Surviving in the World of Global Finance
I wrote this article on my old blog in 2009.
Faster, Closer, Bigger
Due to the increased interconnectedness and globalization of financial markets, everything happens faster and seems to be closer to us. The increased volatility in the last decade and the high concentration of extraordinary events (Asian crisis, Russia, LTCM, dot-com, 9/11, Enron, commodities, subprime crisis), might not be an accident (thought there was plenty of them in more distant history too).
It is probably a structural change in the markets to some extent (only time will show). As a result, the weaknesses of the commonly used risk management tools have been revealed and matter much more than before. A statistician would say that the long tails seem to get quite fat.
We have derivatives and tremendous leverage easily available to everybody.
We have globalization both in life and in markets.
We have high concentration in the financial services industry (banks get bigger).
We have increased competition and race for success in the career part of our lives, often measured only by the “how much money you make/have” means. This leads to moral hazard problem – gambling for short term success, short term bonuses, and hoping that nothing goes wrong too soon.
All these facts have been said many times, especially during the financial crisis of 2007-2009. It’s nothing new.
Adapt to External Conditions
You can’t change the way financial markets are today, unless you want to work as Fed chairman, Treasury secretary, or a big bank CEO. But you can learn how to live with the markets and how to be prepared for the bubbles, for the crises, for the volatility, and for your own fear and greed (we all have both).
The Safe Certificates
Back in 2008 there were some people who had invested big portion of their lifetime savings in some guaranteed certificates. The salesman sold this investment to them as a safe, conservative product, which you could invest 100% of your portfolio in. It had stock market upside exposure and (under normal circumstances) limited downside – guaranteed by a credible, highly rated global bank. The bank’s name was Lehman Brothers. You can imagine what happened with their investment.
Risk Management for Everybody
The goal of this website is to provide useful information for all kinds of investors, ranging from high-net-worth to “low-net-worth” people and including those who don’t have much financial education. Imagine how the world would look like if all people were bankers or traders (scary).
It is definitely wrong that people who are not financial professionals or rich investors often lose big parts of their savings in market meltdowns, bubble bursts, or investment frauds. The sad truth is that when financial product salesmen say “safe” or “conservative” there is often a small invisible “under normal circumstances”. At the same time, having only the very basic knowledge of the principles of how markets work today and how to manage risk in the volatile reality could significantly reduce the odds of getting hurt badly in a “long-tail event”.
A Path with No End
As the markets are constantly changing, we must adapt to them continuously. As a result, reaching a point where you have it, know it, and are a total expert is not possible, because the next moment makes some part of your knowledge and experience obsolete, or in a worse case, harmful to you in the future. After all, it is not the environment but you who has the potential to do the damage.