Volatility & The Alchemy of Risk

“The Global Short Volatility Trade now represents an estimated $2 trillion in financial engineering strategies and share buybacks that simultaneously exert influence over, and are influenced by, stock market volatility. Volatility is now an input for risk-taking and the source of excess returns in the absence of value. Like a snake blind to the fact it is devouring its own body, the same factors that appear stabilizing can reverse into chaos. The danger is that the multi-trillion-dollar short volatility trade, in all its forms, will contribute to a violent feedback loop of higher volatility result in a hyper crash.” – Artemis Capital Management

An outstanding white paper about volatility and how it can be the fuel that’s added to the fire.

The Hardest Part is Taking A Step Back


Whether you like Tim Ferriss or not is not important. Tim wrote a really insightful blog post recently about why he is stepping away from investing in startups. What intrigued me was why he did it. As a trader and investor I can empathize with what he is going through. Whether you’re an investor in startups or a trader in the public markets, stress is your enemy, but almost impossible to completely eradicate. Tim has a number of great points in this blog post. I will attempt to provide some of the most relevant to this conversation.

FOMO results in “B” Player Status

As an investor/trader many know that the “Fear of Missing Out” is strong. You hear of all the good trades and none of the bad. You fear that you are missing out on trades or investments that other people are making gobs of money on. The same goes for startup investing. If you are an angel or venture capitalist “FOMO” is just as strong. FOMO creates stress, terrible stress. This stress takes you out of the game and results a “B” investor status. Tim realizes that because of FOMO he is investing in more startups than he should. He’s becoming a “yes” man, which becomes an overwhelming experience. As a trader or investor I compare this issue with not being able to choose the investment or trading strategy that best fits your character. As an trader/investor your goal is to make money. When you see others make money or hear of these terrific trades, you start to wonder if you’re missing out. Should your trading/investing strategy change? It goes back to the phrase, keep it simple stupid. If you try to take advantage of every “opportunity” available you get stuck in the mud. You get buried alive. You get stressed out. You can’t focus. Your mind is too busy. Public markets give the trader/investor opportunities daily. Stay focused on what you’re good at, don’t worry about what others are saying, and maintain your edge. Don’t become a “B” player.

Does a large guaranteed decrease in present quality of life justify a large speculative return?

This is a terrific question for any trader/investor. I guess another way to ask this question is whether you would take the trade if the stress of the trade created insomnia, lethargy, loss of appetite, and/or moodiness, but the potential outcome could change your lifestyle. I would argue that this investor is on the path to destruction if that trade gets placed. I’ve been there. I have taken positions where the stakes were much higher than my comfort level. That level of uncomfort will almost always result in a negative outcome. There are always going to be individuals that are comfortable in that type of scenario and can think logically in unbelievably stressful times, but those are few and far between. Tim makes a terrific point in saying that you should always know your ROI which comes in the form of cash, time, energy, or otherwise. “An investment that produces a massive financial ROI but makes me a complete nervous mess, or causes insomnia and temper tantrums for a long period of time, is NOT a good investment.”

Leverage your strengths instead of fixing your weaknesses.

If this statement doesn’t make you think as a trader/investor you’re missing the point. Tim states, “Don’t push a boulder up a hill just because you can.” It’s absolutely true, but most “investment/trading guru’s” will push their methodology because it may have worked for them or a few others. Here’s the problem: the chance of that specific investment/trading methodology fitting your personality is pretty damn low. Before putting money on the line you should be seeking out your strengths and weaknesses. I have been a trader and investor for over 15 years and many “trading gurus” will tell you that eliminating your weaknesses will create success. This is a bunch of baloney. I know that my strengths are not geared toward short term trading. So, why should I trade short term? What benefit will that provide me, except years of attempting to change core behaviors to fit the mold. Why not understand and leverage my strengths? That is your edge, right? Understanding this concept will increase your quality of life and ROI as an investor.

Know Thyself.

This statement dovetails nicely and is somewhat related to the previous point. Many traders/investors are completely consumed by their profession. They’re usually an all or nothing type of person. It’s difficult to find the shut-off switch. Personally, I have realized that if and when I find it hard to shut down and focus on something other than investing, I need to step back. We all have a tendency to get completely absorbed by something and it’s difficult to pull yourself away. We don’t even realize our stress is through the roof. So, what do we do to combat this “disease”? Stop. Stop trading. Stop investing, until you can take a step back and see how it’s effecting you. I give Tim a lot of credit. He has been an extraordinarily successful Angel investor. He realized that he is an all or nothing guy. He knows, in theory, that he can’t follow through if he tells himself he will only invest in two deals a quarter, which he has tried to do. If he wants to slow down and create a better quality of life, he needs to stop for a breather. He needs to stop investing, so he can reboot. What’s the worst that can happen? Ask yourself that question, and write down the answers.

I was always told, “take your time, the market will always be there when you get back.” It’s calming advice. I believe the hardest part of being a trader/investor is the ability to step back and see the bigger picture. This profession can eat you alive faster than any other profession in the world. I don’t believe that there is another profession in the world where it’s absolutely imperative that you know yourself inside and out in order to be somewhat successful. Make sure investing is creating the lifestyle you always wanted, not the stress that buries you alive. Your quality of life is positively related to your success. So, if you need to take a step back, listen.

Skeptical of Robo-Advisors? You Should Be…

I’m an information hog. I love to read about the new technologies breaching the financial services industry. In fact, I usually request a demo of financial software if I think it’s unique. I have requested demo’s from JemStep, Schwab Intelligent Portfolios, FutureAdvisor, Motif Investing, Betterment, and so on. I wanted to understand how their software works and how portfolios are constructed. Many times the individuals that I spoke with couldn’t give me a very good answer as to how they construct their portfolios besides providing me with a blanket answer of diversification. Many state that their investment philosophies are backed by big names like Burton Malkiel, but fail to give me an understanding of how portfolios are chosen or how risk is measured. As a result, I made the decision to not provide a Robo option to prospective clients of my firm, but that may change.

Yesterday, I received an email from a small Robo-Advisor/Risk Assessment firm named RiXtrema. RiXtrema came out with a robo-advisor for advisors called BioniX. It looks at risk in a much more reliable manner. For instance, take this excerpt from the RiXtrema White Paper, which I highly suggest you read if your money is invested with a Robo-advisor.

“Robo-advisor methodologies are based on mean-variance optimization, which focuses on trailing variance as a measure of risk. Trailing variance is calculated from relatively recent history of the financial markets, usually a few years. Variance in financial models is simply an average squared difference between the average return and return on every date observed over some historic period of time. Thus it should be clear that when [the] market is trending up like we have seen over the past few years, the average return is positive and deviations from that average are relatively small. That is why in periods of prolonged market tranquility, trailing risk measures have dramatically understated market risk.”

Not to make things technical, but if you have some sense of what that statement means, it should give you pause with the current volatility in the market. The majority of Robo-Advisors will manage risk in this way. To follow up with another great excerpt from the white paper:

“In addition to the problem of understatement of risk prior to a crisis, variance based measures overstate risk following it. You can see that risk in our chart keeps climbing all through 2009 and, in fact, keeps climbing through 2011. As a result, investors that go to robos after the crisis will get portfolios that are now excessively light on stocks. Mean variance algorithms can be thought of as ‘buy high sell low’ strategies around crisis events, which is the opposite of what investors want. Imagine if an advisor had suggested that clients load up on risky assets prior to the Lehman collapse, but then after the collapse in 2009 started putting everyone in bonds. That would be precisely what should not happen, but that is what existing robo technologies are set to do. It is no surprise that the Fed no longer uses Value-at-Risk (essentially same as trailing variance) when talking about systemic risk, but focuses exclusively on stress testing.”

So, you’re telling me Robo’s will buy high and sell low? Yes, that’s what it’s saying. Think of it as measuring risk on a delay. It’s like getting delayed quotes when you’re trying to trade intraday. It’s worthless and you lose money. Why would you do it? My point is that if you decide to use an automated investment platform make sure you understand how they measure risk and how it constructs portfolios based on that risk. For the past 2 years, Wealthfront portfolios have gotten murdered. Wealthfront portfolios have no Treasuries. There’s nothing in the portfolios to soften the blow. Their portfolios have stunk the place up! A person with average risk tolerance still has 38% of their portfolio in foreign plus emerging stocks or bonds. I don’t know if you noticed, but it’s been quite the shit show in Emerging Market bonds and stocks.

Stay safe and do your homework. I’ll update this post once I demo RiXtrema.

There’s a Decrease in Entrepreneurship…

Entrepreneurs are the backbone of America. They produce jobs, incredible ideas, and push the boundaries of possibility. They are what makes this country great. In my business, I choose to predominantly work with entrepreneurs and business owners. I understand that their path to success isn’t linear, mine wasn’t. My business is built to make their financial lives easier, so they can go change the world. This morning I read an article from the Washington Post called “America’s 1 million missing entrepreneurs.”  In this article Mr. Tankersley states,

“At the start of the 1970s, about 3 percent of U.S. households started a new business every year. By the end of the 80s, that rate had increased by a third. By the end of the 90s, it had risen again, by almost a fifth, and stood near 5 percent. Then, quite abruptly, the growth stalled — and after the Great Recession, the rate fell. If the trends of the previous 30 years had continued, the nation would have seen 1 million more entrepreneurs over the last decade than it actually did. For some reason it did not.”

The reason he thinks this is happening is the faltering health of america’s middle class. As the chart below shows, higher income and entrepreneurship have a high correlation.


As an entrepreneur myself, this stat is heartbreaking. That begs the question, is it more difficult for an entrepreneur to make it today than it was 20 years ago? On one hand, technology has evolved drastically over that 20 year period and has created opportunity like no other. Technology has, in many cases, provided individuals with a lower barrier to entry into a certain market. So, why are we running a deficit of entrepreneurs?

Well, even though the above stats indicate that being in a higher income category correlates to a higher percentage of entrepreneurs, I don’t think money is the root cause of the decreasing percentage of entrepreneurs. It doesn’t always take money to make money, although in many cases it helps. Funding startups is easier than ever with crowdfunding, but that’s a separate subject for a different blog post.

Technology is a double edged sword. On one hand it provides companies with efficiency, global reach, automation, etc. On the other hand, the rapid pace at which technology evolves creates the difficult task for companies of evolving with it.

Today, companies have to be creative and flexible. If they aren’t, they perish. Today’s competition, in any business, is fierce. Not only is the competition fierce, but successful companies have extraordinary individuals leading them. This provides for an extremely intimidating environment for any entrepreneur. You need guts to take that step. 2008 created wounds that are still fresh in everyone’s mind and there’s no question it’s a cause of concern for any person with the thought of launching a business. 2008 taught us that even the largest companies can be wiped out in the blink of an eye. An entrepreneur needs guts, an edge, intelligence, perseverance, discipline, risk tolerance, and belief in self.

Is income inequality a factor in the lowered rate of entrepreneurship? Possibly. But, in my opinion, the main cause of the decrease is lack of individuals that possess these qualities and are willing to take on, historically, the fiercest competition knowing that it’s the most difficult path to success. Many of the most successful entrepreneurs were able to buck the typical long path to success. These folks are accelerating success and pushing the boundaries at a breakneck pace. For example, Airbnb vs. Marriot and Uber vs. Yellow Cab. These examples show leadership, belief in an idea, and leverage of technology to create an edge. There’s a ton of opportunity out there, but you have to be willing to take the risk.