How to Decrease Risk & Increase Return Part 2

Ray Dalio

It’s almost impossible to consistently apply this next principle without following the first principle so if you haven’t read part 1 of this series I’d recommend going back and reading it.

This is a point we touched on at the end of the discussion on risk.  If you want to simultaneously decrease risk and increase return what is one of the simplest ways to do so?

Buy for below what it’s worth.

This can easily be explained with some simple math.  Let’s say you buy something worth $100k for 10% less than it’s worth, in other words you buy it for $90k.  In order for you to lose money, the value has to decrease by $10k, the likelihood of that happening will depend on what it is and over what time period, but suffice it to say the chances of losing money are lower if you bought it for $90k than for $100k.

The reverse of those numbers is also true.  If you buy something worth $100k for $90k if it goes up by 5% to $105k have you made more or less by buying for $90k?  More of course, in this case you’ve made $15k whereas if you’d purchased for $100k you’d only have made $5k.  The impact of these differences decrease as the rate of growth increases of course, but they will always remain.  This is really a classic application of the “buy low sell high” concept, the only difference is here we are putting it into the context of value to make the application easier.

What is necessary in order to buy for below what it’s worth?

It might seem obvious to some but few seem to apply it, the first step in buying something for below what it’s worth is:

You need to first know what it’s worth.

How do you do that?  Well, this is where understanding what you’re investing in comes into play.  It requires immersing yourself in the market.  For example, before buying my first house I went and physically looked at over 100 houses.  Why?  So I’d know a deal when I found one.  The same is true when I buy a car, I look at so many deals for a particular type of car that I can quickly identify the ones that are below the market value when they come up.  Because value is dictated not by the object itself but by the market you can’t get around this basic requirement:

You must immerse yourself in the market.

Immersing yourself in the market alone isn’t enough though, it provides a slight advantage but there are three other very helpful lessons:

  1. Know something the market doesn’t – ever hear about how people make a lot of money on insider trading? What are they really doing?  They are learning something about the market that the majority of the market, which determine the prices for things, doesn’t.  Similarly you need to know more about the value of your chosen investment area than others so you can find good deals that others have overlooked
  2. Negotiate a better deal – there is a basic truth in life that you don’t get what you pay for you get what you negotiate. The same is often true with investments, some area obviously easier to do this than others, but the fact remains that you can often negotiate a lower price than the asking price, and in so doing decrease your risk while increasing your return.  What do you need to do in order to make this possible?  Improve your negotiation skills.
  3. Find less efficient markets – market efficiency is really a measure of how quickly and how accurately the market prices things. For example, foreign exchange markets are very efficient, general public markets like the TSX and Dow Jones are also highly efficient and getting more so all the time.  By contrast smaller markets like the Venture Exchanges, S&P 5000, etc. are less efficient.  MLS is more efficient than Comfree, which is more efficient than private sales.  Do choosing less efficient markets ensure or even increase your chances of not losing money and increasing returns?  No, definitely not.  On the other hand it’s easier to find deals, that is to say there are more pricing errors and more significant pricing errors on average in less efficient markets than in more efficient markets.  This is an advantage a small investor has over a large investor; they can look at small deals where there are little pockets of inefficiency and take advantage of them, where those are too small to justify the time and effort for large institutions.

Buying for below what something is worth takes time and effort.  It is not a quick lazy path, but it’s a path that can pay huge dividends (literally and figuratively), and it is one essential aspect of decreasing risk while increasing return.

If you’ve got investing questions you’d like to discuss or like us to cover please click "Ask a Business Question" in the lower right corner of the screen to send it to us, looking forward to hearing from you.

Continued on next part

​Where Are You In the Wealth Journey and What’s the Highest Impact Objective For You Next?

Wealth Scales Map

If you liked this article and would like to receive more like this each time we post, enter your name and email address:

Readers like you were interested in these programs:

Your Breakthrough Marketing Review
Profitable Sales and Marketing Machine
Facebook Ad ROI Training
Campaign ROI

We offer personalized one on one assistance.
Want help?

I want help with marketing
I want help with team
I want general business help
I want help with investing
I want help with money management

Other Popular Programs:

The Greatest Business Course Ever
Scale ROI
Team ROI
How To Become Rich Mini Series