My three-year-old brain knew it had to be safe, but I was scared of the water.
“Come on, jump. I’ll catch you.”
My dad’s friend, who I completely trusted otherwise, was urging me to jump into a pool. I was scared because I could not swim, and it seemed like a long way between me and him. Risk.
In the end, what I needed was a push, which my brother provided. After the scream, the firm but gentle catch, and the lukewarm embrace of pool water in July, I felt my first adrenaline rush. Reward.
Investing is similar.
Cost of Capital
When you lend, you are letting someone else use your money for a while. Risk. In return, they have to pay you rent for the use of your money, called interest. Reward.
Cost of Capital describes the idea that the cost will be high (you will charge high interest rates) if the borrower is risky. More risk—more reward.
It is a conclusion of empirical science that the higher the cost of capital associated with an asset class, the higher the expected return associated with that asset class (Fama*). Yes, the risks and rewards of owning a company are related to the risks and rewards of lending to it.
Ugly truth: the buying of well-positioned, reliable, dividend-issuing stocks is the worst performing stock investment practice in history. Low risk—low reward.
Bonus ugly truth: buying any single stock, risky or safe, exposes you to the risk of losing everything. More risk—more risk!
Beautiful truth: you do not need to go buy riskier stocks. You need coaching.
*Fama, Eugene. “Random Walks in Stock Market Prices”. Financial Analysts Journal, September/October 1965.
Simon Joshua is a licensed investment advisor representative at Cornerstone Wealth Partners in Michigan. He has structured his practice around investor coaching and committed himself to leading communities in establishing a legacy of fulfillment.