Nov '22 in General discussion
The Breakout Report: How To Avoid Financial Catastrophe
If you've watched any financial news over the past couple of weeks, you've heard a lot about the crypto world as it has now completed the entire cycle from mania-bubble to meltdown and fraud.
It’s intuitive that a big part of financial and investing success is the avoidance of financial catastrophe. And avoiding catastrophe mostly consists of avoiding manias and questionable investments as this cycle illustrates. This has been the story of every bubble that has come before and will be again for every bubble yet to come.
With this boom-to-bust cycle now complete, I want to use it as an opportunity to share/review the intentionally simple three-question framework I use to, hopefully, avoid making regrettable investing decisions. Obviously, there is no framework that is guaranteed to work 100% of the time, but I think this framework can help us avoid the large majority of questionable investments.
In abiding by this framework, the rule is simple: If I can't answer each question below with a confident "Yes," then I will not invest.[1] Here we go.
Question #1: Do I understand the investment? (Or is it confusing?)
As crypto went mainstream over the last couple of years, I felt that regardless of the time I spent reading and learning about the space, I couldn’t seem to truly understand how any of it worked, what the use cases were, or how prices could continue to rise if adoption stalled.
Many have said that crypto is a solution in search of a problem. After much research, I mostly agree with that assessment though I continue to reevaluate this position.
Until clarity is obvious, Warren Buffett's "too hard pile" philosophy can be helpful here. If I can't understand it, I probably shouldn't own it.
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Question #2: Is it reasonable? (Or does it sound too good to be true?)
Many investors who eventually decided to invest in crypto did so because crypto “savings accounts” were offering very high yields with minimal risk. At least, that’s how they were advertised. And due to minimal regulation in the space, there were few disclaimers offered to protect consumers from any misrepresentation of the risk that was involved.
What’s great about free markets is that they are a natural pricing mechanism for risk. Because of this price/risk relationship, I couldn't see how a high-yield, low-risk account could truly exist which further encouraged my skepticism.
Given my lack of understanding for how the yield was generated (see Question #1 again), I continued to return to the sage phrase we’ve all heard a thousand times before, "If it sounds too good to be true, it probably is."
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Question #3: Is it necessary to achieve my financial goals? (Or is it a distraction?)
If they're honest, I would guess many people who invested in crypto did so because it seemed like easy money. But we know that money easily gained is easily lost.
As a good rule of thumb, the more exciting an investment seems, the more likely it is to blow up. Though, in the midst of a mania, it's easy to forget this.
When considering this third question, we can disregard most investment opportunities because almost everything that is new or exciting is a distraction from what has worked for decades upon decades. Consider this wisdom from Nick Murray,
"Don't ask what's working right now; ask what has always worked."
The answer is typically a diversified portfolio of traditional, boring, low-cost investments. The rest just isn’t necessary.
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To be fair, this memo isn't designed to be anti-crypto. My intent is to share the decision-making process I follow when making any and every investment decision and am using crypto as my obvious example given its prevalence in the current news cycle.
One thing we know is that we’ll experience another bubble at some point. We don’t know what that will be, but my hope is that these questions can serve as a helpful filter to avoid falling victim to whatever comes next.
Stay Strong
Phil
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The Breakout Report: How To Avoid Financial Catastrophe
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