Protecting yourself from market shocks: learning from Nicholas Nassim Taleb
Flickr image "Imaginary Money Graveyard" by Eifachfilm Vacirca
After having read both his books, “The Black Swan” and “Fooled by Randomness” written by Nicholas Nassim Taleb, I’ve been rethinking my whole paradigm about achieving financial freedom.
For those of you who haven’t heard about Nicholas Nassim Taleb, you can read about him here or visit his website.
Systemic Risks to Financial and Economic Life
Nicholas Nassim Taleb (NNT) has been talking about the systemic risks posed by the rising complexity of financial markets coupled with the over-leveraging scenarios that blew up in the world’s face during the sub-prime crisis. This was the climax of the housing asset bubble building up in the US and spread to the world in the form of collaterised debt obligations (CDOs) that were too complex for even financial institutions and regulators to understand.
Even in Singapore we were not spared as innocent uncles and aunties along with “savvy” investors were hit by the Lehman minibonds scandal that saw a number of retirement savings go up in smoke due to the credit default of Lehman Brothers.
A World of Black Swans
His views resonate with me and I agree that we live in a world of black swans and as human beings our ability to calculate risks are actually quite poor although we give ourselves as a species too much credit in thinking we can predict the tail events or outliers e.g. subprime, great depression, dot com crash etc. and impute specific measures of the probability of such catastrophic events happening.
I watched one of his more recent television appearances on video and his take on the stock market as a place to park investments for retirement is totally against the conventional wisdom. NNT feels that the stock market has some elements of a ponzi scheme in that the stock market rewards earlier investors with monies brought in by later investors.
The speculative part of the stock market which I’m currently engaged in tells me that it’s true. In that you buy when stock prices fall in anticipation that a greater fool investor will buy the same stock from you at a higher price later. The reality of this struck me during the height of the subprime crisis when market prices of stocks collapsed and if you were looking to cash out and sell your equities for retirement cash funding needs, then you’re in trouble.
Rethinking How to Invest for Retirement
NNT thinks that retirement savings should be mostly in cash and cash equivalents. He also believes we should have “hard assets” but not necessarily property. I think he’s referring to gold/silver or something tangible but it was not clear from the interview.
He says that we should invest in stock markets with “play” money because if another systemic shock like sub-prime happens again, and it’s likely to happen as the banks that are too big to fail just got bigger and the people (investment bankers, regulators etc) who brought us to the brink are still around.
The more I read and listen to NNT, the more I believe there will be more shocks in the future as history repeats itself when we don’t learn from the lessons of the past.
There is still a lot of debt going around global financial markets and even in Singapore there is a property bubble building up as evidenced by the recent quick run-up of property prices that appear to be out-pacing the real economy in terms of wages and real income.
The stock market and property market cannot go on sustained climb without end if the economic fundamentals are still weak globally and in Singapore as well.
How Now Panzer?
Going forward, I still think being overweight in cash and cash equivalents and underweight in equities is still my way of dealing with the uncertainly in the short-term. Deploying my capital to fund self-sustaining streams of cash flows from my blogging or blog monetisation, investing in real-world businesses that generates a returns in an area I’m interested in appears to be the steps I should pursue.
I still intend to work as an employee and build up my CPF retirement funds but will deploy investible net worth to more real-world producing assets and need to prepare myself to understand what opportunities there are out there for me.
How will you deal with this uncertainty of market shocks going forward?
Share with Panzer.
Be well and prosper.
Hi Panzer,
Actually sometimes I wonder if I am better off NOT reading these 2 books, even though they are (apparently) highly recommended and have received rave reviews. From what I gather, the recent events may constitute what he defines as a black swan event but then if we were to fear or live in trepidation of such events occurring (of which we have no forewarned knowledge or control over), then it will be like the case of Chicken Little who is afraid the sky is going to fall. With this mindset, one may keep hesitating from deploying capital with the inherent fear that everything may come crashing down.
Even though the recent crisis has made everyone re-think about risk-reward and the long-term returns from investing, I still maintain my view that over the long-term, equities can outperform bonds and the economy will continue to grow. Thus, putting our money to be managed by prudent Management is still the best thing to do. Banks pay scant little interest because they are using the same money to invest in companies/funds as well. So we may as well beat them to it and put our money directly into such good companies.
If I adopt a long-term perspective, then I need not fear uncertainty. It’s important to have a suitably long time horizon.
There’s more to say but I will end here. Otherwise, this may end up as long as one of my posts
Hahaha…
Cheers,
Musicwhiz
Hi Musicwhiz
I think Taleb is not advocating that the world will collapse but his thoughts on how the establishment works to make everyone think that stock markets can only go up (and up) misses the risks that we have to “time” it eventually. When one requires cash for day-to-day expenses when we decide to “retire” or stop full-time employment means that coming to our retirement years, we need to consider an exit strategy which involves some degree of timing.
Be well and prosper.
Panzer´s last blog ..HLF Golden 55 Plus Fixed Deposit Rates
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Hi Panzer, thanks for this great posting. There is some element of truth, in that stock market works similar to a ponzi scheme. However, this is true only in the short term, as people tend to speculate for quick gain for shortest period of time. So who come out last suffer most.
But in the long run, stock is a great hedge tool against inflation, cos Companies will always ensure its profitability by increasing its revenue and profit, faster than our wage increase.
So I would still adopt to my own strategy, buy into blue chips and go for long term growth. I had read a book recently on some simple check list of identifying a good long term stock, including calculating intrinsic value. Will test it out and share with you.
Hi Wi$e
Holding in the long-run gives you no guarantee that your equity holdings in company x will definitely pay off as companies can collapse, get delisted or be removed from the index or stop being covered by analysts.
Thus, one has to pick the right blue chips for the long-term strategy to work as well.
All the best for your intrinsic value calculation and picking of the right stocks.
Be well and prosper.
Panzer´s last blog ..CIMB Fixed Deposits