Importance of Recognizing and Controlling Risk in Investments and Business

03 September 2018

Importance of Recognizing and Controlling Risk in Investments and Business

Greetings from Hitesh! We are taking one after other aspects of successful investing. In the last we had talked about Measuring Risk. Very few people read our post on RISK!! Either they are assuming there is no RISK or they are behaving like OSTRICH. 

Today, we will talk about Recognizing and Controlling Risk in investments and business.

Let me share a real like example of Dhirbubhai Ambani in recognizing and controlling the risk.

When they were building JAMANAGAR Refinery – they projected the construction costing based on Earth Quake on the Richter scale of 6. Dhirubhai asked how much more they would have to spend – if they wanted it to make it at 8 Richter Scale? Additional Cost was Rs.1500 Crs. He spent that additional money and his plant was intact in 2001 earth quake which was at 7.5 Richter scale.

In the above example following issues can be noted.

1.  Jamnagar never had a track record of heavy earth quake, but it was the foresight of the Dhirubhai to think out of the box.

2.  Had the earthquake not come, it would still have been considered as a waste of Rs.1500 Crs.

3.  Many buildings in AHEMDABAD were also affected due to earthquake. Those who were living in buildings were under the impression that their buildings are earthquake proof, and nothing may happen to them. But, one earth quake proved them wrong.

4.  Risk can only be measured in exact terms post events only.

How does this impact the investments?

Risk is not visible because risk is the possibility of loss. Loss is visible. Loss happens only and only when RISK meets the adversity in the market.

If the market was not faced with negative events – does not mean that risk control was adequate. It also does not mean that market would have faced negative events. It’s a matter of vision. Today we are praising Dhirubhai for his foresight – but had the earth quake happened below 6 Richter scale or not happened at all – we would have considered his investments of Rs.1500 Crs as a waste.

It is worth while to consider two important quotes of Buffett at this juncture.

Buffett has often quoted "Only when the tide goes out do you discover who's been swimming naked."

Only bad times can prove that your risk management is adequate or not. Whatever you have done in the name of risk management or controlling is just make believe till you really come across the situations.

Another of his not so favorite quote was “If calculus or algebra were required to be a great investor, I’d have to go back to delivering newspapers.”

This is for FORUMLA loving investors – who use various formulas to ascertain the risk and suggest the solutions. Dhirubhai did not use any formula in the above case. Same way the track record of Warren Buffett, Peter Lynch, Bill Miller, and Julian Robertson proves that they are doing out of vision rather than any formula.

Nassim Taleb has done a satire on these kind of guys with following example in his book “Fooled by Randomness”

“Reality is far more vicious than Russian roulette. First it delivers the fatal bullet rather infrequently, like a revolver with 1000 chambers instead of just 6. After a Few Dozen tries, one forgets about the existence of a bullet, under a numbing false sense of security….Second, unlike a well defined precise game of Russian roulette, where the RISK are visible to anybody capable of multiplying and dividing by six, one does not observe the barrel of reality….one is thus capable to unwittingly playing Russian roulette…and calling it by some alternative “Low Risk” name.

(READ above AS MANY TIMES AS You CAN)

What is the practical way to control the risk for small guys?

Looking at the portfolio it can be easily ascertained that whether your portfolio can withstand any kind of negative events or not. It requires little experience coupled with common sense. It also requires that you built your portfolio based on VALUE investing principles. If you can do above two things, you need not worry much about RISK in your portfolio.

What NEXT?

Investment is the simplest yet the most complex activity. Simple for Value investing guys and Complex for Tip loving guys.

At Destiny Management, we do both above. We help investors to learn themselves and master that art over a period and if they are short cut type – we have readymade ideas for them also.

If you wish to take advantage of either, you can approach us.

Wish you all a Very Happy Week Ahead.

Follow me on Twitter @hiteshmparikh / WhatsApp - +91-9869425399.

Live With Passion…Invest With Passion.

Hitesh Parikh.