When Analyzing Risk, Leave No Stone Unturned

A decade ago, an acquaintance of mine who worked in the mortgage industry told me that business was so good, she couldn’t lose money if she wanted to.

And that’s what really bothered me.

What bothered me was that the eternal rules of supply and demand seemed to have been suspended in the real estate market of this time. But why?

We have a very technical and advanced society, but the fundamentals never, ever change.

There’s no substitute for diligence, doing your homework and working harder than everyone else: these are timeless keys to success. Businesses that succeed are driven by executives with these values. Period.

If you can get rich just by showing up, we’d all be multi-millionaires.

Thus I had a nagging feeling. Why in 2006 and 2007 was the real estate market not only violating all of the basic rules of economics, supply & demand, but also the eternal truths about what it takes to succeed?

I’m a Chartered Financial Analyst with 28 years of experience. During that time I’ve learned one clear lesson: steer away from unpredictability, economic anomalies and anything else that is simply too good to be true. I admit, I’m unusual in this regard. Many in my industry recommend the exact opposite. They advise that you should invest in anomalies and bubbles because you can make extravagant profits.

The one caveat, of course, is that you have to jump out of that investment before it implodes. They all claim to have a sixth sense—they know when to jump ship and cash out. By working with them—so they say — you can benefit from their clairvoyance.

I don’t have a crystal ball. What I do know are some simple, but timeless, truths. For example: If a 20-year old starts with a 10,000 investment earning a very modest 5% annual return and invests $100 a month into that account, the same person at age 50 will have $128,000. At 10%, that 50 year old will have $426,000!

This is how you turn small amounts of money with modest monthly contributions into very large sums of money. No magic here; no crystal balls: Just time plus the beauty of compound interest.

Another thing you should know about me is that I despise unnecessary uncertainty. Just like life, nothing is certain in investing. But, you can take steps to minimize uncertainty to the greatest possible extent with every investment decision you make. That’s how I invest my money.

Back in ’06 and ’07, I read all that I could from the experts. Allan Greenspan said all is fine, don’t worry. George Soros, who made billions betting against the British currency just before it collapsed, said the same thing: no bubble, no reason to fear. Many experts said the same thing: no reason to fear.

In retrospect, this seems insane. But people tend to believe what they want to believe. That’s human nature. Even when we decide to empirically look at all the facts and attempt an impartial judgement, we subconsciously ignore the facts we don’t like and inflate the value of the facts that confirm our convictions. Scientists call this “confirmation bias.” To me, it’s just human nature. And it has cost investors an enormous amount of money.

Soros actually invested in the now defunct Lehman Brothers investment bank just weeks before it collapsed because of over-investment in worthless collateralized mortgage obligations—a gimmick invented on Wall Street. Soros bought Lehman at its highest price in 2008 and lost about $120 million.

But there were some lone voices in the wilderness warning of the impending collapse, not many but some. The housing market had all the telltale signs of a market that was no longer tethered to reality. Housing prices were escalating rapidly in the Bay Area and other hot housing markets. Banks were giving away mortgage loans with zero down and no proof of employment. Speculators bought so many homes, there was a glut of rental properties that sent rent prices plummeting.

I didn’t know how it would end, I only knew that things didn’t add up. This is when I contacted my friend in the mortgage business. I needed an insider’s perspective, but she said the very same thing: All is well, no bubble here.

Weeks later, she was financially devastated by the steep plunge in housing prices and a stock market that lost half its value. So many neighbors and friends had their lives upended. They lost jobs and postponed their retirements. Most have still not recovered.

After all the advice and reassurances I received, I went with my gut and sold our stock holdings before the crash Allowing my analysis and gut instincts to guide me even when it meant taking a position that ran contrary to the advice of a close friend in the industry, enabled me to avoid devastating losses.

I’m not an oracle or a psychic. I just hate illogical conditions and the level of irrationality in the market at that point was too much for me. I decided it would be better to lose a quarter or two of growth than to have our portfolio slashed to the bone.

I don’t tell this story with any joy. So many millions of people were devastated from loose lending practices, financial market gimmicks, ill-conceived housing policies and greed. I only share this to illustrate how I think and how I approach the management of personal investment, whether it’s mine or yours.

If you would like to comment or have a question, please email me at info@oncenterfinancial.com.

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