Welcome to the 141st episode of the Alternative Investing Podcast!
In today's episode, let's talk about asymmetric returns and how it relates to your wealth-building process so you can make smarter investment decisions.
If you're interested in diving deep into the concept of asymmetric returns to improve your investing strategies, then make sure to listen to this episode!
What are asymmetric returns, and how does this relate to your wealth-building process?
Well, today, that’s what we’re going to talk about.
As an investor, you constantly make small and large bets, and the question I want to unpack is whether the upside has to be way more than the downside.
Does it have to be asymmetric?
To give you some context, asymmetric returns mean that an investment's potential profit and potential loss are not balanced, or the potential profit is much higher than the possible loss. For example, if an investment has the chance to earn 10% but only has a 5% risk of loss, it’s considered asymmetric because the potential profit is bigger than the potential loss.
You often hear the term "asymmetric returns" used in discussions about hedge funds, venture capital, and stock markets. This is because these types of investments often involve taking a large amount of money and putting it into multiple ventures.
When venture capitalists invest money in startups, they hope that some of those investments will give them a return 100 times greater than what they initially invested.
They also recognise that the odds they play are significantly riskier than many other asset classes.
So they are prepared for the possibility that most of their investments (70% to 95%) may break even or result in a total loss. But, they also know that a small percentage (5%) of their investments have the potential to earn 100 times their initial investment.
And so the asymmetry they're looking for in terms of returns significantly differs from what most investors seek.
Often, these guys have been lucky enough to invest in companies like Amazon or Apple when they were starting. Over time, these investments have become worth ten times more than they originally invested.
Other deals didn’t do well, and all their investments were lost because the founder couldn't get their ducks in a row.
Are Symmetric Returns Always Necessary?
Now, the question I want to discuss with you is: are asymmetric returns always necessary?
Well, the answer is that it depends.
It depends on how you invest and how much risk you are willing to take.
As a beginner investor, many options are available to you that allow you to invest in new businesses, either through crowdfunding or other methods. Whether for personal interest, a hobby, or fun, the amount of money you choose to invest in these types of opportunities depends on why you are investing.
But intuitively, most of us understand there is a big risk of losing money when investing.
Now, could those investments catapult and give you a great return? Well, maybe.
But for some investors, they are willing to take this risk because they believe the potential gains are huge. It's like going to the casino, where they know the worst that can happen is losing their money.
Other investors prefer to make investments that balance potential gains and losses. This preference depends on several factors, which I want to talk about.
Key Takeaway #1: It All Depends on Where You’re at in Your Investing Journey
The first is whether you should chase investments with a big potential for gains but also a small risk of loss mostly depends on where you are in your journey as an investor. If you're just starting and looking to build wealth, you may be willing to take on some risk because you have time to recover from small losses.
When you're trying to grow your savings and build your capital, taking chances is okay as long as you have the time to make up for any losses.
When I was younger, I was more willing to take a risk on investments that could bring in big profits.
Now, did I lose money at times? Absolutely.
I understand why young or less experienced investors might think, "Why not? I'll give it a try. It might turn out really well." Because they were seen as a way to get rich quickly, many people have lost a lot of money investing in cryptocurrencies like Bitcoin and Ethereum.
But as long as you understand that these investments are highly speculative and have a high risk of losing all your money, it's okay to have some of them as part of your portfolio.
Last year, many people were hurt financially because they took too much risk when they invested in cryptocurrencies.
For example, some people refinanced their homes to invest money in crypto like Bitcoin to make big profits quickly.
When it comes to investing in things with a big potential for profit and a small chance of loss, you need to be extra careful because this can be driven by greed.
As you continue on your investment journey, you'll see that as you become more wealthy and have more money saved, you'll be less interested in taking big risks for a big reward.
From what I have seen with experienced investors, as they build up their wealth, they become less interested in taking huge risks and more focused on protecting what they have. This means that as people become more successful and build a bigger financial cushion, they become less willing to gamble with their money.
Instead, they prefer to make smaller, safer investments instead of putting all their eggs in one basket. This change in attitude usually happens once they have a strong foundation of wealth and want to ensure it's protected.
Key Takeaway #2: Investing Your Money vs. Other People’s Money
Now, the second thing about asymmetric returns is that most people do not have the luxury of playing with other people's money.
The reality is that when it's your money, no one else cares as much about losing it as you do.
A lot of people I've talked to over the past 20 years have given their money to an advisor who invested in things like stocks, funds, or speculative investments.
But sometimes, those investments didn't work out, and the money got smaller or was lost.
Some fund managers might act like it's no big deal, but it's a different story for the person who lost their money.
I recently saw a video where a famous trader, Matthew McConaughey, takes his new worker out to lunch and brags about how being a broker means taking people's money and convincing them to keep investing, even if they lose.
I often hear about this scenario in the wealth industry, where people make money whether their clients win or lose. They try to convince you to keep investing by saying that you will eventually make money in the end.
But when it's your own money that you are investing, the losses become more significant.
Investing your own money has real impact and consequences in your life, unlike when you're investing someone else's money and can ignore it.
Key Takeaway #3: Don’t Risk What You Need for Fun or Ego
The third point I want to make is that when you have worked hard to build wealth, no matter how big or small, it's important to have a smart attitude.
Don't risk what you need for fun or to feed your ego.
Sometimes, the idea of making more money can cloud our judgement and lead us to take unnecessary risks. Right now, there is a lot of risk and uncertainty in the market, so it's not a good idea to take risks with what you really need.
For example, I know people who took unnecessary risks with their money just before the financial crisis.
They were close to having a comfortable retirement but then made bad decisions with their money, like investing in risky businesses or giving it to others, because the potential returns looked too good to pass up.
But these investments did not pay off, and they lost money that could have given them a comfortable retirement.
This is an example of taking unnecessary risks for the dream of being rich instead of being smart with your hard-earned money.
Don't get me wrong, we are all susceptible to taking unnecessary risks with our money.
This is not a criticism but a reminder not to take risks with the money you need and has worked hard for.
Be careful not to waste your wealth on risky decisions just for the thrill of it, like betting it all on red or going to a casino.
Key Takeaway #4: Be Careful With Your Investments
The last thing I want to say about this idea of uneven returns is that, as I have gotten older, I have become more cautious in my investments.
I still make mistakes, and some investments don't always work out, but I spread my investments out over many different options so that if one fails, it won't have a big impact on my life.
If more wealth does not improve your lifestyle, then ask yourself, why bother putting yourself at risk for it?
For example, if an extra 10% in your wealth doesn't help you escape the daily grind, then it's not really meaningful.
Even though some people may be proud of how well their investments did during COVID, it doesn't mean they were actually great investors.
Sometimes, the market just goes up, and your wealth goes up with it.
In my case, my wealth grew during COVID, but it wasn't because of anything I did. It was just because the assets I already had did well.
Even though I could have sold my assets and realised the gains, I chose to play the long game.
Having a secondary income stream that gives me a choice to work or not is more meaningful than just seeing my net worth increase.
Having a high net worth is good, but it's not enough because what's important is how that wealth can help us achieve the life we want and make the choices we want.
We need to look at it in the full picture, not just as a number on paper but also as the income and opportunities it provides us.
Many business owners make a lot of money, but they feel like they are stuck and can't enjoy their lives.
So, we must be careful about what we want and what goals we set for ourselves and ensure that our plans for wealth don't conflict with our desired way of life.
That's where I'll end today.
To answer the question about seeking asymmetric returns, it depends on where you are in your investment journey. As you become more experienced and wealthier, you should be more careful and aim for stable, consistent returns instead of high-risk, high-reward investments.