Wednesday, August 2, 2017

the lance armstrong risk metaphor

Foreword- I know its been a few weeks than my last rambling but I don't want to churn out garbage just for the sake of writing, so yes I'm always torn with the frequency of this-

 The other day when I was adding on some more short VIX positions into an up move in S&Ps and spot VIX around 10, I was contemplating all the possible counterparties as the "long VIX" or at least "anti-short VIX" articles keep coming at full force.  This brings me to one of my core rantings on risk/reward on a life scale in the context of Bogleheads and the like.

Lets back up before specific short VIX or even option trades, and just think about the core vision of investing as an individual/retail investor-  we are trying to reach financial independence, to show them all that we were right and they were wrong, crush your enemies, hear the lamentations of their women, etc.  The conventional path to that is indexing all in S&Ps/bonds//international mix, dump the whole paycheck in, no dry powder, and wait 40 years; hoping to pick up the average 7% per year and survive inflation, etc.  This is the "lowest risk" strategy because you aren't even trying to  beat S&Ps, but there is a macro gamble here that the Bogleheads are going all in on and they don't even realize- what if those index returns aren't enough?  This lifetime of investing boils down to a single bet that that market return will be enough decades later, and there is no room to shift course (besides tweaking the stock/bonds % around).   This isn't even touching on the generational factors of no pensions, a gig economy, cost of living and more which make me think the next generation's 'retirement' will look much different.

This is where my Lance Armstrong metaphor comes in, or fill in any juiced up athlete of your choice.  (Preface here- I think Lance is a champion and by the end of this I hope you agree how small it is to change your view because of the steroids.  Literally nothing changed besides your perception from one day to the next.)

If you have a bike race, general race or anything with placements/qualifiers, lets say the top 3 spots go to the next heat or finals and the rest down to 10th place are out.  In that scenario what is the difference between 4th and 10th place?  Nothing noticeable.  To me those first 3 slots are financial independence- there is a hard number somewhere based on cost of living and other factors that equals financial independence or not and our only goal as retail investors is to hit that.

If the passive indexing approach ends up only making that 4th, 5th place, then how was it better than taking on the risk of having the chance at 1st place, and crashing and getting 10th?  Lets finally bring Lance into the mix, or any other juiced athlete-
The competition is juiced out of their minds, that is the playing field to get 1st.  The real competitors know that and aren't in the fantasy land that hard work is enough.  (Hard work is required but you also need to push every boundary AND get lucky just to get a shot, this goes for basically every field)
To oversimplify- if you have to juice to get 1st (the metaphor being that you take on high risk, or the risk of losing it all), then that is all that matters.  If you look at it like a computer that sees forking paths like calculating all the variations of a chess position, and only one of the paths leads to victory, then the risk doesn't matter because no other path reaches the destination anyway.

If you take on this view of looking at all the possible paths then all the other areas of finance start to make more sense- why do these hedge funds get so risky and blow up? Well if they don't outperform the market then they lose their clients anyway, so there is no real choice there besides leverage and taking a shot at beating the market.  This partially points to how the boom and bust cycle is inevitable and cooked into human nature- some people will always realize the necessity of risk, and some percentage of that group will end up winners (90% will blow up) and then they characterize the rest of their era and inspire the next generation.    

Again, this doesn't mean your retirement strategy should be all in on OTM calls, but it means realizing the structure of risk/reward in the context of indexing.  Even more simply I'm just hating on Bogleheads. 

Some discussion for the pre-rebuttals:

But retirement/wealth isn't binary, there is an almost infinite amount of account balances you can have so how is the metaphorical 4th place just as bad as 10th?

I agree you can adjust your retirement cost of living, etc, but to me the traditional financial independence vision is 100% passive income to work at a certain cost of living, so whether you just need a super small part time job vs work at Walmart forever to fill the gap, neither of those are independence.  Its like a movie ticket costing $10, I agree that $9>$1, but neither will cut it.

But steroids are illegal!

Not all risk is doing something currently illegal, this racing metaphor filled with finish lines and endurance and turtles and hares is just too perfect for investing.  Lance could be doing something else like overtraining with some heart defect, the point is that he is adding calculated risk that could blow him up, but it is necessary for the chance at 1st.  Also in the specific sports/steroid example, how many reversions have there been in all industries at a practice that flip flopped in legality, that is just the whims of regulators and idiots at the time, that won't stop champions.

I'm sure indexing will be enough, look at the compounding numbers!

I mostly agree with you, but you are leaving yourself completely dead if you are wrong.  I think that is an even bigger and undefined risk than naked options or whatever alternate investment road you take.  If you do still stick with indexing, you have to reconcile the macro bet you are taking that all the past numbers and factors for indexing going into a new economy will be ok.

Well ok, that's enough yelling for now-  once more into the breach!

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