Size of Bet Revisited
All else being equal, I think we can all agree that we would risk more on things when we have a higher degree of comfort that they will work out in our favour. The question is, how do we gain this comfort? Do we need to assign a probability to quantify exactly how comfortable we have to be before we determine the size of our investment? Recent research suggests that 99% of human action is based purely on the subconscious, whereby the human body performs quite complex processes to follow a chosen path of motion. It knows the individual functions so exactly, that we can literally shut off and think about the bigger things in life, like what to do next. In operating on automatic, our human machines calculate many probabilities in terms of how to best assign the priorities of each of the individual functions. What is the probability that I will get hit by a car if I cross the road here? What if I look before crossing? What if it rains? We can break down every action, and reaction, every detail of any process, and we assign probabilities quite naturally to almost everything we do. Applying this very part of our DNA to financial investments, and it is surprising how easy it actually is to become completely comfortable with one’s overall strategy. It is in how we feel about the risk of our investments that we can actually determine how much we want to put on. The easiest way to understand is this: when someone asks you, “how has your equity portfolio done in the recent sell off?” and you buckle over in pain, as the sting of the losses has created personal financial distress, then you know you have too much risk on. And you knew it at the time when you made the investment, and you know it now. Investing isn’t about finding the next big thing, taking a huge bet, and becoming rich overnight. Investing is about assigning probabilities, spreading your risk and letting Father Time take care of the rest. Compound interest is the eighth wonder of the world (Albert Einstein), and you would be well advised to trust your gut before making any investment decision. Please also see our earlier post Size of Bet for more of our thoughts.