Saturday, 3 October 2015
No risk, no gain. But risk can deliver staggering, crushing losses if it isn't limited or hedged.
Times are going to get harder going forward, for all the reasons that are already visible in today's headlines. So what can we do to make our own lives easier as times get tougher?
Here are three suggested strategies:
1. Don't get enmeshed with dysfunctional people, families or businesses.
When we're young, we're adept at making excuses for people in dysfunctional families and enterprises. We expect them to work their way out of their dysfunctions. We think we can help in this process.
Alas, we can't. People usually can't rid themselves of dysfunction without an extraordinary effort. Getting enmeshed with a dysfunctional person/family/business can only drag you down.
The only way to avoid the mess is to avoid the dysfunctional person/family/business in the first place. Wish them well and get out.
2. Be fanatical about reducing fixed costs.
This sounds so obvious, but it's really the key to surviving hard times and building productive wealth, i.e. the kind that yields income, rain or shine.
Remarkably, people may acknowledge this in an abstract fashion but few actually live by it. The vast majority let their fixed costs rise with their income. Businesses move to pricier digs once they start feeling flush, and people move up to costlier vehicles, homes, clothing, vacations, etc.
The ideal business has been stripped of fixed costs. For example: rent on home office: zero. Labor overhead: zero, if you hire only other free-lancers-contractors.
Management guru Peter Drucker made the point about reducing fixed costs another way. He famously noted that "businesses don't have profits, all they have is costs." (a paraphrase)
In other words, there's no guarantee of additional revenues/sales or profits; all we know for sure is our fixed costs, i.e. what we have to pay monthly even if our revenues are zero.
Some fixed costs rise despite our fanatic focus. Healthcare costs rise until we qualify for Medicare. That's a given. Our only way to reduce healthcare costs is be fanatical about being healthy.
Servicing debt is a fixed cost. You have to service the debt whether you're making money or not. So eliminating debt is one critical way to reduce fixed costs.
Frugality is exceedingly useful, but frugality is not quite the same as being fanatical about reducing fixed costs. Understanding the difference is an important part of this strategy.
3. Learn how to calculate and manage risk.
Risk is the ultimate yin/yang. If you don't take any risks, you're limited to a salary: the employer takes the risk and rewards, you get the salary and no upside.
But if you take a risk, you can lose the gamble: the investment, the job, the house, the enterprise.
You want to score a ten-bagger (ten-fold increase) in the stock market? Well, belly up to the roulette wheel, because most of the bets that pay off that big are extraordinarily risky.
There is no way to eliminate risk. Life is risk. Doing great things requires taking risks. The "safe way" offloads risk and reward to others. You want the big reward, you have to take the big risk.
When the tide is raising all boats, it's remarkably easy to rank yourself as a genius who manages risk effortlessly. Rising tides are not a good test. Its the ebb tide, when every investment is crashing in value, that tests risk management.
It boils down to this: understand the risks you're taking (especially when your mutual fund manager assures you everything in your fund is low-risk) and set limits on the risks you're taking on.
No risk, no gain. But risk can deliver staggering, crushing losses if it isn't limited or hedged (and hedges have limits, too). Anything else is illusion. This will become evident to all within the next decade as all the "sure things" melt into thin air.