Why You Should Focus on Risk, Not Reward

With this in mind, Mr. Hart goes on to say, the German navy was focused on having its ships armored to the maximum degree possible, and crews were drilled not with added emphasis on rate of fire, as were their British opponents, but on damage control. Mr. Hart captures the German mindset by quoting Admiral Alfred Tirpitz:

“So long as a ship is afloat, it retains a certain fighting value and can afterwards be more easily repaired…We soon found that we had to experiment with real explosions in order to gain sufficient experience. As we could not sacrifice modern ships, and could not learn enough from the older ones, we built a section of a modern ship by itself and carried out experimental explosions on it, with torpedo heads, carefully studying the results every time.”

When the two navies clashed during World War I, the merit of the German focus on risk management became obvious, as time and time again its ships proved able to withstand damage and survive to fight another day, while the British system proved to have dire consequences for its crews, many of whom perished in catastrophic explosions after only a couple hits on their ships.

In essence, the British philosophy of sacrificing armor for speed, and safety for rate of fire, was a kind of leveraged risk with the hope of quickly reaping grand rewards in battle. The German philosophy was focused not on maximizing results by sheer rate of fire, but on surviving the encounter long enough to land lethal hits. This is, in my opinion, an apt analogy for the investment world, where, as Nick Maggiulli points out, even with a high degree of certainty regarding future outcomes, leverage can lead to catastrophic results. All too often when investors are behind on savings, or lagging a benchmark, they try to make up ground quickly by taking on more risk, neglecting of course the possibility of being wiped out should things go wrong.

Related: ETFs are the Rule

The prudent investor always starts with the end in mind, vigorously testing his assumptions, contemplating worst-case scenarios, and focusing on risk management. As the example of the World War I naval clashes illustrates, a defensive mindset does not mean that you will come short of your goals for lack of taking on sufficient risk. On the contrary, a keen awareness of risk will help you achieve your goals by helping you weather the markets when the tide goes out, thus keeping your portfolio intact when it is needed most.

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