The Importance of Investing with ‘Appropriate Fear’

Gregg Popovich, the coach of the NBA’s San Antonio Spurs, is famous for reminding his players to approach each playoff opportunity with what he calls “appropriate fear.”  This fear that Popovich describes is not the kind of panic-inducing fear that can lead to unforced errors, nor is it the kind of obsessive fear that can lead to “paralysis by analysis.”  Rather, what is meant by the term “appropriate fear” is a kind of healthy skepticism of one’s own preparedness and focus, as well as fear of your opponent’s capabilities, so as not to underestimate him and be rudely surprised during the competition.  In other words, playing with appropriate fear means to play with humility and to have an appreciation of the potential pitfalls you will face as you try to reach your goal.

This idea of approaching your goals with “appropriate fear” applies to investing as well.  Obviously, investing one’s resources in hope of a future payoff is an inherently optimistic endeavor as we assume tomorrow will be better than today, though we usually define that improvement in purely monetary terms.  However, just as with the professional athletes whom Mr. Popovich is coaching, it is important that investors approach their financial plans with a certain warranted trepidation.

Consider the many pitfalls investors face as they allocate their portfolios for the long-term:

  • Inflation risk – the chance that my future income stream will purchase less than it can today
  • Market risk – the chance that my assets will decline in value just as I need to liquidate them for cash-flow purposes
  • Health / disability risk – the chance that an illness could deprive me of my prime earnings years
  • Longevity risk – the chance that my life expectancy and spending habits will outlast my wherewithal

There are certainly many other potentially calamitous events or misfortunes that can ruin an investor’s plan, but the point of this exercise is not to overwhelm the reader with anxiety.  Instead, the point is to remind investors to make a sober assessment of the many risks they are likely to face, understanding all the while that no person or algorithm can predict the future with any degree of accuracy, let alone regularity.

Investing with appropriate fear means to build into your financial plan a margin of safety so that you do not become overextended financially, finding yourself short of cash or over-leveraged.  Appropriate fear in this context means to reduce your expectations for the returns on your investments, and to exaggerate your assumptions for costs going forward.

Investing with appropriate fear does not mean over-allocating your portfolio in an attempt to hedge against every possible — though low probability — headwind.  Rather, it means to make a rational assessment of what the most likely scenarios are, and to assign those scenarios probabilities.  Because a portfolio can be hedged against only so many things until prospects of future returns are materially diminished, a prudent investor understands that making a calculated risk to address only the events most likely to occur  is the most cost-effective and efficient way to manage one’s portfolio and position it for inevitable periods of volatility.

Most people assume that investing success means getting a handful of “big things” right when it really means doing countless little things well over a long period of time.  Investors who have appropriate fear know this because they understand the likelihood of getting the “big things” right is very small, so they approach their finances with humility and discipline, maintaining their financial strategies through market ups and downs, ignoring the human impulse to make a rash decision in times of turmoil.  With each “little thing” done, they inch closer to their goals and in control of their own destinies.

In sum, of course investors should be optimistic.  Otherwise, why bother investing at all?  However, appropriate fear is a necessary ingredient to any investor’s success.