Thread by @MnkeDaniel

How would you feel losing $76,200,000,000?

(that's billions, just in case you're too shocked to notice😉)

Yeah, me too. At least, when your first thought was: “Terrible!”

Fortunately, I, and I assume you too, don't know that feeling.

There is a man who does.

That man is Bill Miller.

Billionaire, Value Investor, and someone who knows how losing 76 billion dollars feels like.

In 2008, Miller made a huge and leveraged bet on Bear Stearns and other banks.

As we know today, these bets didn't work out.

His 77 billion dollar fund lost over 90% of its money.

Many investors pulled their money out.

Bill Miller was left with $800 million.

Down 76,200,000,000 dollars.

When I first read that story in @williamgreen72’s excellent book “Richer, Wiser, Happier,” I was shocked.

I knew Bill Miller, famous for his early investments in $AMZN and #Bitcoin, but I didn't know about this.

Two things came to my mind.

First, how in hell do you come back from such a disaster.

Second, how did he underestimated the risk by such a wide margin?

And that's what I want this thread to be about.

Risk in Investing.

First, what is risk in investing?

That's not an easy question.

There are two different definitions.

The academic one and the ‘real world’ one.

The Academic Approach to Risk

Risk = Volatility

Why do academics define volatility as risk?

The answer is quantifiability.

Academics need something that they can put into their calculations.

The ‘Real World’ Approach

Risk = The Possibility of a Bad Outcome

I call it the ‘real world’ because that's the definition all great investors use.

Hence, it's not only used on paper but also in actual valuations.

The Real World approach of risk is not quantifiable.

It's an estimate of the worst possible outcome.

“How much can I lose when I'm completely wrong?”

Say you analyze a company and come up with an estimate of intrinsic value.

That intrinsic value is $40 per share.

Now assume your growth expectations turn out to be utterly wrong.

How bad can it get?

That's the question you need to ask yourself.

Stop focusing too much on the upside.

A good investment is one with limited downside.

Why is limited downside so important?

Two main factors:

First, you can only compound money if it steadily grows.

Significant losses are a no-go.

Second, downside is a lot more predictable than upside.

The future is unknowable.

Your estimates of growth might be precise, but they can be completely off too.

Today's value of a firm is more stable and predictable.

What is the business offering today?

And

How much do you have to pay for that?

Those are two key questions to figure out the downside of an investment.

Often, as was the case with Bill Miller’s banking bet in 2008, there's special uncertainty involved.

The more uncertain the situation, the better the bargain.

But there's one problem, it's only a bargain if the outcome plays out in your favor.

And like we said before, we can't know that.

That's why Peter L. Bernstein said:

“Risk exists because the future is a range of possibilities.”

Bill Miller lost his bet in 2008.

We know that now. But did he make the wrong decision?

In hindsight, it seems easy to say:
“Yes, he did.”

Losing 76 billion dollars certainly feels like a loss.
(Not that I know, just a guess🤷🏼‍♂️😁)

But judging a decision based on the outcome is the wrong approach for an investor.

“Risk means more things can happen than will happen.”
- Elroy Dimson

Maybe Miller made the right decision, and the odds were in his favor.

We just don't know because one of the unlikely events happened, and he lost.

But even if that's the case, there's another thing we can learn from this story.

Never let any bet become so big it can destroy you.

There are many things you don't know about your investment.

And no matter how unlikely they are, there's always the possibility they become a reality.

Never bet so big that you can't afford to lose.

That's it for today.

I hope you learned a little something about risk today.

If so, maybe others could too.

Retweeting or Liking would let this Thread reach more people.

It also helps me.
So, if you enjoyed it, I would appreciate your support.

I mentioned @williamgreen72’s book in which I read about Bill Miller’s story.

In case you're interested, here's a thread I wrote on that book. 👇🏼

https://twitter.com/MnkeDaniel/status/1415017256501846019