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Is Your Stock Portfolio Facing a Systemic Risk?

Those who educate themselves on advanced trading techniques will thrive, no matter what the market is doing. Others, not so much.

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The last couple weeks in stocks were a wild one, and everyone seems to be talking about it. You could practically smell the panic when reading publications like The Wall Street Journal.

More than anything, even though the markets stabilized during the later part of the month, I think people are still very uneasy about falling into yet another Great Recession. And they have good reason to be. With record inflation and rising interest rates, coupled with global unrest, there aren't a lot of places to turn to in order to avoid one.

Are we facing a bear market?

This is not surprising to me. I’ve said for a long time, dating all the way back to my book Rich Dad’s Prophecy, that there was a good chance we’d see massive upheaval in the stock markets. This shouldn’t be a surprise to professional investors. Most professional investors understand that the stock market is overvalued.

Everywhere you turn, the financial pundits are signaling that the stock market is overvalued and that the Fed is going to bring a reckoning. There is a good chance we’ll see the market head into prolonged bear territory sometime this year. But it’s not the professional investors that are panicking.

In fact, what makes professional investors professionals is that they don’t panic in times like this. They instead use their financial intelligence to make a lot of money while others simply crash and burn.

All cards on the table, stocks and paper assets aren’t my thing. I prefer real estate, business, and commodities. If you’ve read anything of mine for any amount of time, that’s not surprising to you. But paper assets are important, and if they are your investment vehicle of choice, you can do very well in any market.

Because stocks aren’t my thing, I have great advisors who help me with them, especially Rich Dad Advisor, Andy Tanner. After all, business is a team sport and the richest people in the world surround themselves with experts who are much smarter than them.

Understanding systemic risk

Andy often talks about the difference between systemic and non-systemic risk when it comes to investing.

Simply put, non-systemic risk is when a company or a stock is performing poorly as an anomaly to the rest of the market.

Systemic risk is when the entire market is performing poorly as a patterned whole.

Understanding the difference between systemic and non-systemic risk is important, because it allows you to understand when the standard investing advice of “invest in a diversified portfolio of stocks, bonds, and mutual funds” is really going to bite you—hard.

Are you really diversified?

Oftentimes, when the market is tanking, financial advisors will tell you to “rebalance” your portfolio. The idea is to move some of your assets into other assets to offset risk. For instance, if you are heavily invested in stocks but the market is crashing, you may want to move into bonds. Almost always, this advice is centered around moving from one paper asset into another.

In a non-systematic risk market, this is conventional advice that probably won’t hurt you. But in a systemic risk market where everything is falling, rebalancing—or diversifying into other paper assets—won’t help you. All paper assets are tanking!

Why is this? Because diversification, as most financial advisors call it, isn’t really diversification. It’s just buying different types of stocks in the same asset class—paper assets. And when paper assets are facing a systemic risk, your “diversified” assets all fall. True diversification means having investments in all asset classes, not just one.

Markets always go bearish and bullish

Seasoned investors know that markets always go up and down. They know that when a bull market is hot, it will come crashing down at some point in time—and the higher a market rises, the faster and harder it crashes.

As the old wise saying goes, “There is nothing new under the sun.” That includes booms and busts.

Sir Isaac Newton, who lost most of his fortune in the South Sea bubble, is quoted as saying, “I can calculate the motions of heavenly bodies, but not the madness of people.”

When there is madness and everyone is thinking about getting rich quickly in the market, it’s usually just a matter of time before many people lose everything. Often this is because people start investing in the markets with borrowed money, instead of first investing in their education and experience. When that happens, many people sell in a panic.

Of course, that is when seasoned investors really become wealthy, profiting on the madness of others.

Generally, crashes aren’t that bad, but the emotional panic that occurs at the times of such financial downturns is. The problem with new investors is that they have not yet been through a real bear market, so how would they know what a market crash and a bear market feels like, especially if it goes on for years?

As with many things, those with experience are in the position to win.

Rich dad simply said, “It is not possible to predict the markets, but it is important that we be prepared for whichever direction it decides to go.”

He also said, “Bull markets seem to go on forever, which causes people to become sloppy, foolish, and complacent.”

The difference between amateur and professional investors

As Andy says, “Risk is related to control.” In a market with systemic risk, you can’t control whether a stock or a group of stocks will go up or go down. But what you can control is whether you are long or short. Again, to quote Andy, “You can’t control the market, but you can control where you are positioned.”

What Andy is talking about is the difference between amateur and professional investors. Amateur investors think that “diversification” will protect them. Professionals know that hedging and true diversification will protect them.

In the stock market, long and short positions are like insurance that hedge against losses, and if you are financially educated, you can read the patterns in the market and know when you should go long or short in order to generate gains and minimize your losses.

Professional investors are also truly diversified

Take a look at this chart. It is the price of Gold Futures over the last decade. As you can see, for a number of years, the price was relatively low. The smart investors were buying during this time, knowing that it will always go up.


Gold Graph

For starters, every currency in the history of the world has gone to zero.

This happened in Rome when the Emperors began clipping the sides of coins and saying those coins were still worth the same amount. It happened in the 1600’s when the Dutch thought tulip bulbs of all things were of estimable value. It happened in France under the Revolutionary regime. It happened in Germany in the early 1900’s. It happened recently in Zimbabwe, where a trillion dollar note can’t buy you a cup of coffee.

In 1971, Nixon took the dollar off the gold standard and ushered in the age of currency. Now, every currency in the world is pegged to the dollar—and the dollar is pegged to nothing.

Its value is based on confidence in the U.S., which for now, still enjoys its role as the leading economic powerhouse. So, when the markets lose confidence in a crisis, they rush into dollars.

It’s not that people have more confidence in the dollar—they don’t. It’s that they want to cash in on gains and see where to put their money next.

The problem is that those without a financial education follow the investors and are always late.

They sell after the damage is done, go into dollars, and buy when the pros have already moved on and pushed up prices. They get sucker punched.

The question is… what will happen when investors lose total confidence in the dollar?

They run to gold and silver. And when that happens, you don’t want to be stuck holding dollars or paper assets. That is because the professional investors understand that true diversification means moving to a different asset class, especially in times where there is potential for systemic risk.

This is what is happening today to amateur investors. Over the last three years, savers have become big losers, and that has hit overdrive this year with record inflation that doesn’t seem to be “transitory” after all. Those who saw inflation coming and invested in gold and silver are doing very well.

What about Crypto?

Interestingly, crypto currencies are getting hit hard right now, and once again, the amateurs are bailing while the smart money is moving in.

Why am I bullish on Bitcoin? Because no government can control it and it has limited supply. Like any commodity, it goes up and down, but the professional investors know that there is always a bottom, and when the true bottom is reached, you will see it skyrocket again…just like gold did around 2020. And if I were a betting man, I’d say it’s close to the bottom now. Just take a look. But I don’t have a crystal ball. If I did, I’d be the richest person on the planet.

Bitcoin price

With inflation at 40-year highs and it looking like it won’t go away soon, you can bet that commodities will see gains as the dollar weakens. And that is true diversification, moving from overvalued paper assets into other assets such as commodities or real estate or business.

Get financially educated to thrive

Investing in other asset classes for true diversification, as well as long and short positions, are a part of technical investing that requires education, but if you want to move beyond being an amateur to being a professional, it’s worth your time to learn this.

Original publish date: September 01, 2015

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