The first in an occasional series on Value Investing
How often have you heard that if you want greater returns you have to take more risk?
It’s one of those stock market investing truisms that not only gets repeated ad nauseam, but most anyone that has ever met with a financial advisor, or opened an online mutual fund or brokerage account, has probably been asked to declare their risk tolerance, as if the more risk you take the more reward you can hope to achieve.
The implication is that risk is tied to reward and you must be willing to take more risk if you want more reward.
However, nothing could be further from the truth.
This is not to say that there aren’t some investments that are safer than others. A Treasury bill is certainly far safer than a corporate bond, for example. However, there’s not a direct correlation between riskiness and return.
The very fact that there is risk means by definition that you have a greater chance of losing money the riskier an investment gets.
The father of Value Investing, Benjamin Graham, summed this seemingly pervasive but erroneous view when he wrote “there has developed the general notion that the rate of return which the investor should aim for is more or less proportionate to the degree of risk he is ready to run.”*
The goal of investing is making money, and it is not just taking greater risk that gets an investor closer to that result.
So, what gets an investor more return if it is not taking more risk?
It is doing the painstaking work that leads to recognizing value.
According to Graham, return is not related to the risk you take, but the preparation you have done (or lack of it) in selecting your investment before you invest.
For the Value Investor, the research you do and your adherence to Value Investing principles is what determines your rate of return.
First among those principles is that price is at the heart of any investment decision, because even a good business or piece of a business can bring a poor return if bought at too high a price.
Graham notes that it’s not the risk you take, but rather “The rate of return sought should be dependent, rather, on the amount of intelligent effort the investor is willing and able to bring to his task.”*
Value Investing lays out the fundamentals that followers of this school of investing are looking for. Those fundamentals lead the investor to the price worth paying for an investment, whether it’s a share of stock or the purchase of an entire business.
Warren Buffett went so far as to state that “The greater for potential for reward in the value portfolio, the less risk there is.”**
So, the next time you are making an investment, don’t let risk be an indicator of reward, it will only lead you astray.
*Graham, Benjamin, et al. The Intelligent Investor: a Book of Practical Counsel. Harper Collins, 2013.
**Buffett, W. (1984). The Superinvestors of Graham-and-Doddsville. Hermes, (Fall)
© 2019 David Mazor
Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.