On avoiding losses
It's déjà vu all over again
One of the hardest challenges for any investor is to be honest with him/herself. Although we like to believe that a great payout is a result of superior insight or execution, it is really hard to tell if you were smart or lucky.
Given that investment advisors and fund managers would not be able to raise a single dollar (and charge fees) for lucky outcomes, there exists a plethora of gimmicks, jargon, strategies, tactics and random financial marketing bullshit anchored by scientifically sounding terminology.
To the average Joe it all sounds too complicated so they just hand over their money to those guys at Wall St with fancy degrees and hope for the best. Even those who think they are managing their own money do not understand how those mutual funds, hedge funds, leveraged ETFs, close-end funds, REITs and master limited partnership (MLPs) work.
Wall Street is infinitely capable of staying one step ahead of the game by creating new investment stories to keep the public confused. Over the past 70 years, a key investment theme has broadly characterized each decade. In each case, a particular asset class, sector, or region captivated investors for an extended period, driving the news cycle and outperforming the rest of the market – until it didn’t.
In addition to themes, Wall Street is also a formidable marketing machine that is always rebranding products to better sounding names in order to facilitate investor adoption. It always amazes me that people ever bought junk bonds. The story was that aggressive fast-growing companies were not able to borrow because they burned a ton of cash, but eventually they would execute their business plan and achieve investment grade. Therefore, overtime investors could earn a high interest rate AND see the bond price appreciate with the upgrades from credit agencies. As Michael Milken used to imply: the junk of today is the gold of tomorrow. If that is not brilliant marketing, then I don’t know what is?
Examples of Financial Rebranding
· Leverage Buyout -> Private Equity
· Junk Bonds -> High Yield Debt
· Fish -> Day Trader
· Used Car Debt -> Pre-Owned Vehicle Financing
· Synthetic CDO (Collaterized Debt Obligation) -> Bespoke Tranche Opportunity
The last one is particularly worrisome. The term Bespoke Tranche Opportunity (BPO) was first used in January 2015 in an e-mail from an employee at Goldman Sachs. It was defined as follows: “A tranche of a bespoke portfolio of credits can offer exposure to diversified risk with the possibility of leverage, credit enhancement and enhanced returns”. Oh boy, here we go 2008 again.
BTOs are created according to the preference of each investor, as opposed to a CDO that is created by a bank and then sold on the market. This distinction seems trivial, but it allows the circumvention of regulations enacted after 2008 to prevent a future financial crisis. To make matters even worse the underlying assets in BTOs are not asset-backed securities as was the case with most CDOs. As such, the value of the BTOs are not directly linked to the performance of the real economy as most bonds would be, but rather to the rating of the rating agencies. And one thing we learned from 2008 is that we “can” trust the rating agencies.
So, what is the average investor supposed to do? First, don’t be a fish (sorry day trader). Unless you are a high-frequency house such as Citadel you have no business putting even one trade per day. Just because you were told $0 commissions, you are paying in other ways. Interesting that the real Robinhood would take from the rich and give to the poor while the eponymous trading platform does exactly the opposite.
You will always lose money trying to time the market – Charlie Munger
Trying to time the market is a fool's errand and a guaranteed way to losses. Don't do it. Don't get seduced by complicated strategies or massive overnight gains in the latest crypto coin. The first rule of making money is avoid losing money.
Over the next few posts I will focus less on philosophical points and more on practical financial advice by building a portfolio that I will share with readers. I’m doing so assuming my daughters had asked me to help them build one (they didn’t) so given their age it will have a bit more risk than if it was my portfolio, but I hope it will be helpful.
Thanks Pedro!