Transcript
Mike:
Today, we are talking about risk and return. The two big R’s when it comes to investing in here’s the dirty little secret risk matters, at least as much, if not more, even than return, let’s imagine that you win Lato you win some lottery at a check after taxes for like 3 million. Let’s write that down. Cause it’s such a fun number 3 million. Yeah. Everybody’s happy. And you’re so excited and you start going this crazy spending spree, like all lottery winners do it first. Right. But then after going through about a million of it very quickly, you’re saying oh, I don’t 3 million anymore. I’ve got two and still a great number, but you’re starting to think, well, I, I gotta be, you know, mature about this. I, I should probably invest some of that million dollars. And, and so let’s pretend that you decide, you know, for the sake of discussion that you’re going to take half of this money, half of this million, and you are going to put 1 million in like a stock fund, some kind of a stock index fund, like the S and P 500 index fund has 500 different stocks in it.
Mike:
Something like that. And the other million, Hey, let’s, let’s have a little fun here. You say, I’ve always seen these crypto millionaires. I’m gonna put the other million in Bitcoin. Now I’m making Bitcoin. It could be an individual stock. Maybe it’s maybe it’s Facebook stock, cuz that’s, you’ve always wanted to own Facebook doesn’t matter. And the very first year you invest your money. Here’s what happens. And we’re going to ignore tax is do taxes make a difference. They might. But for now let’s just kind of go over this. So here we go. Your stock index, you’re up 30%. And you’re like, wow, I’m a great investor. Cuz are, you know, the market just cooperated that year. Right? Well what about our Bitcoin or our Facebook stock over here? How did it do that? Same year. That thing was up 60%. Whoa who’s winner winner chicken dinner now, right?
Mike:
I’d be like, wow. And in year two we come across this idea. How, you know how sometimes what goes up must come down. Well, let’s imagine year two is a down year. This on the left, my 30% percent that I was up, ah, now I’m down, it’s down 10%. It was a bad year in the market. And maybe on the right side on the the crypto or the Facebook also a bad year. But you know, it’s risk year. It’s down 40%, but now it’s two years in. You put a million dollars in each of these and you start doing the math. You’re like, okay, let’s let’s do a little math here. Plus 30 minus 10. I’m up 20%. I’ve done this for two years. Right? Divided by two. That means that I’ve averaged plus 10% per year. Not so bad. Right? You had some ups and downs, but not so bad.
Mike:
What about over here? Well, plus 60 minus 40 you’re up 20 again divided two years means, oh, look at this. We have gotten the exact same return, same return. We’re about 10%, both years. We are same old, same old. It didn’t matter where we put the money. We got the same thing, right? I mean that’s math. Whenever you invest money, it’s about not just return. Remember it’s about what risk and return risk and return. This risk would be. Plus 30 minus 10. That’s a range of about 40% that we saw between a good year and a bad year. What about over here? This range is like a hundred percent, right? And we’re like, that’s more risk. Risk means how much of a, you know, how much uncertainty do we have? How much of a range do we have in getting to our final number? Let’s go ahead, get a fresh sheet here and let’s do some math.
Mike:
So here we are. Here’s our stock index. We were plus, and remember we put a million dollars in and what happened the first year? We were up 30%. What is 30% of a million? Well, that’s equal to 300,000. So we start with a million, right? And we’re up positive 300,000, Hey, we’re at $1.3 million after one year. And you’re like, okay, Hey, that’s cool. I’m a happy camper. Right? But remember what happened the next year? Let’s change this to red. To remember our losses. It was down 10% the next year. Well what’s 10% of $1.3 million down $130,000. I mean, that’s pretty straightforward. And so when we go through and we say, okay, after we we’re at 1.3 million, we we’re down one 30. Okay. After two years, 1 million, $170,000. That’s where we end. Well, let’s do our Bitcoin or our Facebook or whatever. You know, we happen to go in the other direction, right?
Mike:
Let’s do that one beside it here in the first year. If you remember, we were up, remember how much? 60%? That’s like 600,000. And we started again with our million, right? And so we do our math and we’re saying, wow, look at this rat 1.6 million. And you’re like, wow. But the next year, remember what happened? We lost how much 40%. And what’s 40% of 1.6 million. Well, if you pull out your little calculator, it is a minus $640,000. We added up. We’re like, we’re at how much? $960,000. What is going on here? In both cases, we averaged 10% per year say same exact rate of return. But remember this one had a range of about a 40% when it came to risk, what was this one over here? It was a hundred percent, a lot more risk, same average return. Somehow you average 10% of the year and you lost money.
Mike:
How you feeling now? This is what they don’t talk about. This is what people like Warren buffet understand and what the average person doesn’t understand. It’s not just about this number right here. It’s not just about the return equally important. Maybe even more important is what is the risk, right? Is it down here? Is it a 40% range of potential return? Is it a hundred percent range of potential return? What is the risk? Whenever you reduce this number here, you get this number lower, the lower you make that number for the return you’re getting. The more money you have in your pocket. It is that simple. The whole financial industry focuses on return, right? You need to be smart. You need to also say, okay, return is important, but Hey, let’s make sure I’m also focusing on risk. It’s. It’s like you’re at the plate, you’re playing baseball at the plate. This is home runs and striking out over here on the left. You’re just hitting a lot of singles and doubles when it comes to your financial security, a lot of singles and doubles wins the game. All right. That’s our message. This week. See you again soon.
