Sam Zell is best known as a real estate and private equity investor, but that doesn’t mean his many decades of experience aren’t applicable to stock market investors. In particular, his views on risk management are extremely relevant to retail investors. In a January interview with the Ross School of Business, he shared his wisdom on the subject.
Control the downside and the upside will look after itself
When asked about the investments that he has made over the course of his career and how he thinks about risk, Zell explained why certain opportunities appeal to him, whereas others scare him:
“We start with enormous respect for the risk of execution. I have a watch here. If my watch has one moving part, it has a very small probability of not working. If my watch had 50 moving parts, there would be another 49 potential reasons why it didn’t work. In the same manner, when somebody comes to me and they say: 'We have this great opportunity: we’ll buy this, and sell this, and so on,' I just think that represents enormous risk. What happens if you get into the third step and it doesn’t work? Where do you go from there?“
This is quite similar to Warren Buffett (Trades, Portfolio)’s perspective on risk. The Oracle of Omaha doesn’t worry about missed opportunities and doesn’t try to find the next Google (GOOG, Financial) or Amazon (AMZN, Financial). It’s also why he doesn’t invest in initial public offerings. He prefers to jump at opportunities where risk is limited and controlled and where he has a high degree of confidence that his investment will succeed.
Nobody goes broke taking a profit
“If you take a quote from Bernard Baruch, a financier who sold out before the Depression in 1929, 'Nobody ever went broke taking a profit.' In the same manner, when I look at risk, I don’t worry a lot about it being too good. The problem is always 'what’s the downside?' And if you can control the downside, you can control the risk.”
Zell described an investment where his team assessed the risk of a business at $50 million. Following a disastrous chain of events, which almost caused the company to go under, he was able to sell at a loss of $50 million. While this was certainly not pleasant from a risk management point of view, it was a sound investment because the risk was correctly assessed. In his words:
“If during your career, you correctly assess the risk, the likelihood of you excelling is very high. In my career, there have been lots of skeletons along the way, and they have generally been people who have taken uncapped risk.”
The main takeaway here is that even though he lost money, the fact he was able to limit his risk gave him confidence to come back for another shot. Investors who are able to do likewise will be the ones who survive in the long term.
Disclosure: The author owns no stocks mentioned.
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