While I do not agree with never investing in equities it is very clear that people generally do not appreciate risk or perhaps more correctly the effect that volatility has on their psyches. The words risk and volatility get interchanged often but I don't think risk is the best word, especially for people who use funds (traditional or exchange traded). A fund is not reasonably speaking going to go to zero so what you are vulnerable to in that instance is volatility.
Anyone who implemented a portfolio of funds in December 2007 became subject to some very painful volatility but if they were not lucky enough to have taken some sort of defensive action then they are way off their low-water mark and at some point will get back to their high water mark of course as I always say the time needed could turn out to be "too long" but it will happen.
Risk would seem to be more like putting all your money into a restaurant that subsequently fails. Putting too much into any one stock could also be risky but done correctly buying individual stocks doesn't have to be risky as opposed to taking on the threat of volatility. A portfolio of 50 stocks each weighted at 2% faces very little risk but plenty of volatility. If the market cut in half after purchasing those 50 stocks then clearly the volatility would be brutal but the odds of even one stock failing (based on the number of stocks that go to zero versus the number of stocks that exist) are pretty low. Yes possible but the probability would be low.The context of this conversation of course assumes correct asset allocation. You don't put a $50,000 college fund for an 11th grader into equities.
But after things have been good for a while people forget how they felt when things were bad and they go on to repeat or come close to repeating the type of behavior that supports Taleb's assertion. I remember in 2006 getting a lot of email in my TSCM email account from people not understanding my belief in small weights to emerging markets. Then sure enough in the 2nd quarter of that year there was a short but reasonably deep correction that rattled some people and one reader emailed back saying that they understood where I was coming from.
We know that after a bull phase there will be a bear phase. The bear phase will erase some portion of the gains made in the bull phase, we know this. If we can operate with this in mind and try to navigate toward a result thought of in the time frame of an entire bull bear cycle it should lead to a different take on how much volatility you expose yourself to and gets you away from gaming XYZ's earnings report or trying to figure out how to make money this week.
The picture is from Red Canyon which is on the way into Bryce Canyon National Park.
10 comments:
Good morning,Roger. I enjoy your column.
I am pondering a new strategy, for me. I buy stocks for dividends and for value.
Part A of my new strategy is to buy dividend stocks just before their ex-dividend date and sell them as they pay the dividend.
Part B is to find a value stock and buy it and go out 90 days and buy a put and a call on that stock.
An example would be VZ as the dividend stock and CMCSA as the value stock.
I would appreciate any comments you might have.
Dynan Candon
i would advise you explore the shortcomings of what you have in mind.
Dynan,
This is known as dividend capture. Google it. It's not as good as it seems as the stock price may reflect the new value of the company after the cash is given to shareholders. Plus you have risk of further fluctuations of the day, plus commissions. Please consider these.
Part B, I don't understand what you're trying to capture here. You're putting a collar on the stock. This is a synthetic vertical. Why not just put a vertical on and save yourself a lot in the way of tied up capital.
Volatility is a good thing in bull markets and painful in bear markets.
Does a 7% decline deserve heavy focus on the negative or is this just shaking out weak hands with the wall of worry during a bull market?
dynan,
you are trying to manufacture a money pump that you believe is not obvious to the rest of the market. Sorry but it is just not that simple.
Roger,
I have been in this game since 2007. My early experience with trading was 28 years ago. A large gap. Following 50 stocks is much and for long term is almost impossible, IMO. Look at TomTom(tom2.as) it hit 65 high two years ago started to correct because of the teleatlas acquisition and went down to 3. I started to pick up at 5.40 and unloaded at 8 after it had reached 9, went to 5.40 and then zoomed to 13 and now is 6.51. Where will it be two years from now. I cannot tell you. Can you tell me? or Can anyone tell me? Look at the new entry Google-Motorola. It has changed the outlook of all Garmin, TomTom, and hand sets companies like Nokia. What I am saying is that long term it is difficult to predict what will happen. And thematic investing, I am still struggling with how in the long term I can predict the outcome. My trading is based on time and price, and based on short-term timing. The rest of the time I am into cash, because I cannot predict the future with certainty. However when things look bleak and everyone feels hopeless then I feel that the worst is discounted and therefore the risk has lessen and the market provides a good entry point. I give you another example which I had posted. My program gave me a buy signal on MCO. I purchased at 23 and sold it at 25 while Warren Buffett was unloading. The program gave me another buy at 21 and after it drop to 18.60 I unloaded at 21. However the program gave me to purchase at 18,60 and was prudent not to buy more but MCO went to 25. Here we had oversold conditions and buy signals at 23, 21,and 18 were sound, at a particular time. But I am struggling with long term investing. Roger, maybe in the future if you care, can you tell me how you can predict what will be the price of a stock after you purchase it. For example SQM on of you favoraties, can you tell me what the price might be in two years from now, and how you arrived at such a price. That is exactly what I am struggling with.
Jeff From Milan, Italy
Roger,
After you answer Jeff's question - please tell me who will win the World Series in two years...ditto for Super Bowl. And if your not strapped for time - will I weigh more or less than I do now in two years?
(knee-slap) actually i have an answer that I think will be tomorrow's post. i doubt it will be the type of answer he has in mind though, but hopefully constructive.
I've "been in the game" since 1972 and have always enjoyed it, even when self-annointed, brilliant singular ideas flopped. One moves on and learns. Establishing risk tolerance and the ability not to be too dogmatic is important.
To paraphrase Warren Buffett, if you don't know who the patsy is at the poker table, you're the patsy.
T
Hussman is on his game this week at http://tinyurl.com/yh3avlh extending his discussion of risk mgmt when the business cycle appears abnormal and asset price signals ambiguous.
The stealth bear of 1998 (a host of non-tech and non-big cap issues rolled over with apparent disregard for quality) was odd enough for me to begin paying attention to the view that the increased size and influence of the financial sector might be giving the credit cycle more muscle than the business cycle; e.g., http://tinyurl.com/ygdu5q9
That is a view I have generally accepted for nearly a decade now. It has been a very profitable view on the whole but primarily in tactical accounts since, with the exception of an increased strategic allocation to gold (and some other commodities), I have remained largely defensive in long-term strategic accounts since 1999. Got to watch that convexity [g].
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