In classic Greek mythology, two hazards awaited sailors attempting to pass the Strait of Messina. On one side was Scylla, a horrifying six-headed sea monster. On the other was Charybdis, a whirlpool that threatened to sink the entire ship. The strait was so narrow that attempting to avoid one invariably put the men within reach of the other. Only the best were able to navigate the strait.
Investors face a similar dilemma. On one side, you have the risk of losing money. Losing money is the hazard that everyone is familiar with. Say you buy options that expire worthless. The money you spent on those options is gone. Let’s call it “actual loss”.
You can try to avoid the risk of actual loss by never playing. But in doing so, you expose yourself to the risk of missing out on gains. If the stock market doubles while your 100K portfolio was sidelined in cash, you lost out on a 100K return.1I’m ignoring inflation and currency risk for simplicity’s sake. This is known as opportunity loss.
Rationally speaking, opportunity loss is no different than actual loss. If you only have 100K when you reasonably2To use an extreme example, it would not make sense to say that you lost hundreds of millions of dollars because you didn’t buy the correct Powerball numbers. Nor would it be reasonable to bemoan the opportunity loss from a deal that you didn’t have access to or knowledge of. could’ve had 200K, you lost 100K.
Every investor has to thread the needle between the two risks, which even the best occasionally fail to do. Take Stanley Druckenmiller for example. Famous for breaking the Bank of England with George Soros, his own fund Duquesne Capital boasted industry-leading results. Yet, in March of 2000, he took a 50% loss on a bad $6bn bet:
So like around March I could feel it coming. I just — I had to play. I couldn’t help myself. And three times the same week I pick up a — don’t do it. Don’t do it. Anyway, I pick up the phone finally. I think I missed the top by an hour. I bought $6 billion worth of tech stocks, and in six weeks I had left Soros and I had lost $3 billion in that one play.
And more recently, he admitted in June 2020 that his family fund only returned 3% while the market rose 40%:
When COVID hit, I was pretty much of the view that there was a good chance that the credit bubble had finally burst and the unwinding of that leverage would take years.
Just as Circe counseled Odysseus to accept a few Scylla deaths instead of risking his entire ship, the savvy individual investor prioritizes capital protection over maximizing returns. A 50% loss requires a 100% gain to recover, and there will always be more opportunities in the future. Professional investors may have to dance with Charybdis more intimately to meet their targets though.