A basic concept of modern finance is that you should get a greater reward if you take greater risk. So risk management is critical. However, there is a difference between how financiers and entrepreneurs approach risk management.
Financiers seek to diversify risk
Financiers use portfolios of securities to maximize their return given the risk they’re willing to accept. It’s a timeless principle: “Don’t put all your eggs in one basket.”
Yet, in the financial meltdown we witnessed in 2008, we see a flaw in thinking like a financier. They placed too much confidence in diversification as a risk-management strategy.
They didn’t recognize that a small portion of their portfolios was so risky, it could wipe out all of their assets. It appears that this mindset pervaded Wall Street. It’s a great example of group think.
Entrepreneurs seek to minimize risk
Risk management may be the chief ability of entrepreneurs that reach BIGG success. Entrepreneurs find ways to manage seemingly unmanageable risks – those that the average Jane or Joe would never take on.
Entrepreneurs focus on bringing risk down to a level within their comfort zone. Preferably, they eliminate it altogether!
Then look at the rewards in relation to the remaining level of risk to determine if they want to proceed.
3 financiers who think like entrepreneurs
Entrepreneurs usually don’t have the resources that financiers have. So diversification isn’t an option.
But they can think independently. In fact, they often go against conventional wisdom because they see something that most people don’t.
1. Dr. Michael Burry
He bet against sub-prime mortgages when Wall Street was still in love with them. His hedge fund made $725 million as a result!
2. Warren Buffett
He became one of the richest people in the world by placing BIGG dollars behind unpopular positions in financial securities.
There have been many times in his career when he’s held a very small number of stocks in his portfolio – far fewer than most financiers. But he invests in businesses he understands so he knows he fully understands the risk.
Yet he’s earned returns of about 20% a year, far more than most financiers.
3. Our friend
We have a friend who owns his own buyout firm. He’s delivered returns to his investors that dwarf Warren Buffett’s.
Of course, he’s not operating on the same scale – living proof that there are BIGG advantages in being small!
He’s made money on every business he’s ever bought. And he’s bought a lot of them! He’s a millionaire too many times to count. (He would be worth more but he’s given a lot of his fortune away already.)
He doesn’t accept that you have to take greater risks to get BIGG rewards. He doesn’t define himself as a financier. He thinks like an entrepreneur. He minimizes his downside. That’s why he’s a BIGG success!
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