“Victorious warriors win first and then go to war, while defeated warriors go to war first and then seek to win.”
– Sun Tzu
When I started writing today’s article, I wanted to talk about risk. I wanted to show you how devastating a huge loss is to your wealth.
I wrote it all out… and then I deleted it all. I thought to myself, “Talking about is risk is boring. I don’t want to focus on the negative stuff, I want to focus on the positive stuff. I want to talk about all of the exciting ways we can build wealth.”
So, I deleted it all and started to write something new. But after I read this head line, “FTSE 100 hits record high as pound falls further,” I decided that the best way to preserve and build our wealth is to talk about risk.
The FTSE (informally called the “Footsie” and basically like the S&P 500 for the UK) tracks the top 100 companies by market capitalization.
Today, October 11th, marks the highest intra-day level this index has ever been, with the previous peak being the last trading day of the year 2000 – the dot-com bubble.
This type of news where indexes, real estate, and many types of assets are reaching record highs seems to be common these days. This should be a screaming sign of risk for you.
We don’t have to look much further than the historical S&P 500 index to see what type of risk we are exposed to right now. I say we, because even if you don’t personally have any exposure to the stock markets, a significant fall will play a huge impact in the economy we live in. From January 2000 to July 2002, this index saw a fall of about 45% in about two years.
From July 2007 to January 2009, this index saw a fall of about 48% in about two years.
If today’s S&P 500 fell back to the lows of 2002 and 2009 (around the 800 mark), then the index would fall more than 60%.
Of course it’s difficult to say where or when the index will decline, but the fact that a 60% fall is possible should really be understood. What does a 60% fall in someone’s wealth mean?
If you have $100,000 and you lose 60%, you end up with $40,000. If you want to get back to $100,000, then you’d have to make 150% gains on your $40,000.
However, if you were to limit your exposure to the risk (as in don’t buy things that are near or at the top of the market), then you would never have think about 150% gains. Simply protecting your downside risk could be considered a win.
Finally I’ll leave you with this:
Also… I have a fun book to share with you later this week that I guarantee none of you have ever seen.
Hey Cody – excellent article as usual. I am sitting on significant amount of cash. Waiting it out for the next market crash/value to get in to assets( stocks, real estate). My concern is that all my cash is in GBP.
Given the further headwinds in upcoming months to GBP, what are your thoughts on the following hedging strategy?
50% in INR in Fixed Deposits (earning 9% returns) in a bank (this is liquid as I can easily repatriate back into UK)
30% in Gold
15% in Silver
5% in speculative investments
Hey Cody, props for the focus on protecting your downside. I don’t think it gets enough attention — we’d all rather fixate on how we’re gonna make a boatload of profits and wish away the attendant risks.
Two questions I try to ask myself:
– How much upside am I willing to give away for downside certainty? Not all of it. But some, sure.
– How can I create asymmetrical investing situations where my downside is limited and my upside is, well, much less so?
I don’t know when The Next Big Crash(tm) is coming (there have been reports of its imminent arrival ever since the last big crash ended), so I don’t know how much upside I’m giving away by moving out of the market in anticipation. It could keep marching upward for a while yet.
Between one extreme (moving it all to cash and gold), and the other (ignoring the risks altogether), how about using some profits to buy long-dated put options over the index as a middle ground? My thought is that if the 60% crash happens, my investments will lose out but the options will win big. That’ll also give me a windfall with which to reinvest in the market while it’s on sale.
Cody – Great article as always. Almost all of the wealthy individuals that I represent in commercial real estate always look at the downside risk first and always have. “Just don’t lose money” is heard numerous times per year.
I trade a couple times per month and really don’t have the time to research the markets as many of your other readers do, but I do believe in cryptocurrency, gold and that a market crash is imminent. If/when the market goes significantly bearish, what sectors do you believe will come back the quickest? To extend that further from a 40,000 FT view, what do you believe would be a better strategy, get into individual equities or ETFs and S&P broad performance funds?
Can I simply just say what a relief to discover somebody who actually
understands what they’re talking about over the internet.
You actually realize how to bring a problem to light and make
it important. More people should look at this and understand this
side of the story.
Thanks for the comment, Marc.
Yes, it’s a great trait that wealthy individuals have; which is to put priority on NOT losing money, instead of worrying too much about how to multiply their money. You’re not going to have any money to multiply if you lose it all!
As far as investments, I think we’ll have to wait until that time. We can look at historical examples, but really it all changes and it’s undetermined until it (a decline) actually happens. I’ll keep my eye on it!
Yes to everything you said.
That downside risk is what so many people are ignoring. Nobody wants to miss making money in the markets… it’s hard to see people around you killing it in the stock market or having their home drastically increase in price. But, it’s the downside that will take a lot of these same people out. So, while the times are good now, the tide always changes.