Fear of Missing out continued….

Our conversation turned to an investing four-letter word: risk. “Tell me your thoughts on risk”, I asked. “Risk is the chance that I lose my money”, seemed like a straightforward reply that needed further exploring. “If you own shares of a company and the share price declined by 5% yesterday because of general market fluctuations, does that mean you’ve lost money?”, I asked. “Yes, and that’s what I’m trying to avoid, losing money” was his reply. I mentioned the issue is related more to time horizon than actual loss of capital but it is a common misconception with investors. At that moment, this made no sense to him and he said these two things are not related, “a loss is a loss is a loss”.

Time horizon is critical to understanding one’s risk appetite and the ability to handle risk. I explained that if he needed to have access to all his money nearly instantly, he has a very short time-risk horizon and should be in highly liquid money market vehicles. If, however, he had a longer time horizon view, more investment alternatives are available to him. Having a longer time horizon effectively deals with a number of perceived problems of losing one’s money. It’s not like we ignore these price changes and it always presents itself as a bit of a conundrum: is this an opportunity to buy at a better price or is it a signal of increased risk?

Here is a true life example. In the summer of 2020 a well known energy company traded at about $12, fantastic company, great financials and high inside ownership, the problem was that the natural gas they sold was at depressed prices, but we knew it would come back over time. Admittedly, we did have a higher price and on paper the loss did not look good. This investor called, very emotional about the loss and said “Just get me out of that one, I can’t stand to look at the loss” We talked about time horizon and he agreed wholeheartedly that for a number of reasons, longer term, natural gas prices would eventually improve and that he did not need to sell but didn’t like seeing the loss on his statement. We discussed this company’s financials and debt levels and agreed that even at current gas pricing, the company would not go to $0. A few days later, the shares were up about $12.70 and he called again, this time more adamant to sell. “I just can’t take it anymore, get me out”….so we did.

Earlier this week, the same investor called (you guessed it) to talk about natural gas prices and why we didn’t have exposure there. We revisited risk and time horizon again in our conversation and how it was emotion rather than sound fundamental thought that triggered him to sell back in 2020. He is now experiencing a different emotion because the shares he could not stand to look at when priced at $12.70 are now about $66.

The lesson here is that if your time horizon is long enough and emotions can be checked at the door, short term price declines represent opportunities with lower (not higher) risk. Risk is not short term price fluctuations, the risk investors are trying to avoid is permanent loss of capital. Permanent loss of capital happens when emotion clouds sound judgement.