Thursday, April 9, 2020

What are the essential principles of Risk-Free Success

Do you believe in success without risk? I just read The Warren Buffett Way and there’s an interesting passage there about how Warren Buffett considers risk:
He does not add a risk premium to his formula for the simple reason that he avoids risk…
“I put a heavy weight on certainty,” he says. “If you do that, the whole idea of a risk factor doesn’t make any sense to me. Risk comes from not knowing what you’re doing.”
Interesting, isn’t it? This is similar to what Malcolm Gladwell wrote in The Sure Thing. 

Gladwell argues that successful entrepreneurs, contrary to the conventional wisdom, actually don’t take risk. Instead, they are looking for “the sure thing”, the thing that can give them success with the least amount of uncertainty.

Knowing that Buffett has similar idea makes me really interested. Is it true? Is there really such a thing as risk-free success?

Here are five principles of risk-free success that I learn from The Warren Buffett Way:

1. Build your competence
If risk comes from not knowing what you’re doing, then eliminating risk means you must know what you’re doing. So it’s essential that you build your competence in the field you’re interested in. The best way to do that is by finding a mentor (Buffett was a mentee of Benjamin Graham) but you can also learn by reading books or talking with people. The important thing is that you should test your knowledge in the real world. It gives you the feedback necessary to quickly build your competence.

2. Never move out of your circle of competence
Everyone has a circle of competence. You need to know yours and be careful not to move out of it. Buffett, for instance, never invests in technology companies for the simple reason that he doesn’t understand them. Even during the dot-com boom when everyone rushed to buy technology stocks, he remained unaffected. Doing something outside of your circle of competence invites a great deal of risk.

3. Master your emotions
You might wonder: if people don’t know what they are doing, then why do they do it? The answer is that they can’t control their emotions. There are two primary emotions at work here: fear and greed. When they see that other people profit from a trade, greed makes them follow the crowd even though they don’t understand what they’re doing. And when they see that other people avoid something, they also follow the crowd because of fear. Your emotions make you do something that you don’t know. That’s why essential to master them.

4. Do your homework
It takes a lot of work to be certain about the prospect of a business. In Buffett’s case, he analyzes different aspects of the business such as its economic performance, management team, track record, and more. Only after doing the research can he be sure whether or not a business is worth investing in.
Similarly, you need to do your homework for the opportunities that come your way. Just because everyone else says that it’s good (or bad) doesn’t necessarily mean that it’s indeed good (or bad).

5. Be patient
This is related to mastering your emotions, but I think it’s worth a deeper look. Patience is one important lesson I learn from Warren Buffett. He said that one strength of his company is, strangely, inactivity. Other managers are often “addicted” to activity which makes them trade a lot of mediocre stocks. Buffett, on the other hand, is patient enough to wait for the great opportunity to come. This is probably one of the biggest reason why people do what they don’t know: they can’t wait long enough. Greed (to get quick gains) or fear (of not looking good in front of others) are at play here.

The next time you are about to take a risk, stop for a moment and ask yourself:
Do I know what I’m doing? 
o Is it in my circle of competence?
o Have I done my homework?

Do I master my emotions? 
o Are greed or fear at play?
o Am I being impatient?

By being honest with your answers, you can avoid many unnecessary troubles.
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