Came across this write-up about how a fund with $80 million in assets blew up in just one very volatile month in August of last year. That fund up until then seemed to have been making a killing and then suddenly…poof. How could that happen? This one sentence in their fund literature explains it all…
“The Spruce Alpha Fund seeks to generate high alpha, low beta, and low correlation returns by identifying daily-resetting, highly-levered ETFs experiencing volatility decay, and shorting them in bull and bear pairs.”
There are other details in that link but this goal of “make a killing” strategy is always the primary cause behind such blow-ups. And because this and other funds like this only allow accredited investors to participate in, investors who are left holding the bag have no recourse. Being accredited by the way means that you have so much money that the losses that could flow to you by being an investor in that fund would have no material impact on your quality of life. The fund manager can decide to hold all your money in cash or bet it all on black…basically he or she has free reign on the way your money is invested. If the fund loses that bet and a bet it is, you lose and there is nothing you can do about it.
This brings us back to that friend or acquaintance of ours we meet every once in a while who brags about this or that stock he (and it’s always a he…) bought that went up 30% or 40% in a relatively short span of time. Now there you are, wondering whether that very well thought out, globally diversified and an all equity portfolio you own that is spread across the many market sectors and company sizes is too conservative? Why didn’t your portfolio do like what your friend’s portfolio seem to have done? Remember, your portfolio is still an all stock portfolio and it’s going to be volatile but you get compensated for taking on that volatility…over time. On the other hand, a flier here and a flier there on a stock here and a stock there is going to be equally volatile, oftentimes more but the risk your friend is taking is uncompensated risk. What that means is that the portfolio your friend owns, if it goes down, there is no guarantee that it will come back up, ever. The world will move on but that portfolio could remain where it was. A diversified portfolio of stocks on the other hand, if it goes down, will eventually recover and it has to. If it does not, you will have bigger problems in your life to worry about.
So should you abandon the plan you have in place and start taking fliers on this or that stock, hoping to imitate your friend who is next in line to become twice as rich as Warren Buffet? Because the returns he claims he is making are twice as good as what Berkshire Hathaway made over its 50 year lifetime. And that’s the other keyword…Lifetime. What happens this year is not that important. Will it repeat next year and the year after that for decades? Because that is what you need to enable you to meet your life goals instead of relying on these one-off chance events.
We know that some of you will still clamor for that extra juice in your portfolio and we do cater to that urge by constructing a very, very aggressive portfolio that holds anywhere from 20 to 50 stocks of ultra small-cap companies. But it will still comprise a small portion of your total family wealth. All we are hoping for is that a few of these companies hit it out of the ballpark and could add a percent or two to the overall portfolio returns over a couple of decades. Not one year, two years but decades. This is still relying on hope and hence we don’t implement this for client families nearing retirement or for families with less than a million dollars in liquid net worth set aside for retirement. Once you meet those criteria, we will start diverting funds into this explore portfolio over time until it reaches 10% of your total family net-worth.
And if you are doing it on your own, there is no reason to not take a flier here or there on a stock or two but don’t do it with money you cannot afford to lose. Every mistake in your 20’s and 30’s could amount to a mistake worth tens or hundreds of thousands of dollars in retirement so you’ve got to do it with play money only.
Will write more on the “Core & Explore” investing approach we use with some sample portfolio structures but until then, Happy Investing.
Image credit – Mary Shattock, Flickr