I don’t claim to be an expert when it comes to hockey, but being a Canadian and a long-time fan, I have an opinion about Canada’s Olympic loss to the US hockey team. Some of the mistakes that can be made in hockey related to risk and reward carry over to the investing world.
There is no doubt that the Canadian team is absolutely packed with talent. However, they seem to play each game from start to finish with the desperation of a team trailing by 3 goals. By taking chances and pushing hard to score, they seem to be increasing the risk of giving up goals.
This is the right strategy when you are trailing toward the end of a game, but is unnecessarily risky at other times. Taking a risk that increases the odds of scoring by 5%, but also increases the odds of being scored upon by 10% is a formula for losing games over the long run.
The same principle carries over to money. For most people, the best hope for making $10 million quickly is to buy a lottery ticket. However, a $2 ticket usually has an expected return of less than $1. So, buying lottery tickets is a formula for losing money over the long run. This is true despite the fact that so many lottery players claim to have won more money than they’ve spent.
In investing, the best bet to make a lot of money fast is to borrow to the maximum and buy some highly volatile stock or option. But the odds of financial ruin are frighteningly high with this strategy as well. The potential reward just isn’t worth the risk.
It is important to take risks when the odds are favourable. This is why we choose to buy stocks instead of just bank GICs. For those who buy individual stocks, you have to ask yourself whether you can live with one or more stocks losing most of their value permanently. For those who are broadly diversified, you need to ask yourself whether you will be able to ride out steep declines in stock prices and wait for the eventual recovery.
If your answer to these questions is that falling stocks prices will lead you to financial disaster, the potential reward isn’t worth the risk. If I’m right about the Canadian Olympic hockey team’s problems, here’s hoping that they start to choose better calculated risks.