STEWARDSHIP 30 february 2026 www.goodnewsfl.org Good News • South florida edition “Going boldly where no man has gone before… while doing so without Captain Kirk or First Officer Spock to lead us out of the coming storm,” is how Paul Tuder Jones described today’s monetary easing cycle, staggering annual fiscal deficits, $38T+ of debt and lofty asset valuations from wealth effect policies over near two decades. Concluding, “Can’t say when, but it won’t end well.” We all have life experience in the school of hard knocks. With investments those knocks can prove quite expensive. Most of us think we are risk adverse, believing that riskier investments have to offer higher returns in order to attract capital. But riskier investments have to offer the potential of higher returns, while nothing guarantees higher returns will materialize. If, in fact, higher returns could always be realized, then there really isn’t an investment price that matters. Riskier investments are those where the outcome is less certain. The probability distribution of returns is wider, since there is a higher probability of lower returns and even losses included with some probability of higher returns. It is here that academicians conclude that risk equals volatility, because volatility indicates the unreliability in the investment. But this largely ignores the factor of price. Investment risk isn’t measured by volatility, but rather by the likelihood of losing money. And nothing influences risk more than price. Calculating error Benjamin Graham described the concept of reducing risk as developing a strong-minded approach to investing firmly based on the “marginof-safety principle.” This being like an engineer calculating an error specification into a structural design. Warren Buffett describes it this way, “I would rather sustain the penalties resulting from over-conservatism than face the consequences of error, perhaps with permanent capital loss, resulting from the adoption of a ‘New Era’ philosophy where trees are said to grow to the sky.” Markets tend to have a way of making fools out of those that prognosticate. The fact that something happens doesn’t mean it was likely, and the fact that something didn’t happen doesn’t mean it was improbable. Improbable things happen all the time. Similarly, probable things don’t. No one can predict the future course of an investment, but only a probability of what may or may not happen given historical experience. “Modern portfolio theory,” and understanding history’s experiences in differing asset classes, along with their interactions with other assets, are not the only investing factors to consider when assessing risk. The single best way to minimize risk is to buy an otherwise strong asset cheaply. The opposite is also true, even if not considered a traditional risky asset. A true investor always considers an investment’s future that appears reasonably predictable; where the margin-of-safety of past performance value over current price is so large that they can take determined chances on future price variations. Mr. Graham insisted that any equity-like asset should be only purchased with “60-cent dollars.” A strong track record Warren Buffett outlines his investing approach this way: “Seek a franchise company with a strong brand, an easily understandable business, robust financial health, a near market monopoly, and buy the asset when there is a black cloud temporarily overhead.” In other words, buy only great assets and only when they are cheap. Moreover, “the company must possess strong management, with realistic goals, that builds their business from within, rather than through acquisition, allocates capital wisely and does not over-pay themselves.” Buffett always insisted upon a track record of consistent and sustainable earnings growth. This is a practical explanation of the margin-of-safety principle being applied. There is a highly logical connection between the concept of a safety margin and the principle of diversification. One is largely correlative with the other. Even with a margin in our favor, an investment can still work out badly. The investment margin only guarantees that it has a better chance for profit than for loss; not that loss is impossible. But, as the number of such investments is increased, the more certain it becomes that the aggregate of the profits will exceed the aggregate of the losses. (This is the essence of the insurance-underwriting business!) Moreover, a diversified and reliable stream of investment income helps increase the likelihood of investment profit. A concept we learned from the bond market was to calculate the time it took to recoup the initial investment amount from the interest payment stream. In a very simplistic way, one might consider this as a means of lessening one’s investment cost, and probability of loss, with time. Minimizing our time in the investing school of hard knocks is a worthwhile effort. The goal is to own assets of exceptional quality at discounted prices in order to weather storms that inevitably will come. We take no credit, Messrs. Graham and Buffett taught these core concepts. Their many writings are valuable reads. Patrick J. Kelly has spent more than four decades at the most senior levels in the financial services industry. He has held executive leadership positions in banking and securities firms, served numerous profit and nonprofit boards, possesses advanced education in economics, accounting and finance, and has been a featured guest in numerous financial media forums. At present, he endeavors to impart his experience and knowledge to younger generations whenever possible while also offering consultation on securities and banking industry practices for litigation-related expert witness testimony. - Patrick J. Kelly - President, Kelly Advisory Group Margin-of-Safety Principle
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