would lead to possibly the worst scenario: panic.

Panic selling and panic buying are the most surefire way to lock in losses. Why? Because when you panic buy or panic sell, you’re reacting to price movements that have already happened. Instead of guaranteeing returns, you’ve guaranteed losses.

And here’s the thing about panic buying and selling – ultimately no one knows how they’re going to react until they live through it. Just like any stressful situation, your fight or flight instinct can kick in, overriding any rational thought you might have.

Many are the “aggressive investors” who saw their portfolios losing value, and suddenly found themselves risk averse.

Remember this: more risk means more of a chance you can wake up tomorrow and suddenly have thousands gone from your portfolio. You have to ask yourself: How would that impact your life? How would you truly react?

A lack of clarity about what leads to a fulfilling life. The reason people ask that question, aiming for more money, is because of a belief that more money leads to a more fulfilling life.

Unfortunately, that is ultimately wrong.

If you really start thinking about what money is worth, you can quickly fall down an existential rabbit hole (“If money doesn’t mean anything, does anything mean anything?!”). We won’t go there, except to say that for our purposes, money only means as much as you let it. And more importantly, only as much as you value the things you can get with it.

One of Aesop’s fable tells the story of a man who melts all his gold into a brick and buries it in his backyard. Every day he’d go out, dig it up, and stare at it for hours. One day, someone saw him doing this, and stole it. The man was furious! A neighbor sees this and hears the man’s story. After trying in vain to comfort him, the neighbor finally says, “Look, if you weren’t going to spend it or use it in any meaningful way, then all you need to do is bury a brick in that same hole to come out and stare at! You’ll get just as much use out of it, and you won’t have to worry about anyone stealing it.”

Money in a portfolio is just like that brick of gold. It’s not good on its own unless you’re using it on things that make your life more fulfilling.

In other words, what is the purpose of the money?

Once you know exactly what you want the money for, and when you need the money, you can start building a portfolio that will be ready with that money when you need it.

Case in point

Here’s an example of why these are important. Economists tried to find the best way for an investor to become filthy rich by the end of their lives. What they found was that one powerful investing strategy is to use leverage to invest heavily in the stock market.

That leverage means using borrowed money. It means that investors would make twice as much money as others. However, this also meant that there was a strong chance of literally losing all of your money at least once in your lifetime.

The end result of all this is that this strategy is absolutely terrible for people. Why? Because I don’t know of anyone who could lose literally all of their money and go “I’m going to keep doing this. This strategy seems to be working!”

A better question

Take the emphasis off of the money. The questions to ask are actually much harder to answer, but lead to much better results.

I’m talking about open ended questions like “What does your ideal life look like?”

That’s right, we opened the article with a quote by a philosopher, and we’re ending it with a heavy philosophical question like that!

Here’s where we can help.

If you’re looking to identify what your financial goals could be, and what the best strategies would be to achieve those goals, we’re here to help. Sign up for a free Bronze Account here and a licensed financial advisor will reach out for a complimentary strategy session.

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