Risk is defined in many ways. Many say it is volatility. However, those who can maintain a long-term perspective tend to view risk as the estimated probability of a permanent loss of capital. Those who hold the latter view are more apt to invest in securities that others may deem “risky.” Sure, with broad strokes one can say that some investments are more inherently volatile and have a greater chance of loss, but this all depends highly on the purchase price. There is always a price where something becomes a value.
Ironically enough, a “risk” first approach to investing inherently focuses on returns. When an investor is more aware of risk, they tend to be picky about the security and the price they ultimately are willing to pay. Often times, this leads investors to unique and underappreciated markets, which can result in putting them into the position of a “lender of last resort” to the other side of the trade. As a liquidity provider in this instance, the investor can offer his counterparty cash to ease their concerns. In return, they then receive a security to which the previous owner had negative emotions attached. In this instance, one investor’s trash can indeed be another’s treasure.
Furthering on this concept, I was recently introduced to an idea that was, at first, baffling to me. The idea was that profits are booked when you purchase a security, not when you sell. Counterintuitive to most, this idea merits further consideration. To be sure “buy low, sell high” certainly makes sense, but with the massive amounts of information now available to investors the problem is not transparency, but an overflow of pertinent data. After all, what is “low”? What is “high”? There is so much data that it has become difficult to siphon through and make a decision. Moreover, even if you do, you’ve now got to wait for others to arrive at a similar conclusion. Luckily, there are some absolute principles to guide investors through.
As many value investors say, look for a margin of safety. A margin of safety is buying an asset for less than it is worth, often times, significantly. This can occur when fads take over the collective psyche of the market and when people want out of a certain investment due to overreaction or any number of other irrational reasons. What if this margin of safety wasn’t theoretical? What if you could look at it as a tangible level on a daily basis?
With closed-end funds, you can. You can buy one dollars worth of assets for less. You can book your profit when you buy, not when you sell – in a relative sense anyway. A dollar in a ETF or mutual fund is a dollar in assets and there’s nothing wrong with this approach if fees (as opposed to total return) are the crux of your decision. However, if you want more money in your pocket, after fees, you may want to consider looking at the bigger picture.
Risk-first investing means protecting your capital at the time of purchase. Finding treasured returns often comes by way of first mitigating risk in seeing the value in something that others might not find as attractive, investible, or understandable.