June 20, 2005

The Way We Live Now; See a Bubble?

Roger Lowenstein, who wrote the must read book When Genius Failed: The Rise and Fall of Long-Term Capital Management, offers some recent insight:

"In limiting risk, people also limit the opportunity for gain. It is common, today, for investors to own six or eight mutual funds, each of which is likely to be invested in hundreds of stocks. This will, they hope, assure that no little bump, no little meltdown, overly upsets their portfolios. But since when was investing about avoiding the bumps? Anyone investing for the longer term can safely ignore them."The Way We Live Now See a Bubble?Roger Lowenstein June 5, 2005

Avoiding the bumps is exactly what trend followers do NOT do. They accept the bumps. Lowenstein continues:

"George Bernard Shaw observed that every profession is a conspiracy against the laity. The financial profession duly warns us of meltdown risk, but it has adopted a pinched definition of risk that has led us into fruitless and sometimes harmful diversions. The odds of a meltdown being necessarily uncertain, Wall Street fosters an overly precise, pseudoscientific approach. Investors are told to ''balance'' portfolios (rather than to select stocks), to ''allocate'' (rather than to ''invest'') their assets and to reckon with quarterly earnings forecasts down to the penny per share -- an absurd irrelevancy for someone whose retirement is years away. Wall Street properly worries about what might go wrong, but it has recast the issue in spurious terms, detaching us from the messy and often subjective considerations that might help us avoid truly perilous bubbles: those that (like the dot-coms) subject us to the risk of enduring loss. If you tune in to enough financial shows, you are bound to stop asking considered questions like ''Is the Web going to be full of other companies competing against this one?'' and to start toying with numerics like a stock's volatility or the percent of your holdings in a given ''sector.'' No wonder people are jittery: this stuff changes every second. To listen to the anchors on cable TV, we should reshuffle our portfolios in response to each new, tangential threat -- oil prices, the dollar, real estate. And, of course, we should diversify in the extreme. Diversification is insurance against the possibility that we might do something stupid; it also heightens the chance that we will do something stupid. People with flood insurance build their homes closer to the shore, and people in the 90's, having diversified, figured they could afford to take at least a small flier on dot-coms. Risk prevention can lead to risk."The Way We Live Now See a Bubble?Roger LowensteinJune 5, 2005

Once again, trend followers know that risk is part of the game. Trend followers know there is no risk free lunch. It just can't be had.