Fundamentals of Investing - Part VI

IMPLICATION OF THE BLACK SWANS CONCEPT

Yesterday, I talked briefly about the Black Swans Concept introduced by Nicholas Taleb. Today, we shall review the implications of this simple, yet often overlooked fact of life. Simply put, NOTHING IS CERTAIN IN LIFE.

It’s strange; sometimes our lives are so routine and mundane, it seems that every day will be just like the day before. Just like the Turkey, we tend to think that just because something has happened for the umpteenth time previously; it’ll be the same today. Ah-hah, maybe today will be the day you’ll be led to the slaughterhouse, just like our Turkey.

In the world of investing, this has astounding implications. For instance just before the stock market crash in 1998 in Malaysia, I believe almost all of the so-called experts, investment analysts, brokers, stock market punters etc. were raving about the Malaysian Stock Market and how it would go higher, Higher and HIGHER! Well, in 1998 the Malaysian Stock Market did move all right… Just in the OPPOSITE direction, it moved DOWNWARDS :( and went lower, Lower and LOWER!!!

Black Swan events such as the Tsunami that hit Aceh on 26 December 2004 can happen instantly without warning. These can have severe implications on your investments, so you need to have contingency plans for your investments. Otherwise, you may be caught flat-footed. So, what can you do about it?

KEY INVESTMENT STRATEGY: ALWAYS CASH OUT AND RECOUP YOUR CAPITAL
When the stock market is booming, there is always the tendency to be GREEDY. Once you are hit with the fever, you might sell off all the assets you own, including your house and borrow to the hilt to invest in the stock market. After all, it is easy money right? Invest RM100K and see it grow by 30% the next day. All that without even lifting a finger!

Well, that’s true. Don’t forget however, that the converse is also true. You could just easily lose the RM100K in the blink of an eye. Think about Enron and Bear Stearns. Shares worth over USD90 per share can become almost worthless overnight (see the charts above).

I am not saying, sell all your shares once you make a 5% gain. What I am saying is, please review your investments periodically. If you make a capital gain of approximately 30%, why don’t you sell half of those shares and lock in your gain and recoup part of your capital.

Remember, the shares you hold are merely pieces of SCRAP PAPER. They are literally WORTHLESS unless someone else is willing to buy them for you. So, always have some CASH in the bank. Don’t put all your eggs in one basket, especially in the SHARE MARKET basket.

CONCLUSION:
ALWAYS CASH OUT SOME OF YOUR CAPITAL GAINS FROM THE STOCK MARKET ONCE YOU HAVE MADE A HANDSOME GAIN. REMEMBER – THERE ARE ALWAYS BLACK SWANS SWIMMING AROUND READY TO RELIEVE YOU OF YOUR MONEY! (AND TURN A BULL RUN INTO A BEAR DIP)

LEAVE SOME OF YOUR SHARES IN THE STOCK MARKET DURING A BULL RUN. IF THE STOCK MARKET KEEPS GOING UP, YOU’LL STILL PROFIT FROM IT SINCE YOU STILL HAVE SOME SHARES LEFT :)