Leithner & Company Pty Ltd

Risk, Management & Disclosure

A popular fallacy considers entrepreneurial profit a reward for risk-taking. It looks upon the entrepreneur as a gambler who invests in a lottery after having weighed the favourable chances of winning a prize against the unfavourable chances of losing his stake. This opinion manifests itself most clearly in the description of stock-exchange transactions as a sort of gambling.

Every word in this reasoning is false. The owner of capital does not choose between more risky, less risky, and safe investments. He is forced, by the very operation of the market economy, to invest his funds in such a way as to supply the most urgent needs of the consumers to the best possible extent …

There is no such thing as a safe investment. If capitalists were to behave in the way the risk fable describes and were to strive after what they consider to be the safest investment, their conduct would render this line of investment unsafe and they would certainly lose their input. For the capitalist there is no means of evading the law of the market that makes it imperative for the investor to comply with the wishes of the consumers and to produce all that can be produced under the given state of capital supply, technological knowledge, and the valuations of the consumers. A capitalist never chooses that investment in which, according to his understanding of the future, the danger of losing his input is smallest. He chooses that investment in which he expects to make the highest possible profit.

Ludwig von Mises
Human Action (1949)

An investment is the act of exchanging money for a security which confers title to a business, debt or building. In such a transaction, the investor typically incurs inconvenience – namely, the money required to buy a capital good (such as a stock or bond or title to real estate) cannot be used to buy a consumer good or service (such as a house or motor car or overseas holiday). To invest is thereby to defer current gratification. The investor is prepared to wait because he believes that the investment will generate certain benefits over time, and that these eventual benefits will outweigh the inconvenience incurred in the meantime. One exchanges cash today for (say) a title to a commercial building because one expects that the property will generate a stream of earnings (i.e., regular payments of rent) sufficient to finance some desired level of consumption tomorrow, the day after and into the indefinite future. The investor postpones the consumption of jam today so that (he hopes) he can consume more jam (or give it to others) tomorrow. In Warren Buffett’s words, “investing is laying out money now to get more money back in the future – more money in real terms, after taking inflation into account.”

To read the full document (PDF), click here.

Chris Leithner