Volatility – Mind the Gap

Volatility has reared its ugly head again, panic (and blood) has struck wall street and Bitcoin-land. What should you do? Run? Fight? Play dead?

21 · 2 · 2018
ANDRÉS Allende

3 minutes

In truth, when danger is on the horizon, our instincts take control. We are programmed to respond, our actions become reflexes. We have faced danger and risk since the time man raised above other animals. And even before then… we’ve been managing these phenomena for millennia.

The problem is that since then a lot of water went under the bridge. What’s more, today’s risks are not as obvious and the right response is not as intuitive. It’s no longer about running or fighting back. Two tips: preparation and patience.

Frankly speaking, thanks to a few (police, firefighters, army, etc.) the rest of us live in structured, organised societies where physical risks have been practically removed altogether. Plenty of rules and regulations protect us from ourselves, such as speed limits, traffic lights, pharmaceutical regulations, building standards, consumer protection, etc. We even warn ourselves of obvious risks, take the famous “Mind the Gap” as an example.

We’ve done such a good job that some of us miss the adrenaline rush. We need only to take a look at YouTube for videos of impossible feats achieved by some and for painful wipe-out suffered by others. There is no longer any need to take risks really, it is all about the fun and “the glory”.

But the truth is there are still risks lurking out there. So, what may be the critical “Mind the Gap” warning for us in our day and age? There are two parallel realms involving elements of risk that help us understand the modern-day “Mind the Gap”: medical interventions and our savings management.

Indeed, sooner or later, we are all faced with the decision about whether to go under the knife or not, on different grounds, from the mundane to the very serious: for example plastic surgery, a torn ligament, or a brain tumour… The operation or treatment can either turn out well, average or badly. Just like the investment of our savings.

In medicine, uncertainty is attributable to the fact that no two patients are the same, nor are illnesses or injuries exactly the same in two patients. Therefore, we still rely on the odds of success for some part. When it comes to investing, uncertainty is due to dynamism of the businesses we invest in and the human factor of the market; who knows whether the response to certain factors today will be the same as in the past?

The better our starting point, in other words, the better our quality of life before the operation or the more we invest, the more there is to lose and, therefore, the greater the risk we are assuming. Therefore, we could define risk as “the possibility of a PERMANENT negative result” and measure that risk assumed by HOW MUCH IS AT STAKE. This is where planning, anticipating events comes up. And by the way, this has nothing to do with predicting the future.

The first, and perhaps the most important, question we have to ask ourselves is: what happens if I don’t invest or don’t go ahead with the operation? As the saying goes “better the devil you know than the devil you don’t”. Perhaps we can wait for surgical technique improvements and better investment opportunities to come around. However, doing nothing is often the most difficult thing to do!

The next question we would ask ourselves should be: what is the worst that could happen if we go ahead with the surgery or if we decide to invest? And finally: what will supposedly happen after the operation/investment? And how likely is this outcome?

Sometimes, the response is obvious – if we don’t go ahead with the surgery we will most likely die, whereas if we do, then we will live. Or, if we don’t invest, we are certain to lose to inflation or if we invest, it’s a “sure bet”.

Based on the foregoing, we can draw up a plan A and perhaps a plan B. However, in real life, things are never just black and white and often involve shades of grey. Risk management is about navigating these grey areas and mitigating permanent losses. So, in medicine, only desperate cases would justify the risk of permanent loss – at stake is a unit of “life”, 100%. And at best, we can live a bit longer, not earn ourselves another life. There’s no possible plan B. In investment, risk can be one unit, or 100%, whereas the reward can be 20%, 50%, 100%, 200%, or even more… Although as a general rule, one shouldn’t accept the risk of permanent loss either. The market tends to be efficient and extreme gains are often a lottery (or a hoax).

Volatility is a nuisance, but it doesn’t affect the end result if investors are patient

Once we have made the decision, we reach another turning point: recovery. There are good days and bad days. Sometimes it seems everything went perfectly, as the doctor or fund manager would say. Other days are a lot worse, our whole-body aches, progress is slow… or our investment drops or seems to have stagnated. In an ideal world, our doctor or fund manager would have explained this phase too: VOLATILITY.

If objective data is available and our doctor or fund manager thinks that everything is still in place, then the end result should still be the one we anticipated, our plan A. Volatility is a nuisance, but it doesn’t affect the end result. Unless the PATIENT “loses patience” and abandons physiotherapy/treatment/investment before time. It is all about the “bigger picture”, we have to know how to (and be able to) persevere if needs be.

To withstand volatility, or the recovery process, we need two things: PATIENCE AND TRUST that we are on the right path. Some people are better at this than others, they have a better character. But it’s not easy and every little bit of support helps. Just like footballers who tear a ligament and play again in just 6 months, thanks to the work of their doctors and physios. When it comes to investment, surrounding yourself with the best possible team that has both character and common sense, that draws up a good plan for you, measuring the risks well and accepts only the reasonable ones, is key.

In my opinion, today’s threefold “Mind the Gap” warning consists of the following:

1.- Drawing up a plan, based on risks well measured before accepting them, rejecting permanent losses insofar as possible.

2.- Volatility is not the same as risk.

3.- Being patient and having the confidence to stick to the plan. Whether by ourselves or seeking the right kind of help.

Thus, in medicine, or investment, or in many other fields in life, it is all about striving to avoid the wrong (and potentially lethal) decisions and be able to live to fight another day (plan B). I’m only talking about serious matters here. If we want to play the lottery, get a piercing or purchase a few bitcoins, those are a different matter: those are mere diversions, not decisions.