Luck and risks are two intertwined concepts that share a close relationship. They can be thought of as companions that accompany us through life and have a significant impact on the outcomes of our actions. They are so closely linked that they exist in almost all aspects of our lives and can greatly influence the result of our endeavours.
Managing luck and risk is particularly important in investment because it can greatly impact our investment outcomes. These two can determine whether our investments are successful, and one must fully understand one by giving equal respect to the other.
Therefore, as an investor, we must give equal respect to both elements and have a well-planned Investment Strategy to manage both. A balanced approach that considers both risk and luck can lead to better decision-making, more consistent outcomes, and potentially greater returns over the long term.
In this article, we will explore the concepts of Luck and Risk in Investment, their impact on Investment Outcomes, and the Investment Strategies investors can employ to get the best of both.
Table of Contents:
1.)The Omnipresence of Luck and Risk in Investment:
2.)2020 and 2008- Factual Exemplars of Luck and Risk in Investment:
3.)Luck in Investment
4.)Penny stock Investing: Can the success be replicated?
5.)Risk in Investment
6.)Is the Stock market a Risky bet?
7.)Managing Luck and Risk in Investment
- Why managing luck and risk is important in investment?
- SIP: A Consistent and Disciplined Investment Approach
- Asset allocation
- Rebalancing Scenario 1 – Feb-March 2020: Buying the Dip
- Rebalancing Scenario 2 – Nov-Dec 2022: Selling the Rally
The Omnipresence of Luck and Risk in Investment:
In life, any financial decision or action we take is influenced by two fundamental factors: luck and risk, and so are our investment decisions. Both luck and risks are significant determinants of investment outcomes, and understanding how they operate is critical to making informed financial decisions.
But how have luck and risk played their roles in our investment journey?
Let’s look at some examples where they were prevalent and had an effect on our Investment Portfolio.
2020 and 2008- Factual Exemplars of Luck and Risk in Investment:
To better understand the roles of luck and risk, let’s take 2 examples. One from the year 2008 and another from the year 2020.
A person who entered the market in March of 2020 would have likely seen significant gains as a result of the market’s overall upward trajectory. Whatever they had invested in would have given exceptional returns. During this mega Bull Run, he might have even made more ROI than seasoned investors like Warren Buffet and Ray Dalio. While the individual may believe that their success is due to their own investment savvy, the reality is that luck is likely the biggest factor.
Now back to 2008. If you had entered the markets in 2008, your Investment Portfolio would have been red for the next few years. If the investors believe that this is what happens in stock markets, always citing this as the reason, they may be discouraged from investing further, even if they have the potential to make back their losses over time. This fear of risk can be a major barrier to Investment Success.
These are the instances where we need to think logically and dissect the impact of luck and risk on our Investment Outcome. Whenever we get remarkable returns, we shouldn’t be over egoistic and think about whether this return can be made consistently forever and whether this is a fail-proof investment scenario.
There are no such investment instruments that offer these.
Similarly, when we lose something, we should study the risks we fail to notice and correct the same in our next investment choice.
One other learning from these facts is that we investors should analyze our past experiences in the stock market and evaluate if the outcome was because of luck or risk involved in our Investment Choices.
For instance, the person who invested in 2020 might be extremely buoyant about markets as he had extreme luck. In contrast, the person who invested in 2008 might be subdued about investing in markets as he had seen the risk.
Luck in Investment:
Luck refers to events that are outside your control and can significantly impact your investment outcomes. For example, winning the lottery or inheriting a large sum from your father or grandfather can significantly impact your financial situation. However, luck is often unpredictable and unexpected and may or may not happen the next time.
While luck can positively influence investment outcomes, investors need to understand that luck is not a sustainable strategy for investing. Relying on luck to achieve your Investment Goals is not a sound strategy, as luck is unpredictable and fleeting.
In his book Psychology of Money, Morgan Housel quotes, “Everything worth pursuing has less than 100% odds of succeeding, and risk is just what happens when you end up on the unfortunate side of that equation.” It is as simple as that. When one works, the other one is in deep slumber.
Penny stock Investing: Can the success be replicated?
Let’s consider that you invest in a penny stock that is trading at less than a rupee with little research. You had heard about this stock from a friend and decided to try your hand at it. You invest a small sum of money in the stock and have a gut feeling that this stock is going to grow manifold.
After some 5 years, you see the same stock trading at a value of over 100. In essence, you would have made a bumper 100X on your investment.
This is what we call luck in investment. But can you be complacent and invest all your hard-earned money again into penny stocks?
The first time you were lucky, and you made tremendous wealth. Ok, sounds good.
But can the same be expected the second time as well? Not.
Many times, after this kind of lockful success, investors sell all their other assets and also borrow and invest everything in the next penny stock opportunity and lose everything.
This is where we should be rational and say Ok, I was lucky the first time, and I may not be lucky the second time around.
Risk in Investment:
Risk, on the other hand, refers to the possibility of losing money or not achieving expected returns due to factors such as;
- Market Fluctuations
- Economic Conditions
- Company Performance
Risk is a more predictable factor than luck, as you and I can analyze market trends and company performance to make informed investment decisions.
Risk is something that is under our control. We incur risks on the assets we choose to invest. So, it is all on us. This is where rational thinking comes into the picture. We must set realistic expectations and invest according to our Financial Goals.
Is the Stock market a Risky bet?
Stocks can have positive and negative attributes, with some providing strong returns and others underperforming. However, the fact that some stocks perform poorly does not necessarily imply that all stocks are poor investments.
A good example of a stock that was once a solid investment but declined in the Indian stock market is Satyam Computer Services Limited (Satyam). Satyam was a leading Indian IT services company with a reputation for delivering innovative technology solutions to its clients.
However, in 2009, the company’s founder confessed to a massive accounting fraud that had been going on for years. This revelation sent shockwaves through the Indian stock market, and Satyam’s stock value plummeted. The company was subsequently taken over by Tech Mahindra, and its name was changed to Mahindra Satyam.
The example of Satyam Computers highlights the reality that the stock market is not entirely black or white, good or bad. Investing in Satyam Computers would have resulted in significant losses for investors.
Therefore, it is crucial to perform effective risk assessments and adopt appropriate mitigation strategies to avoid such losses in your investments.
Managing Luck and Risk in Investment:
Why managing luck and risk is important in investment?
Before we move on to the Investment Strategies for managing the luck and risks in investment let’s understand why is it good to manage both the params viz. luck and risk.
But wait! Managing Risk is okay? But should we manage even luck? Yes definitely. Risks in investments make you fearful of the markets, whereas the luck factor can make you complacent.
Failure to manage risk and becoming too complacent can result in taking unnecessary and blind risks that could potentially lead to substantial financial losses. This can happen when investors become overconfident and make poor investment decisions based on the belief that they can beat the market. This thought may have crept into their mind as they might have experienced luck in their previous investments.
For instance, an investment in a stock could have given you even 2X-3X returns earlier. If you have the same mindset and go all-in there is also a possibility that this may go to zero. This is where you will have to put on your rational thinking hat and take a wise decision.
As investors, it is important to pay attention to general trends of success and failure, such as the advantages of systematic investment planning (SIP) asset allocation and portfolio rebalancing. These strategies can help us navigate the fluctuations caused by luck and risk in our investments.
SIP: A Consistent and Disciplined Investment Approach
SIP involves investing small, regular amounts of money into a chosen fund over some time rather than investing a large lump sum at once.
During periods of market stagnation, investors have the opportunity to accumulate more units. Later, during a fortunate phase known as the “Bull Run,” these accumulated units can contribute to the growth of their wealth. This strategy can mitigate the impact of market fluctuations and potentially generate more stable returns over an extended period. You can check the common SIP mistakes and how to navigate through them in one of our earlier blogs.
Asset allocation reduces risk and increases returns by spreading investments across various asset classes, including;
- Real Estate
This diversification helps to offset the negative impact of underperforming assets with the positive performance of others. Therefore, even if one asset disappoints, another may perform well and compensate for the shortfall.
For Asset Allocation, you consider multiple factors such as your Financial Goals, and Risk Profile, and then decide the right asset allocation in your Investment Portfolio. Say you have arrived at 60-40% i.e., 60% of the portfolio is in equity while 40% is in fixed instruments.
After a few years, these allocations may change depending on the economic conditions and the market value of your Investment Portfolio. Hence the earlier allocation of 60:40 may have also changed. Now is the time to make amends to your Investment Portfolio and change it back to the required levels.
- Rebalancing Scenario 1 – Feb-March 2020: Buying the Dip
Let us say you had maintained the desired ratio of 60:40 in Feb 2020. Now in March, we saw the stock market nose dive to 8K levels. This would have caused your investment value to go down, bringing your desired equity allocation say to about 45%.
Now is the time to think smart and rebalance and bring the equity-debt asset mix back to 60-40%. By doing so you buy low. This Investment Strategy not only helps in bottom fishing but also makes sure you participate in the market reducing your risk and enhancing luck.
- Rebalancing Scenario 2 – Nov-Dec 2022: Selling the Rally
Now the bull run from March 2020 has begun to lose steam. At this point, your equity investments may have grown at a good pace and as a result, your asset mix might have been skewed to say 75:25 in favour of equity investments. So, we apply the same Investment Strategy again here. Rebalancing. We sell certain equity portions and buy some fixed instruments like debt funds or bonds, making it back to square one. i.e., at a 60:40 ratio.
The fundamentals of these approaches are to avoid pursuing paths of excessive risk and relying solely on luck. Although such opportunities may appear thrilling initially, they may not be sustainable over a longer duration and lack a solid foundation. Instead, it is advisable to opt for the most rational and logical investment approach, which is more dependable and less prone to failure.
In conclusion, the interplay between luck and risk is essential to financial success. While luck can provide a temporary advantage, effective risk management is crucial to long-term financial success.
Understanding Personal Financial Goals, Risk Tolerance, and Market Conditions is essential when developing a Risk Management Strategy.
We all may want luck in our investment but without any risk, which is impossible. The only way is to minimize the risk and let the show continue.
You can also consult with your Financial Advisor in order to draft an Investment Strategy according to your Financial Goals to attain better results in your Investment Journey.