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Most investors care little about what might have happened. They only value and rate the quality of their bets by the final outcome. In other words, often without realising it, they subscribe to the old saying: \u201call's well that ends well\u201d.<\/p>\n
But when in the investment equation we leave behind simple performance and look at something as subtle and complex as the ultimate downside risk that has actually been taken (not volatility<\/a><\/strong>), things are getting more complicated... but for the better. And this is of particular importance in this New Normal, where security and risk have changed hands to the amazement and ignorance of the financial world, as we warned in \u201cThe New Normal\", \"The New Normal\" and \"The New Normal\".\u201cWho has taken my risk?<\/a><\/strong>\u201d<\/p>\n Today, more than ever, the goodness or badness of an investment has to be calculated by analysing the profitability\/return trade-off. actual risk taken<\/strong>. The result only indicates that one of the possible scenarios has occurred, no more<\/strong>. If you haven't already done so, I recommend reading one of the best treatises on what randomness in finance means: \u201cFooled by Randomness<\/a>\u201dby Nassim Taleb. Because we should not lose sight of the fact that investing is, at the end of the day, trying to place and accommodate our wealth in the best possible way in anticipation of what may happen in the future, for its consolidation and growth.<\/p>\n There is little point in pursuing investment strategies which, although they may have been profitable for once, make savers assume high risks of ultimate losses. Because the mere fact that they have done well this quarter or this year does not mean that they will not crash the day after tomorrow, nor that their intrinsic risk is lower. And vice versa, in other words, the safest of investments can fall victim to a dark swan, taking a large part of the assets with it forever. And this can happen even if cautious investors have settled for a very moderate return in exchange for presumed security.<\/p>\n Therefore, the fact that a very safe investment has had a positive and moderate result does not imply that it cannot generate losses the next time. Nor should the success of a risky investment lead us to believe that the risk taken was lower. For sceptics to believe this, they need only think that if such a risky investment had the capacity to do well most of the time, it would in fact no longer be a risky investment, i.e. we would simply have considered it to be more risky than it really was, and so we would be doubly wrong.<\/p>\n Let us look at some examples of how paradoxical it sometimes is what ends up happening versus other possible scenarios that could have happened, and in fact may well happen in the future:<\/p>\n Investors who have placed their savings in the bank deposits of virtually bankrupt Spanish banks in recent years have obtained moderate returns that, to date, have not suffered any insolvency event. In fact, not even the Deposit Guarantee Fund (FGD by BBVA;) has had to face any coverage (aDg), beyond the plundering that the creation of the FROB and the regulatory shocks of the BdE and other regulators entailed. Even those bondholders who bought Spanish sovereign debt last year are currently obtaining capital gains with the reduction in the risk premium, religiously collecting - as a good act of faith - coupons and principal at their due maturities.<\/p>\n The million-dollar question is: Do these happy endings - or rather present endings - imply that these investors made good and safe decisions by placing their savings in these assets? The answer is NO<\/strong>. Because objectively and unconsciously, they have been taking on default risks all this time that do not compensate for moderate returns (and I would dare say not even high returns). Therefore, the risk of permanent loss of their assets has been and remains high, even if the scenario to date has worked out well for them.<\/p>\n If we transfer this to the world of chance, you will see it more clearly. If millions of people flip a coin 25 times predicting whether it will come up heads or tails, the number of individuals who have got all their predictions right will logically decrease, but in the end we will get a few dozen people who will have got it right each and every time.<\/p>\n Back to the million-dollar question: Does that mean that these people have a better than 50% chance of guessing whether it will come up heads or tails on the 26th pitch? Obviously. the answer is again NO<\/strong>.<\/p>\n However, these lucky ones, if instead of tossing coins at obvious chance they had made investments, would feel secure and confident that they could continue to make good returns, for their own money or for the money of others. They would thus believe, both themselves and their followers, clients or devoted parishioners, that the risk they take of being wrong is much lower than the risk they actually run.<\/p>\n For them, and unfortunately for most investors as well, only the outcome determines how good the investment is for them. And they simply disregard what might have happened with their bank deposits or their currency in other scenarios that did not occur this time, because for them the most likely and most likely outcome is always precisely what happened. A crass and expensive mistake.<\/p>\n Perhaps this post will spoil the party for some who rejoice in their performance and their ability to find \u201cthe best\".\u201csilver bullets<\/a><\/strong>\u201cconstantly. But it should escape no investor's attention that the valuation of risk (like the valuation of companies or the very prediction of the future financial scenario) is an art that goes infinitely beyond simple short-sighted performance.<\/p>\n