I’m pecking at the keyboard in the middle of a severe market correction in both the stock and crypto markets. Chicken Little is starting his “sky is falling” campaign and things could very well get worse before they get better. It’s a bit laughable that people forget that markets don’t go up in straight lines and are indeed cyclical – I’m sorry to say that this time isn’t any different. Everyone feels like a genius in a bull market, but these are the lessons “bull market geniuses” never learn:
- Leveraging Limits Optionality
- It’s a euphoric feeling (or so I’m told) when your returns are multiplied by debt.
- However…it’s catastrophic when leverage cuts the other way.
- Cash Isn’t Trash
- Cash looks like trash when assets are in a bull market and inflation is rearing its ugly little head due to interest rates near zero and the printing presses creating money out of thin air around the globe are working overtime.
- Cash is King when the market inevitably corrects and removes excess from debt-driven euphoria.
- The Trend is Your Friend Until the Bend at the End
- It’s easy to get caught up in the good times and believe you will be able to time the downturn.
- But all of a sudden, when there is nothing but red on your investment statements, people are surprised that assets have corrected 20-40% in a blink of an eye.
Don’t get me wrong, I’m a (Gen Y) Finance Guy through and through, but these are the lessons I make sure I never lose sight of whenever I’m feeling like a boss. There is a reason I don’t always do what “academic finance” would prescribe as optimal. I don’t optimize for the highest financial return but instead for maximum peace of mind, which to me means not losing. I don’t have the energy to be one of those people who make and lose fortunes several times in their lifetimes. Life is too short (and I’ve got other things I want to spend my time on)!
I’m debt-averse because I value optionality over magnified financial returns. I choose to use the forms of leverage that aren’t catastrophic when the music stops and the debt collector shows up at the most inopportune time. I find it funny that although many forms of leverage are available to you in your pursuit of wealth, financial leverage gets all the attention. Below is a list of the six major forms of leverage available; I choose to over-index on 2 through 6:
- Financial Leverage: Other people’s money so that you are not limited by your own pocketbook.
- Time Leverage: Other people’s time so that you are not limited to 24 hours in a day.
- Systems and Technology Leverage: Other people’s systems and technology so that you can get more done with less effort.
- Marketing Leverage: Other people’s magazines, newsletters, radio shows, and databases so that you can communicate to millions with no more effort than is required to communicate one-on-one.
- Network Leverage: Other people’s resources and connections so that you can expand beyond your own.
- Knowledge Leverage: Other people’s talents, expertise, and experience so that you can utilize greater knowledge than you will ever possess.
Note: I got the above from Todd Tressider’s book The Leverage Equation: How to Work Less, Make More, and Cut 30 Years Off Your Retirement Plan (Financial Freedom for Smart People Book 6)
I’m constantly de-risking, which is why I am 100% debt free for the second time in the last four years. That stance was also a big motivator for why I was opportunistic in selling 60% of my company when I did. Did I leave money on the table? Absolutely! There is no doubt about that but it remains a decision I would make over and over again to maximize peace of mind and minimize stress. I also de-risk by building up large piles of cash in order to be prepared for the eventual downturn whose significant hurt I’m always trying to avoid, instead hoping to profit from it with my liquidity.
The best way to deal with uncertainty without hiding in a bunker is to save like a pessimist and invest like an optimist. – Morgan Housel
Optimism and pessimism always overshoot because the only way to know the boundaries of either is to go a little bit past them. – Morgan Housel
I believe that the long-term trend is up and to the right but I’m not blind to the reality that shit happens in the short term…shit that nearly always seems unpredictable or unexpected although history tells us that these “unpredictable and unexpected” events are inevitably going to show up. So, although you might not be able to prepare for any specific event, you can try and make your financial position as anti-fragile as possible.
I know it sounds like an oxymoron but I’d describe myself as a paranoid optimist in the short term and an irrational optimist in the long term.
The game of wealth building is really rigged in favor of the optimist…I mean how many people have you read about that got rich (and stayed that way) betting against things improving over time?
You might say that my rose-colored glasses are equipped with 20-20 prescription lenses.
I truly save like a pessimist and invest like an optimist.
– Gen Y Finance Guy
p.s. check out this post about why it’s not a good idea to bet against America in the long term: Warren Buffett on Betting Against America – Don’t Do It!
4 Responses
Good post Dom!
Once you hit your $10M financial target do you plan on your risk tolerance increasing with the delta you have above $10M?
Thanks, Keenan!
It’s certainly a possibility that my risk tolerance increases but at the same time why change something that isn’t broken?
My aim is 10% compound growth which will allow net worth to double every ~7 years or so. And that is conservative for as long as I keep making new contributions (i.e. savings).
Would you change your risk tolerance level? Why? What kinds of risks would you take?
Dom
That’s fair!
I think there’s a good chance that I would seek out higher returns since the downside risk of an investment going to zero wouldn’t have any impact on my family’s financial security. Instead of my current asset allocation of ~95% market based index funds and ~5% speculative (at this point that’s just crypto) I could see the speculative % increasing substantially, perhaps to 25-50% of future investments.
Might as well swing for the fences when you’ve already won the game!
I think the effective altruism movement is pretty interesting and could see myself contributing significantly towards that once FI is achieved.
Maybe it’s the fact that my net worth allocation as it stands feels right to consistently compound. At the end of Q1’22 I had the following:
– 8% Cash
– 4% Crypto
– 18% Other Alternatives
– 38% Real Estate (including primary residence)
– 29% Business Equity (should be less than 20% by year end)
– 3% Stocks
I don’t think I’ve been that conservative in deploying Capital…just conservative in the use of debt and holding onto much larger cash reserves.
I could see a future where I set up a holding company (think Berkshire) to buy boring businesses and use moderate debt secured by significant cash flow. But I’d work with an attorney to optimize the structure so that no one company could take the whole holding company down.
It all depends on what I think I can accomplish with only 30 hours a week dedicated to it all.
Dom