Having two little girls, I, like many parents, am constantly challenged with animated cinematography. And watching Luca a few days ago, a beautiful Disney movie, I wondered how and how much we adults, soiled by our personal experiences, are willing to step out of our comfort zone.
We often deal with other things in our daily lives, and it is comfortable to think that someone is interested in business in areas in which one has little knowledge and in which one often makes choices because one has heard or a friend has said so.
Is one aware of where one wants to go? And of the risks? Is one aware of them? What affect do they have and could they have on our state of mind?
Lived life and financial markets reside on the same plane; if you only think about your savings and what you would like them to generate, wealth for you, your children’s college, that car you so enjoy, or that trip you have always wanted, then you will discover how much your efforts and having them capitalized on, requires even more attention than you put into them today, to achieve goals that in such a Western world are characteristic, in some way, of being.
So it takes getting your hands dirty, learning a little bit, getting informed, getting out of that comfort zone that seems to be the whole thing.
The financial market is a place where people and institutions invest in stocks, bonds, currencies, commodities and other assets. It is a place where the prices of these assets are determined by supply and demand. The risks investors face can be classified into two types: systematic risk and unsystematic risk.
Systematic risks are those that affect the entire market or economy. These risks cannot be avoided or reduced by diversifying investments among different asset classes, but they can be limited with some strategy, which, however, appears to be out of the box just because it is unusual.
Unsystematic risks, on the other hand, are those that do not affect the entire market or economy, but affect only certain assets or asset classes. Investors can reduce their exposure to these risks by diversifying their investments, and they can do so in different ways and strategies.
Thus, one such strategy is diversification by asset classes.
But as we have seen, over this past decade, macro-systemic changes (See tapering and various injections by central banks) have undone that mechanism, which is only just returning today: gold, commodities, bonds and equities were taking and have taken different paths, synchronized with the phase of the economic cycle in which we find ourselves. There are, however, more effective ways to reduce risk, and Taleb explains this well in his yet another creditable work Antifragile, in which convexity can make uncertainty a real advantage. The concepts may seem complex at first glance, and if they continue to be complex after several readings, fortunately there are those who approach financial markets in a way that takes advantage of this uncertainty without penalizing portfolio value creation.
Market risks are defined as the uncertainty of return on investment. Financial markets are constantly evolving, and to remain competitive, investors must be able to manage their risks and take advantage of opportunities as they arise.
To manage the risks of financial markets, an investor should have a clear understanding of his risk tolerance so that he can set appropriate expectations for himself. He should also, as mentioned just above, know what he wants to achieve with his investment so that he can make decisions in line with this goal. These assessments are rarely made, and if made, are very easily disregarded. The reality, as Peter Lynch says, is that “In markets, the most important organ is the stomach, not the brain. If you study history, and history is an important lesson, what we learn is that markets go down, and down a lot. The math is simple: in 93 years, the market has had 50 10% declines, on average once every two years, we call this a correction. Also in 93 years then, the markets have suffered 15 declines of more than 25%, once every 6 years or so, we call this a Bear Market.
Here is all you need to know! You need to know that every now and then the market goes down. If you’re not ready for that, you shouldn’t own stocks.
So why not think of something that will reduce that general discomfort caused by sudden declines like the ones we are seeing and allow people to stay in the market without running away?