By: Douglas J Utberg

Reading the title of this article probably creates a sense of confusion because of the apparent paradox of being ‘cautiously bold.’  After all, acting with caution and acting with boldness are often contrary to one another.  The cautious person generally seeks to minimize risk for the sake of stability.  The bold person generally seeks to maximize the return that they capture.  So how do we blend these two characteristics into a workable philosophy?

The way to fully understand caution and boldness is by viewing them as a balanced equilibrium, instead of an ‘either-or’ proposition.  This paradigm shift moves the conversation away from concepts like ‘minimizing risk’ and toward ideas like ‘managing risk.’  Similarly, a balanced perspective doesn’t simply seek to maximize returns . . . it seeks to maximize the return for the amount of risk that is being taken.

The importance of this insight lies in the fact that risk and return are positively correlated with one another.  This means that pursuing high returns generally involves taking increased risk, and that minimizing risk involves sacrificing returns.  It is also important to consider that not all risks are created equal.  Thus, the goal of successful investing is to seek the opportunities that produce favorable returns in relation to their risk.

One way that many smart investors seek to implement this strategy is look for opportunities with a limited downside and large upside.  For example, when real estate bubbles deflate there tend to be properties that are available for less than their construction cost.  (These opportunities typically come from distressed sellers and bank-owned foreclosures)  In this case, the downside risk is limited since any new construction in the future will cost more than what you have just purchased this property for, since they will need to purchase land and build a structure on that land.  If the property is rented for income, the owner can frequently cover their property expenses from the tenant cash flows and ‘wait out’ the down market to capture value from future appreciation.

As we have seen, the notion of being ‘cautiously bold’ isn’t a silly paradox, but a statement of desire to maintain balance between minimizing risk and pursuing returns.  Keeping that balance in mind is what drives us to pursue opportunities that limit our downside exposure but maintain significant upside potential.