Hedge Fund manager Seth Klarman (net worth $1.5 Billion in 2017) once posted his 20 Lessons from the 2008 Financial Crisis. I am posting these here as they make a good reference tool.
Lesson #1: Expect the Unexpected
The classic “expect the unexpected” is true for the market. Take measures to prepare for the worst because the market reality can be worse that what you imagined. Nassim Taleb popularized the term “black swan” based on rare and hard to predict events happening. But it does happen.
Lesson #2: Too Much of a Good Thing
Watch out when there is too much of a good thing. Markets constantly rising? Loans available to anyone? Interest rates constantly hovering near zero? This environment creates a false sense of security and when things fall back to the mean, it will trigger a crisis.
Lesson #3: Control Risk First
Don’t try to milk the last drop from your investments. Always consider risk and downside first over potential returns. When entering a crisis, you have to make your positioning conservative and be able to pounce on new opportunities while others are forced to sell.
Lesson #4: Paying Less is Less Risky
Risk comes from the price you paid for the stock. It isn’t uncertainty or volatility. When there is great uncertainty and it drives prices down, you buy with less risk.
Lessons #5: Financial Risk Models are Useless
Market risk models done by computers are a waste of time. Reality is impossible to model. Human logic based on actual and real time facts is more accurate than boxed formulas and numbers.
Lesson #6: Don’t Invest for Short Term Gains
Don’t be tempted to invest for short term gain simply to earn something off cash that’s doing nothing. This is a higher risk strategy which increases the likelihood of losses and illiquidity precisely when the cash is needed.
Lesson #7: Stock Price is Not an Indicator
The stock price is not the fair value of a stock. People mistake that the stock market is completely efficient. During good and bad times, the stock price is not an indicator.
Lesson #8: Expand Your Circle of Competence
When a crisis hits, your investment approach has to be flexible. Don’t get too stuck on one method because opportunities can come in many different ways. If your investment approach is too rigid, start to expand your circle of competence.
Lessons #9: Buy When Prices Go Down
Buy when the price is going down. Volume is higher, there is less competition. It’s better to be too early than too late. Don’t be afraid to buy things on sale.
Lesson #10: New Financial Products are Not For Your Benefit
Be wary of new financial products. They are always created in times of exuberance and never questioned. The sub prime loans were the rage as institutions only saw the upside. Then it got killed.
Lesson #11: Rating Agencies are Useless
Ratings agencies are useless and always a step late. What’s the point in lowering or increasing a rating after it’s happened?
Lesson #12: Illiquid Stocks Come at a Price
Illiquid stocks will cause high opportunity costs. Make sure you are compensated for that illiquidity.
Lesson #13: Public Investments Still Rock
All things being equal, public investments are better than private ones. During a crisis, you have a better change to average down with public investments over private ones.
Lesson #14: Debt is Evil
Stay away from all forms of leverage. Don’t assume a maturing loan can be rolled over since you have no idea what the capital markets will do.
Lesson #15: LBOs Are Disasters Waiting to Happen
LBOs (Leveraged BuyOuts) are stupid man made disasters. If the price paid is too high the equity portion is an out of the money call option.
Lesson #16: Financial Stocks are Risky
Financial stocks are very risky. For example banks are highly leveraged, very competitive and difficult to run businesses. Unless you have deep experience and knowledge of the industry, invest in safer industries that you understand.
Lesson #17: Long Term Clients is Key to an Investment Fund’s Success
If you manage funds, having clients with a long term orientated mindset is crucial. You don’t want investors pulling out their money during a crisis.
Lesson #18: Government Officials Don’t Know Anything
When a government official says that a problem has been “contained”, it’s a contrarian signal. Pay no attention.
Lesson #19: The Government is the Ultimate Short Term Trader
The government is the ultimate short term oriented player. It will do anything to quickly ease the pain with band aid patches on the economy or financial markets without thinking about the implications. If the pain can be deferred to the future, the government will take on huge amounts of risk to do so.
Lesson #20: No One Cares About You More than Yourself
No one is going to take responsibility for the crisis so you have to look out for yourself and manage your risk well. Why? Because no one will take responsibility for making you lose money.