Risk: The Most Misunderstood Four-Letter Word
Last week, I told you a story of what happens when you over-commit to an idea founded in foolishness.
This week, I want to tell another story — one of my favorites, and probably the bane of those close to me who have had to suffer through it more than a few times over the years.
This story isn't about over-commitment to a bad idea, but rather under-commitment to what turned out to be the opposite of a bad idea.
I'm not doing it just to indulge myself in some really, really juicy schadenfreude, though there may be a trace of that at play here, too.
Mostly, I'm doing it to illustrate what happens (or in this case what can happen) when one takes advantage of one of the most misunderstood and needlessly feared concepts in investment: risk.
Who Leaves Stanford to Start a Website?
It all began in 1996, at a gathering of family and friends at my parents' house in Wilmington, Delaware.
Though I forget the occasion, there was one conversation that will always stick out in my mind, and what triggered the memory was my father preaching on how he views the practice of investing.
He said this in Russian, and after a few drinks, so my translation is devoid of the requisite colorful expressions and implied contempt, but getting down to the bare gist, it went something like this:
People who spend their time doing it are just undiagnosed gambling addicts. They need to learn a trade and be useful to the world. If you want to make money and get rich, there is no substitute for work. Years of consistent hard work.
It was one of his favorite things to rant on about, and from his perspective, it made sense.
He was a doctor. He worked for a living. He always had. And after relocating here from the USSR in the 1980s, working consistently had definitely worked for him.
Investing was something he begrudgingly let other people do for him, and in his mind, it was less of a job and more of a cultural habit that set Americans apart from most of the civilized world.
Among those present at the table was a couple who had been our neighbors years earlier, when both of our families had just immigrated to the States from Russia.
Do You Remember the Biggest Mistake You've Ever Made?
She was a chemist and he was a mathematician teaching computer science at the University of Maryland. We'll call them Lina and Simon, for the sake of respectful anonymity.
As my dad was reaching the crescendo of his self-righteous preaching, Lina quietly chimed in.
“Last month, we were offered an investment opportunity. One of Simon's friends at work has a son at Stanford. He made a program for the internet. It's supposed to be very interesting.”
“Oh?” My dad's voice suddenly changed. “Yes, the internet. That is interesting indeed.”
“Interesting? It is good cause for a heart condition!” Simon jumped in, droplets of wine landing on the table as he nervously moved his hands about. “This boy and his friend wrote a few pages of code and now they want $10,000 for some reason. Is this how people get rich working with computers today? They write some lines on a screen and then send out letters requesting small fortunes?”
Everyone else at the table, the adults, were now shaking their heads, taking sips of their booze, and smiling with thinly veiled disdain.
These were all people who stood distinctly on the side of my father. It was work, not gambling, that gave you what you deserved. It was the natural and obvious way, and it was what built the world — and the great nation they had chosen over their own homeland.
As a member of the younger generation, however, my interest was piqued immediately. I was already familiar with the story of how Apple Computers got started, and Bill Gates was, at the time, the richest man in the world.
I had grown up around computers, and the internet was already transforming the world, even in these early stages.
Sometimes the Easy Way Out Is Also the Smartest
Compared to a lifetime of “consistent work,” investing in revolutionary ideas sounded like a faster, more efficient, and all around better way to go.
“Well, I'm not doing it,” Simon muttered. “That little snot can take his algorithms and web pages and find some other fool to lie to.”
“Don't be so hard on the boy,” Lina quietly added. “He's planning to take a break from his studies to build this company, and his advisor is helping him do it, so it must be more serious than you assume.”
“Ha!” Simon scoffed. “Planning to leave Stanford to build a website. The last thing this advisor should be doing is giving advice to students! He should be fired!”
Simon's anger effectively killed that topic, as everyone at the table, besides me of course, was eager to move on.
Simon's annoyance, however, would transform into another emotion within the next couple years.
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You see, back in the late 1990s, there weren't too many Russian immigrant mathematicians working in the computer science department at the University of Maryland.
But there was one such man whose last name would become notable in the years to come: Brin.
And his son Sergey, who was a graduate student at Stanford back then, would go on to become a legend of Silicon Valley.
Our hardworking but tragically shortsighted friend Simon was among a few lucky individuals who had been extended an opportunity to invest in the company that would become Google Incorporated.
That's a story I probably don't need to tell, as it became common knowledge even years before the search engine giant went public in 2004.
Sergey and his partner Larry Page are now billionaires dozens of times over, and that $10,000 Simon was so dead set on holding on to would be worth somewhere in the neighborhood of $100 million today.
Not bad for a mathematician from the former Soviet Union... if only he'd taken the chance.
Now, back to the original point.
Don't Fear the R-Word
Risk, in the world of investing, isn't the same kind of risk one takes when running across a busy highway.
Risk is the process of strategically exposing existing assets to uncertainty, with the expectation of emerging from that uncertainty better off than you were when you went in.
An investment in Google that early on was indeed risky. Had things not worked out, all of Simon's $10,000 would have vanished.
That's the nature of pre-IPO investing and the reason why by law, only a select few are allowed to participate...
People directly involved with the company, professional investors, investment funds, and, in the case of Simon, friends and family of the founders.
The greater the initial risk, the greater the ultimate reward.
But today, there are intermediate levels of risk exposure, available to investors lacking such extraordinary industry connections.
Somewhere between the early pre-IPO stages and the late post-IPO retail investment stage (like the kind you would be getting yourself into if you bought some Amazon stock this afternoon) is a little-known corner of the investment world that can maximize the risk/profit potential ratio.
Few everyday investors get into these investments for one very unfortunate reason: They simply aren't aware that these opportunities exist.
You might not be turning $10,000 into $100 million, but you're also not shooting for 6% annual returns.
Your results, if you apply a few basic risk management tools, will yield you something in between.
For most people, that's more than enough to do what my father, to this day, considers a silly American aspiration: retire early and enjoy life.
Fortune favors the bold,
Coming to us from an already impressive career as an independent trader and private investor, Alex's specialty is in the often misunderstood but highly profitable development-stage microcap sector. Focusing on young, aggressive, innovative biotech and technology firms from the U.S. and Canada, Alex has built a track record most Wall Street hedge funders would envy. Alex contributes his thoughts and insights regularly to Wealth Daily. To learn more about Alex, click here.
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