Random Readings

A quick tour of the financial interwebs.

A few different things I’ve read over the last couple of days.

I have written several posts in the last few weeks (before the early February panic) about the dangers of selling volatility and selling puts. Of course, the short volatility trade blew up in spectacular fashion while put-writing funds merely took a sound whoopin. The Wall Street Journal took up the topic on Valentine’s Day, noting that Harvard as well as State of Hawaii Retirement System and Illinois State Universities Retirement Systems all may have gotten caught wrong footed on the short vol trade. I specifically wrote about Harvard doing this on January 8th. The Journal also touched on put selling which I first touched upon since joining TheMaven on December 28th.

By all means, read the Journal article but ideally investors would be able recognize the risks before they blowup. Forgetting about the 115% jump in VIX that caused Credit Suisse’s ETN to terminate, VIX can pretty easily move 30-40% in a day. Shorting something capable of that kind of move should be enough to understand the picking up nickels in front of a steamroller aspect of the trade. I am sure the funds that sell puts disclaim as they are required but I saw one marketing-type commentary for one of the funds right before the panic, right before, saying why now was a good time for the strategy and how it can reduce volatility. The strategy is valid, but it only reduces volatility on the way up. Depending how it is done, it can make downside volatility much, much worse than plain vanilla equity exposure.

Barry Ritholtz wrote about 5 Rules to Help Avoid Investing Disaster; avoid new products, learn from mistakes, don’t buy what you don’t understand, beware of institutional products packaged for retail investors, understand the risk/reward tradeoff.

Or, keep it simple. If you buy one broad based equity fund and continue to add to it over the long term, assuming a suitable asset allocation, you’re going to have accumulate a lot of money. If you’re 40 years old and started working in 2000 and putting everything into Fidelity Contra Fund, Morningstar says that $10,000 would now be $41,000 plus if you’d be putting in $200 or $300 per paycheck you’d have a serious piece of money for being 40 years old.

I picked the Contra Fund only because it is one everyone has heard of, I have never owned for clients or personally and I specifically did not check whether it outperformed anything. In 18 years it is up a lot and has a good chance of being up a lot in the next 18 years regardless of whether it outperforms anything. It is a simple, broad based equity proxy and could get the job done. Ditto any S&P 500 fund. In this context you are managing against the reality that the simplest possible thing, provided you save adequately, is very likely to give you what you need. If you accept that as true, then how complex should you really make your investing?

There are all kinds of reasons not to just put it all in one fund as described above but it can be an influencer in terms realizing at some point complex/sophisticated goes from helping to hurting.

The Get Rich Slowly blog had an interesting post about financial empathy. Here’s a useful quote;

For instance, I’ve noticed that people have a tendency to think that because they do something a certain way, everybody else can (and should) do it that way too.

I am not exactly sure what to do with the quote, but this is probably something I should work on.