The One-Sided Coin
A man was walking into town when he came across a pedlar. “Good day to you, pedlar”, he said, “A fine day it is today. What is it you have to sell?”
The pedlar talked the man through his various items. Old pots and pans. An egg cup. Some boots and a blunt axe. “There’s nothing I want here,” said the man. “It’s all old, used wares.”
“There’s one more thing”, said the pedlar, reaching into his pocket, a sly expression crossing his face. “I have this one-sided coin. It’s not something you see every day.”
Incredulous, the man responded: “A one-sided coin? How can a coin only have one side?”
The pedlar showed him the coin. On one side was the king’s head in sharp relief. When the coin was turned over, there was nothing. The coin itself disappeared. But turn it again and there was the king, just as before. “It’s a special coin. It has one side. There is only one side. There is nothing else.”
“I don’t believe it,” said the man, and went about his day.
Investing is like a coin. We invest for return, but to get return we must take risk. There is no one‑sided investment; risk and return are two sides of the investment coin. Generally speaking the return we’re likely to receive is proportional to the risk we’re willing to accept. That’s why cash deposits earn relatively less than shares. The risk of cash and short-term interest-paying investments is far less than the risk on a share investment.
Investment managers love to talk about return, but they’re often reluctant to talk about the risk you’ll have to take to achieve it. They’ll give statistics about outperformance of a benchmark over various periods. They’ll mention the teams of research analysts flying the world (business class) who ensure you’re given the best opportunity to outperform. They’ll refer to the special talents of their highly-qualified investment teams or the secret skill they employ in their quest for outperformance.
But what of risk? It’s rarely mentioned or, if it is, you’ll find it there at the bottom of the page in a small font. If you’re lucky it’s written in terms you can understand. If not it will be in words you’re not sure the meaning of.
Here’s a good one: “Diversification cannot assure a profit or protect against loss”. Hmm.
I just read another statement of risk that runs for 1,239 words; mostly just words, not much actual meaningful stuff.
Investors, particularly retail investors are, broadly, not good at decoding statements of risk. Investment managers know this and if they’re not glossing over it they’re piling it on too thickly.
I’d like to see a statement of risk that is understandable by a normal person. “You may lose money in one year out of every three”. That’s pretty clear.
Or here’s an idea: talk about investment options in a way that makes them easily compared. Can a normal person understand whether 12% return in domestic equities is better or worse than 18% return in emerging markets? It doesn’t have to be called Sharpe, Treynor or Information Ratio but a statement of the reward-to-risk payoff of an investment would make it more understandable to a normal investor. Perhaps there should be a regulation to force this type of disclosure. Active managers would find it hard to compare favourably with passive funds if they were required to publish the reward-to-risk ratios. Some index managers might be worried if they had to disclose Information Ratios.
Telling investors about the risk of an investment is just as important as telling them about the return. For some people it might be more important. Allowing investors to compare investment options on a risk/reward basis seems the fair way to go.
Investing is not a one-sided coin, and if someone tries to peddle you one, just go about your day. Don’t let anyone forget to tell you the full story.