7 Core Investment Strategies To Lower Risk And Increase Returns

by: Jae Jun


Risk in investing.

Risk in casinos.

What the gurus teach us about risk.

There's no such thing as a zero risk investment.

The supposedly risk free 10-year treasury bill yield is a pathetic 1.9%. Inflation will eat it up in a heartbeat. However, there is such a thing as low risk, high return investments. It's unconventional but it's there.

A few years back, I read Monish Pabrai's book The Dhando Investor which explains risk and the basic concepts of investing in a very reader friendly fashion. One of the main ideas from the book is that low risk investing can equate to high returns.

The common thought is that high risk = high reward.

But that's only if we talk about short-term, immediate gains. However, with value investing, it's about taking a step back and looking at the long-term picture.

Buffett's forever holding period is a perfect example of low risk, MEGA returns. During his partnership and early days at Berkshire, he didn't take big risks. His investments into stocks like Coca-Cola (NYSE:KO) or Wells Fargo (NYSE:WFC) were based on lowering risk and letting the underlying businesses generate the huge returns for him.

Gurus Teach You to Focus on Low Risk Investments

What Pabrai preaches in his book is to go after the low hanging fruit. The investments where the downside risk is protected.

As Monish Pabrai puts it;

Heads, I win; tails, I don't lose much!

Seth Klarman pounds the table on the same topic in his book, Margin of Safety where he emphasizes the importance of reducing risk in an investment because the upside will take care of itself.

Phil Town even wrote a book dedicated to Buffett's rule;

Rule #1: Don't lose money.
Rule #2: Don't forget rule number 1.

Buffett wrote a paper a while back called The Superinvestors of Graham and Doddsville which discusses the value investing strategies of Benjamin Graham, Warren Buffett and his coalition of "The Superinvestors of Graham and Doddsville" that shows it is indeed possible to keep risk low while producing staggering returns.

Here are the 7 Core Strategies to Lower Risk and Maximize Returns

1. Focus on an existing business - Look at businesses with a long history of operations that you can analyze. This is less risky than trying to figure out a startup or the new hot trend.

2. Buy simple businesses in industries with an ultra slow rate of change - Buffett tells us,

We see change as the enemy of investments… so we look for the absence of change. We don't like to lose money. Capitalism is pretty brutal. We look for mundane products that everyone needs.

3. Buy distressed businesses in distressed industries -

Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives it good results.

4. Buy businesses with a moat -

The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products and services that have wide, sustainable moats around them are the ones that deliver rewards to investors.

5. Bet heavily when the odds are overwhelmingly in your favor - If the market is offering you 10 to 1 odds in your favor for a particular company, would you bet on something else or bet heavily on that one bet and look to do it again and again?

6. Buy businesses at big discounts to their underlying intrinsic value - Minimize downside risk before ever looking at upside potential. If you were to buy an asset at a steep discount to its intrinsic value, even if the future turns out completely unexpected and worse, the odds of loss in capital are low. Ben Graham first brought this concept by stating that

… the function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future.

7. Look for low risk, high uncertainty businesses - This is a great combination. It produces severely depressed prices for businesses. Think back to the tech bubble. Had you bought great businesses such as Adobe (NASDAQ:ADBE), Apple (NASDAQ:AAPL), Cisco (NASDAQ:CSCO) at those depressed prices, I'm sure you would be a happy camper sitting on your millions right now.

In reality we know that risk doesn't equal volatility, but because we tend to get too consumed with stock prices, we fall into the trap of ignoring these 7 core principles.

There's nothing earth shattering in what I've listed, but it's surprising how little of it is applied.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.