Returns Per Unit of Stress | Fundoo Professor

Investment returns are typically measured in the form of returns per unit of risk.

?Risk? however does not mean the same thing to different people.

To most financial academics, risk is a measure of volatility, a proxy of which is the famous beta. At the other extreme is Warren Buffett who thinks of risk as ?probability of permanent loss of capital? and who claims that beta has nothing to do with risk.

While the debate on the meaning of risk between academics/finance practitioners who follow CAPM (a model that equates beta with risk) and value investors who follow Buffett is not going to end anytime soon, I propose that one should also think about measurement of investment returns based on ?return per unit of stress.?

For proprietary investors (and maybe for all investors), stress should figure in one?s investment strategy, much more than it does, perhaps, even more than financial risk, because stress is a killer and high stress situations ? whether they carry high or low investment risk ? will always carry a high risk to one?s health. In fact, one can now measure how many years of one?s life is cut short by being exposed to a high stress life.

In my view, its no co-incidence, that day traders (who have very stressful lives) and who look like this?

? will possibly not live very long, while spiritual, long term investors like John Templeton (who lived till he was 95) have calm and serene faces and look like this:

If one was to think about stressful way of investing vs. a relatively stress-free way of investing, what would the differences look like? The following table offers some suggestions.

High Stress	Low or No Stress
Investing in Highly Leveraged Companies	Investing in Zero or Low Debt Companies
Borrowing to buy stocks	Never borrowing for buying straight equities
High Frequency Trading & Day Trading	Long Term Investing
Shorting	Long Only Investing
Cigar Butts	Moats
Business exposed to Negative Black Swans e.g. Banking and Commodity Trading	Businesses not exposed to black swans
Corporate Governance Issues	No Corporate Governance Issues
High P/E for Growth Stocks	Low P/E for Growth Stocks
Cyclicals	Stable businesses
Hostile Takeovers	Passive Investing
Dealing in F&O	Staying Away from F&O
Trading on Inside Information	Avoiding inside information
Event Driven Investing	Moats Driven Investing

Once you start incorporating return per unit of stress in your investment thinking, the trade-offs become obvious. You would start settling for investment situations which offer a satisfactory return per unit of risk and stress over those which offer high returns per unit of financial risk but low returns per unit of stress. You will slow down and start appreciating the slow process of long-term, stress-free compounding as opposed to nerve-wracking, adrenalin laden high frequency operations in the stock market.

My advice to those who ignore the stress part of the equation but focus only on returns per unit of risk:?You cannot take it away with you, so what?s the point of all that stress, just for the money?

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