On Investing and Poker

At a networking breakfast event on Thursday, I spoke briefly about the QE Taper and risk to investors.  The owner of a competing financial advisory spoke to group moments later, “investors should be in the market at all times,” he said. This is the worst financial advice I ever heard spoken.

On Friday, the Dow Jones Industrial Average finally climbed to a new all-time inflation adjusted record.  It took 14 years and the broader indices the S&P 500 and NASDAQ aren’t even close. So if you had your money in the stock markets before the crash in 2000 you’re likely still not back to breakeven.    

A bit of history first. The 2000 crash was easily anticipated, no earnings and enormous valuation. The crash of 2008 was less easily anticipated.  With mortgage fraud and Lehman Brother’s solvency/liquidity problems concealed, and no insight from policy makers, main stream media, and banking executives denying that a problem even exists, investors complacency can be understood.  Yet, when Lehman imploded a sensible response was to get out. And if you did you would have saved yourself from a further 50% fall, from 1250 to 666 (S&P 500.)

I see investing much like poker.  When the right hand comes along you can bet it all.   The risk with this, of course, is that if another player "calls" you and you lose – you’re busted.   In investing when you have the opportunistic set of conditions in your favor such as an extreme oversold market condition, panic and fear from investors, deep discounts in valuations, etc. these are times to invest more heavily into equities as the "risk" of loss is outweighed by the potential for reward because the "hand" you are holding is a strong one. 

The single biggest mistake that investors make today is they continue to be "all in" on every hand regardless of market conditions.  "Risk" is only a function of how much money you will lose "when", not "if", you are wrong. 

The advisor community too often abdicates the most important aspect of fiduciary duty, risk management.   If you are all-in at market tops you can lose everything on one hand.  If you are patient and adjust your risk appetite for the investment environment, you’ll do much better in the long run.

Here is my advice:  If you haven’t already, sell equities and let the cash sit un-invested. Cash provides ultimate optionality, all other investments assume price and liquidity risk.