At your own risk!

5 Min Read
929 words

Yesterday, I was trying to work out which supervisors needed to receive an internal email and I was staring at the organizational chart, flicking from slide to slide and back again, completely lost. At times it is like people are speaking an alien language (or are Scottish), and I can only catch fragments of what is being said and not enough to understand the overall meaning - But I am understanding everything they say. Not being able to visualize concepts makes life suck!

But talking about visualization, a cryptolleague and I were just talking about dealing with investment risk, trends and returns and I gave a little scenario for him to consider. Assuming people generally think that crypto is high risk and traditional investments like index funds are low risk, what do the returns look like?

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I was trying to get across the idea that risk is only one side of the equation, as it has to be cross-referenced with potential returns. How much of X are you willing to expose to get an amount of Y?

For example, let's say that a particular an indexed fund is about 8% per annum and you have 100,000 dollars in there. That means at the end of the year, there is 8000 in profit. Great! The problem is that the inflation rate in the US is around 5% currently, which means the value of that 8000 is far less as the value of the entire 108,000 is now worth about 103,000. So, there is 3000 profit. But, the 8000 is subject to capital gains tax. Let's say that is 20%, so 1600 for the year. So, that means the 100,000 dollars generated 400 dollars in usable income.

Don't quote me on the numbers!

But, let's look at Bitcoin over the last year

100,000 into Bitcoin would have bought 10 BTC with a worth today of 450,000. That is 350,000 dollars profit, subject to capital gains of 20%, 30% or even after 90% tax, would see a profit of 35,000 dollars - or about 85 times as much. But at 30% capital gains would see 245,000 in profit after tax, and after 5% inflation applied, it would equate to about 230,000 in purchase power - 575x more.

Still don't quote me on the numbers!

But, most people are not going to put 100,000 into Bitcoin, because most people do not have 100,000 to put into anything - including an indexed fund. Assuming a person can put 10,000 dollars away a year, it would take ten years for them to have the total value in the fund to get the 400 dollars profit a year. Of course, there are more complications and calculations than that, but you get the idea.

However, risk and reward works on percentages, not on total amounts in the technical sense - but for the living sense, risking a little isn't that hard. So, if someone could put 10,000 away a year to invest and split that investment into a risk category, how much would it take for them to get around about an equal return? Well, pretty much a year ago, someone would have had to buy 2000 dollars worth of Bitcoin to get the same amount as the 100K in the index fund - that is 2% of their total capital, so 200 dollars worth of Bitcoin in September would have been enough - which is not very much.

However, if wanting to be very conservative on risk, it is definitely manageable to play with this kind of sum, but because people are so loss averse, they would rather have the certainty of the 100% being "safe" in the fund, without considering all of the other factors that eat into their gains.

Investments always have an asymmetry with the hope of a positive asymmetry - put 100 in today, get 200 out next year. However, we also have a risk aversion asymmetry where the potential for loss far outweighs the potential for gain. So many of us end up not risking anything because we don't want to lose even 2% of our capital, even if that small percentage can return as much as the other 98%.

That 2% gains could also be used to supercharge the "safe investment" capital also, where skimming from those gains and shoveling them into lower risk will see a much faster increase in generative capital. It seems like a bit of a no-brainer for an investor, doesn't it?

Well at least for my colleague, he started to get a different sense of potential and the evaluation of risk. It doesn't have to be completely accurate, but it has to be able to represent a world that just doesn't come intuitively to us. No human is genetically programmed to have an intuition on complex financial process or, large numbers.

For example, if BlackRock was to put 2% of the funds they managed into crypto, it would represent almost 10% of the entire market cap, as they manage nine trillion dollars of other people's money. Now, that doesn't increase the cap by 10% of course, because not all of that cap is saleable at that price, meaning that if they were to pile their 2% in, it would likely send the total cap up by 50-100 percent, with the early sellers lamenting their weak hands. What happens if they put in 4% and then, Vanguard follows suit?

From an investment perspective it is essentially,
Don't take risk, at your own risk!

Taraz
[ Gen1: Hive ]

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