The 3 Ingredients to Every Investment: Rate of Return, Time, and Risk

No matter what you’re investing in, you’re balancing three things:

  • Rate of Return
  • Time
  • Risk

Like most things in life, the general rule of thumb is “pick two” if you want them to be good.

  • You can have a solid rate of return in a short amount of time, but with high risk.
  • You can get great returns at low risk, but it’ll take a long time.
  • You can find low risk and low time horizon opportunities, but they’ll probably have a very meager rate of return.

Other versions of the pick two rule are:

  • In business, “good, fast, or cheap”
  • In dating, “sane, attractive, or intelligent”

The rule is undefeated.

Examples of the “Pick Two” Rule

Common examples:

  • Bitcoin – high return, high short term risk but low long term risk (therefore long time horizon)
  • Other “crypto” – all of the same, except I’m skeptical of the high return, and hella more risk because almost all altcoins aren’t decentralized, are pre-mined, etc.
  • Roulette – high-risk, high-reward, extremely low time preference
  • Real Estate – high risk (because illiquid), high return (esp. if renting out), long time horizon
  • Index Fund – Medium return, medium risk, medium time horizon
  • Savings Account at Bank – No return, No risk, No Time Horizon

These are all conventional investing and savings vehicles (maybe not roulette).

99%+ of your investments will be a balancing act between these three factors.

When you’re younger and/or poorer, you tend to have a higher risk preference (time preference can go either way, depending on your goals).

Old investors tend to have a lower time and risk preference (e.g. buying bonds lmao).

You’ll have a harder time convincing a 70-year-old to buy Bitcoin than a 20-year-old because (1) the older has more to lose and less time to win it back, and (2) the 20-year-old has 50+ years for Bitcoin to go to the moon.

Speaking of the moon…

Young Investors Want The Moon 🚀

Retail investing is in its heyday right now. For the uninitiated, “the moon” just means outrageously high returns.

These days, it’s not a sin to openly want lots of money. That’s why I’m writing this blog. Because of this, people are chasing down high-risk, high-reward stocks and crypto.

Those two are highly liquid, so they have the chance to spike and have their gains realized quickly.

As legendary investor Charles Schwab put it, when he was younger, he was trying to “get as far away from zero” as he possibly could as quickly as he could.

Obviously not a strategy he recommends to his clients, but exactly what he needed to have a standout career.

Mature Investors Want “Uncorrelated Returns”

Ray Dalio invests money for people who don’t want to lose money. Appropriately, he values diversification. He’s not trying to get crazy gains but merely wants to prevent losses.

Here’s him discussing the power (and math) behind uncorrelated returns:

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In sum: if you want to avoid losing money, find 10 investments—all with a decent return—but make sure they don’t all go up or down at the same time.

No investment is totally stable (not even gold), but if your investments all take dips at different times then your overall portfolio will remain incredibly stable.

More Money, More Opportunities to Lower Risk

This isn’t just true for the quantity of investments you’re able to do, but also the quality.

If you opened a storefront on a bad block, people will hesitate to go there. If you buy up the entire block of storefronts and can afford to hold them while finding tenants/leasees, every store on the block will benefit that their neighbors are new, the neighborhood is safer, etc.

That is less diversified than buying 10 storefronts in 10 different neighborhoods (the whole basket is safer because it’s spread out), but you have better upside potential by concentrating all your effort in one locale (the whole neighborhood will grow together).

Yes, it is riskier because you’re putting all your eggs in that one basket. However, you are also lowering the risk premium for each individual asset in that basket by concentrating them together.

Focus versus diversification.

RELATED: WHAT TO INVEST IN WITH $0, $1000, $10,000, AND MORE

Can You Ever Get All Three?

Nothing is risk-less, so depending on your definition, no.

However, if you mean finding an investment with asymmetric upside (low risk and high return) with a brief time horizon? Sure.

But they’re rare.

“Brief” may still be one year. Short for a great return, but long for the greedy or aggressive.

Another classic strategy is finding something with mediocre returns, and then milking it with leverage.

For example: you expect a stock to return 20% in the next month. Instead of buying 100 shares for $10,000, you long 5 call options for the same amount. Assuming the calls’ expiry was far enough out, you’re now earning the gains of owning 500 shares instead of 100 (if you don’t know how options work, this example may not make sense). You also have a greater downside risk…

Leveraged real estate is a good version of this if you plan on using the property for income and not merely principal gain. Almost all real estate uses leverage, which helps your cash-on-cash return.

Here’s a creative example: you start a business in a new, growing, but competitive field (e.g. VR). Your skillsets are already rare (how many VR developers are out there again?) so while you hope to create a powerful new VR tool/game/whatever, you know you’ll never be out of work because there are tons of companies looking to outsource to specialized devs—just in case your own project fails.

Special Opportunities Usually Exist For Individuals, Not For Everyone

The truly rare opportunities are out there, but they get snatched up quickly—representing a promising young talent, a startup that has a stunning solution to a hated problem, the person you want to date happens to be your neighbor’s best friend—if it’s a rare opportunity, then you can’t let it go by.

It’s not fair. It’s not equitable. And it never will be. Act decisively when you spot these.

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