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Lower risk doesn't mean lower returns. It's the opposite.
Do you need to take higher risks for higher profits? No.
Many misunderstandings regarding investment rules circulate among Wall Street newcomers and even pros. And, because financial journalists rarely have an in-depth understanding of the issues on which they write, they tend to repeat what they have read from their colleagues without fact-checking it.
One of the most widely held Wall Street myths is that in order to make more money, you must take on more risks.
This couldn't be further from the truth.
The typical argument is that a savings account is the safest place to deposit your money because it offers the lowest risk and interest. From there, the risk climbs in proportion to the potential reward, with stocks having the most risk, followed by CFDs and options. When you read anything like this, you know it's theoretical. Why? They did not account for inflation. Assume you earn 0.5 percent on your savings account and inflation is 3%; you will almost certainly lose money. However, a savings account is seen as a low-risk investment, despite the fact that it guarantees a loss.
Consider stocks as an example of a higher risk class. If the low interest on my savings account is insufficient, I must accept a proportionately larger risk and select the "riskier" asset class.
So far, so good.
But this assumption misses one key element of investing: the margin of safety.
When you always consider the potential downside of a stock rather than wishing for it to increase, statistics are on your side and your winnings will multiply over time.
The less likely it is that a stock would lose value, the more likely it will grow or, at the very least, you will not lose money on it. This contradicts what you generally hear on Fintwit, which is all about how much a stock may climb and its future prospects. As an example, consider the following:
The Apple stock was at a low in January/February 2019 after multiple analysts downgraded it and the sentiment about the durability of its growth shifted to the negative. They were overly reliant on the iPhone etc…
If you had listened to the "experts" back then, you would have lost out on a fantastic chance that many others neglected.
It was already trading at low multiples so it caught my attention, and then I remembered one article from the previous year:
Apple also announced a goal to use nearly all of its $163 billion in net cash, hinting at more stock buybacks, dividends or acquisitions. Its total cash holdings rose to $285 billion in the December quarter, while its total debt was $122 billion.
Now let's take a look at their market cap in 2019:
At the start of 2019, investor sentiment toward Apple was low, and they had a few weeks to buy them at a market cap of 750-800 billion dollars. Furthermore, they had significant cash reserves that they hoped to "neutralize" in the coming years through share buybacks, dividend increases, and acquisitions. You were buying their business model even cheaper if you subtracted their cash reserves. They were also in the middle of a shift towards a subscription-based model called Apple One. This was the downside protection you need to look out for. Two years later the market cap was at +2Trillion $—around a 200% gain.
The savvy investor had a one-of-a-kind opportunity to acquire an exceptional firm with more upside potential than downside danger. This is the type of chance you should be on the lookout for: Low risk, huge potential payoff.
When it comes to investing, change your perspective and take everything you hear from the financial media with a grain of salt.
I hope you learned something today. Until the next issue. 👋
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