Risk

[Julia]

So far as investing is concerned, the same principles apply. There is always something which can go wrong that you won't have foreseen and/or won't have dealt with. There is no such thing as zero risk.

Completely agree. Which makes it even more important to avoid the obvious risks.

Smurf makes a very pertinent point regarding the knock on effects of particular events.

I think this is far more important now because

1) Everything is so interconnected
2) Modern business techniques have emphasized just in time practices which mean that any hold up will cause immediate problems
3) Modern business practice (again) has reduced the amount of redundancy and thus resilience in our economic systems.

Yes, all relevant points.

In a swift united effort all the major economies threw trllions of dollars at the banks to keep the system operational. We breathed a sigh of relief when we seemed to dodge the bullet.

basilio, could you perhaps be a bit more specific about how you see the above in terms of Australia? As I understand what happened here, yes the government offered the guarantee, for which the banks paid significant fees.

Three years later it is now countries not banks that are threatening to drown and there appears no plausible way to keep the current financial systems operating.

So do you think it would have been more useful in the longer term to let more banks/institutions fail during GFC1?

This has to be the biggest risk we face but what can be done on an individual level ? So what steps are governments preparing to cope with a disorderly default ? And should we be told about these steps to keep up public confidence ?

All good questions. Let's hope there is some planning in place.

 

[Smurf1976]

2) Modern business techniques have emphasized just in time practices which mean that any hold up will cause immediate problems
3) Modern business practice (again) has reduced the amount of redundancy and thus resilience in our economic systems.

I used to lament the fact that the energy industry now operates with far less margin for things to go wrong before the lights go out than it used to. It concerned me somewhat about the economic damage which would result from a major failure.

It was then pointed out to me by a consultant that this situation was not unique to energy but has in fact occurred across the entire economy with very few exceptions.

20 years ago if there was trouble with a plane or at a power station then it was no big deal since the major airlines had spare planes and the utilities had 20% spare capacity to cope with such things. But these days, there is very little to spare in any industry and once things go wrong it all falls apart rather quickly. Hence things like the public transport nightmares that result from a single train breaking down etc. There just isn't any resilience in that or any other system these days.

Just because your local council survives a financial crash doesn't mean they will actually be collecting the rubbish if that happens to be outsourced to someone else who went broke and the council has long since sold its own trucks. Just because Woolworths survived doesn't mean they'll have much on the shelves to sell you if the transport companies went broke. Or if their mechanics, fuel suppliers, tyre suppliers or anyone else up the chain went broke. Or if it was the farmers. Or whoever makes bottles and cans. Or...

Looking at my own job, if a few suppliers fall over then I'll be out of work real quick even though I'm employed in an essential industry. No supplies = we can't maintain equipment no matter how important it is. It's not like in the past when we could, and did, manufacture most things in house.

The physical world is just as interconnected as the financial world these days. If something big enough falls over, a lot of others will follow.

 

[prawn_86]

The physical world is just as interconnected as the financial world these days. If something big enough falls over, a lot of others will follow.

Yes a lot is preached about the benefits of 'just in time' logistics, but very little is ever mentioned about the risks if things do not run smoothly (or if it is not just a once of glitch/problem in the supply line)

 

[basilio]

I'm glad that Smurf was able to verify what I have observed indirectly with regard to the dangerously insecure situation of almost all business operations. The most sobering point is realising that even quite large organisations can be crippled if a significant parts supplier falls over.

With regard to Australia's financial position. As far as I can see I don't think our government had to really bail out the banks. The loan guarantee was sufficient and as Julia pointed out was actually paid for by the banks. The one off stimulus packages at least kept confidence and the economy going during a very scary time. As a result we didn't suffer the business collapses and unemployment rises that occurred overseas. The increase in national debt is currently handleable BUT you wouldn't want to see another financial shock occur (and isn't that what we are facing ?) I think it would be far harder this time to throw another $100b at the economy to keep it going.

Where to from here ? I just can't see how Australia won't be quickly affected by a financial crisis in Europe or America. Collapse of overseas banking systems would feed through our banks instantly and I think will destroy confidence in the banks. If that happens a bank run would be very likely and be catastrophic. So what next ?

1) The government must as an absolute priority ensure that the capacity of the banking system to pay bills, hold funds and keep society operational is 100% guaranteed. This would be regardless of failures in investment areas.

2) Somehow there needs to be an overhaul of our financial system to
a) Reduce the amount of gambling that is now the mainstay of investment banks
b) Separate the essential service components of banks from the investment sector.
c) Work out a practical way to deal with the current debts that doesn't crush our economies for decades to come.
I can't see how the financial system itself can address these problems. They are too conflicted and self interested.

3) The issue of lack of resilience in all our systems has to be addressed. On personal levels it may come down to meeting our own needs at home or closer to home. On organisational levels it might mean similar projects as well as identifying back up suppliers of essential services and reversing the just in time strategies we currently have. And perhaps we have to go back to simpler products and operations that can be more easily maintained in difficult situations rather than technically superior but more complex products.

Any thoughts ?

 

[pixel]

On the other hand, if I had enough capital to put it in the bank and just live off the interest and have it grow each year then I wouldn't risk my capital elsewhere. Or to simplify, if I had more than enough then I would not need to or want to invest in anything other than 100% Government Guaranteed term deposits or other similar safe investments.

I've only come across this thread this morning.
FWIW, Bill summed up my own approach:

I took a big risk leaving a well-paid job and working for myself as a full-time trader.
To a certain extent I kept the risk at a bearable level when I resigned still young enough to return into a salaried job, should the proverbial "hell break loose". Luckily, it didn't.
Meanwhile, that drop-back is no longer an option; but there's no longer a need for it either.

Those of you, who have read some of my trade-related posts, will know how I keep an eye on each trade and won't open a position without a Plan B. Doesn't mean I never had to "write-off" a position, but that is inevitable when one includes penny stocks in one's portfolio. In some cases, Plan B consists of "I risk 100% of a small investment, but I also see the potential for a multi-bagger."

For as long as I enjoy what I'm doing, and feel mentally fit enough to remain successful, I intend to keep trading. But, like BillM, I am not driven to accrue wealth for its own sake. If my capital had the decimal point further to the right, I'd probably put it in the bank and live off the interest. No idea though what I'd then do with all my spare time. It might drive me nuts and Mrs P to despair - and that's a risk I won't take lightly either.

As regards global financial threats, I take a rather sanguine (stoic?) approach:
No matter how irrational I "know" all those international eggspurts are, I am one in 7 Billion; my chances of winning every Powerball jackpot are far greater than the odds of being able to influence the Fed or ECB, let alone governments of Greece or Italy. So I enjoy the ability to spend money while I can; I try to keep a safe balance of funds that will get me through a 1930's style crisis. But I rely on my ability to find a Plan B based on the particulars when they're known. No use fretting about what may be if...

 

[basilio]

As regards global financial threats, I take a rather sanguine (stoic?) approach:
No matter how irrational I "know" all those international eggspurts are, I am one in 7 Billion; my chances of winning every Powerball jackpot are far greater than the odds of being able to influence the Fed or ECB, let alone governments of Greece or Italy. So I enjoy the ability to spend money while I can; I try to keep a safe balance of funds that will get me through a 1930's style crisis. But I rely on my ability to find a Plan B based on the particulars when they're known. No use fretting about what may be if...

Well put Pixel.

 

[Smurf1976]

I'm glad that Smurf was able to verify what I have observed indirectly with regard to the dangerously insecure situation of almost all business operations.

A real example that I know about (yes it's energy related... ).

In the past there would be 20% or more spare capacity to cope with things going wrong. In addition there was backup fuel (oil) on hand at gas-fired power plants in case the gas supply was interrupted (since nobody stores gas on site due to the hassles of doing so in large enough quantity to be useful). In addition, there were contracts with the oil companies to access fuel stored by them also, and to get tankers on the road at short notice hauling it to the power station etc if it became necessary to do so.

What happens now? Well instead of all that there are simply contracts with other power generators, often in another state, to cover the financial risk to the owner that the plant is unable to operate for some reason. Much of the risk in Victoria is underwritten by two generators based interstate, one in NSW and one in Tas.

Just one problem... On a hot day Victoria already needs supply from Tas and NSW, with the direct source of that generation being the very same generating companies who are underwriting risk for Victorian rivals. That supply is needed in order to keep the lights on, since Victoria does not have sufficient capacity within the state's borders to do so even if everything works perfectly.

So what about those contracts? Well if interstate generators need to physically deliver due to a disruption of production at a Victorian plant then they can and will do so. But the energy they supply will be the very same electricity they could have already supplied anyway, the availability of which is factored into planning. The only difference being that it is being supplied to meet a contract rather than being sold into the spot market.

So on paper, interstate generators have fulfilled their obligations with respect to supplying backup power during a plant outage in Vic and the owners of that plant in Vic have met their own contractual obligations to retailers by on-selling the energy supplied by interstate rivals.

But what about the physical supply of electricity in Vic? Well that falls in a heap simply because no amount of "on paper" contracting can actually deliver physical supply that would not already have been available. NSW and Tas already supply peak energy into Vic, all the contracts do is provide financial certainty for them and (financial) insurance for Victorian generators. They don't address the physical lack of production because some plant in Vic broke down, ran out of gas etc since their supply is needed anyway.

So what we've done is to swap physical means of maximising reliability, things like having some spare capacity and backing up the gas supply to gas-fired plants with fuel oil etc, to a situation where there is much less spare capacity and less backup fuel available (and some new plants don't have any at all - zero).

So if the Longford gas plant, that's the one that was crippled by disaster in 1998, goes offline then there goes the output of the gas-fired power stations in Vic once they burn through the few hours worth of oil they have on hand, and then find that (not surprisingly) the oil companies haven't kept more on hand because they are not contracted to do so. On paper it's fine, they are financially covered by hedging contracts, but that doesn't stop the lights literally going out if it happens to be a hot day.

It gets even worse. I won't say too much, but suffice to say that someone's worked out that having water in storage isn't a good idea and that it's better to sell the water for cash, since cash earns (or saves) interest whereas water sitting in a dam doesn't. Just wait until the next drought...

It comes down to financialisation of the energy (and every other) industry. In other words, it's OK if it physically falls in a heap as long as there's a hedge contract to cover it. That's a bit like taking out the fire sprinklers in a building on the basis that insurance has made them redundant in a financial sense. True perhaps, but an insurance payout doesn't make a new building appear overnight, now does it?

On a related note, I'm told that there is only 3 weeks' worth of diesel held in storage in Australia. That won't last long if someone starts a war or a refinery blows up in a big way, now will it? Commonsense tells me that this is high risk, especially as we are becoming increasingly reliant on imports of both crude oil and refined products as demand increases and local production (both crude and refined) declines. Contemplate for a moment how we would function, even briefly without diesel? No trucks. No farm machinery. Non-electric trains at a standstill. Mining industry shut down. Etc. And yet apparently (so I'm told) we've got very little of the stuff in storage in case of problems.

If this is how it works these days with things like electricity and diesel fuel, then I'd be surprised if any other important industry had much of a buffer in case of disruption.

 

[Eager]

If this is how it works these days with things like electricity and diesel fuel, then I'd be surprised if any other important industry had much of a buffer in case of disruption.

Just on that - diesel shortages caused by peak usage by the farm sector are not new, and reinforce your post.
http://www.heraldsun.com.au/news/vi...ng-truck-drivers/story-e6frf7kx-1225795172539

 

[SJG1974]

This is a great thread, with some really interesting perspectives. Good stuff.

My own personal attitude to investment risk is fairly simple and has so far (touch wood) enabled me to avoid any catastrophes…

• Do my own research…don’t just believe what a product salesman or an advertisement tells me….verify that independently. Too much advice is conflicted.

• Don’t simply chase past returns (just because something did well in the past does not mean it will continue to do so).

• Understand how the investment is supposed to make me money (obviously I won’t invest if I don’t think I can make money, but if I don’t understand how it can make me money, then I will steer clear).

• Understand what can go wrong, assess the likelihood of the worst case scenario occurring, and how much I can potentially lose (for example I have never borrowed to invest in anything other than my home- I don’t like the idea of potentially losing more than 100% of my investment).

• Weigh up the potential for gains versus the potential for loss and decide whether the risk is worth the reward (and typically the higher the risk, the smaller my investment).

• Monitor my investments.

• And importantly, diversify (I think diversification almost became a dirty word pre the GFC when shares were delivering great returns each year, but the GFC has shown how important that old chestnut continues to be).

I think an additional rider is to treat your money with the respect it deserves and take an active interest (and understanding) in what you are investing in…we see too many people claim they haven’t got the time or inclination to manage their own money, so hand it over to someone else. A recipe for disaster in my opinion.

Whats more important…watching the Biggest Loser, or reviewing your investments? I think some people have their priorities wrong, to their own detriment.

 

[basilio]

If this is how it works these days with things like electricity and diesel fuel, then I'd be surprised if any other important industry had much of a buffer in case of disruption. Smurf 1976

Apparently there is some serious rethinking in business about the effects of natural disasters on just in time production. The Japanese Tsunami and the floods in Thailand have had critical effects on many businesses. Good overview in the following story

The global supply chain: So very fragile



December 12, 2011: 11:21 AM ET

Manufacturers have spent years building low-cost global supply chains. Natural disasters are showing them just how delicate those networks really are.

By Bill Powell, editor-at-large

FORTUNE -- The image to the right is almost surreal: It shows part of a Honda auto factory in central Thailand, one of the largest in Southeast Asia, swamped under 15 feet of water, brand-new cars floating in the currents. The devastating November flooding in Thailand, which killed more than 600 people, also knocked out some of Honda's key suppliers, including electronics component maker Rohm & Co., forcing production delays in plants as far away as Ohio.

The Thailand floods alone would test any company's operational prowess; now consider that much of the auto industry and many technology companies are still recovering from the earthquake and tsunami that tore through north-central Japan in March, shutting down dozens of contractors and subcontractors that supply everything from glass to test parts.

http://tech.fortune.cnn.com/2011/12/12/supply-chain-distasters-disruptions/?iid=SF_F_Lead
.

 

[So_Cynical]

Risk taking behaviour is closely linked to "comfort zones" ~ certain individuals are more comfortable with some risks when compared to other risks, often due to confidence learned thru experience of assessing particular types of risk and successfully dealing with them.

For example an individual can to taught how to accurately asses the risk of driving a vehicle across a flooded road and then correctly drive a vehicle thru flood water after making an assessment that it is indeed possible to do so safely...after you do this a few times it just gets easier and easier.

The above can be applied to pretty much anything.

 

[Wysiwyg]

For example an individual can to taught how to accurately asses the risk of driving a vehicle across a flooded road and then correctly drive a vehicle thru flood water after making an assessment that it is indeed possible to do so safely...after you do this a few times it just gets easier and easier.

And that is how people die. The risk doesn't disappear after an assessment, it is still there. How anyone could assess the road surface and flow rate across the flooding section is a job for superman.

 

[Wysiwyg]

Since risk is ever present, risk control is the method.

 

[So_Cynical]

And that is how people die. The risk doesn't disappear after an assessment, it is still there. How anyone could assess the road surface and flow rate across the flooding section is a job for superman.

Ok so your not comfortable with your ability to asses the risk of a flooded roadway crossing, so for you a flooded road = extreme risk do not cross....a person that is familiar with that particular section of road and with experience of other flooded roadway crossings may come up with a totally different assessment than you.

--------------------------

It occurred to me today that sometimes people take on one type of risk in order to avoid another type of risk...like say some of the storm victims may have taken on market risk in order to avoid the risk of not having enough money to guarantee a comfortable retirement, they were offered a comfortable way of making extra money and jumped at the chance.

 

[Wysiwyg]

Ok so your not comfortable with your ability to asses the risk of a flooded roadway crossing, so for you a flooded road = extreme risk do not cross....a person that is familiar with that particular section of road and with experience of other flooded roadway crossings may come up with a totally different assessment than you.

Would the outcome differ relative to assessment?

I would only cross if I had a tank.

 

[So_Cynical]

Would the outcome differ relative to assessment?

It shouldn't "all things being equal" but that's my point...all things are not equal, a person with experience and knowledge may well come up with a more realistic and thus positive assessment...and go about the crossing with skill and confidence and thus achieve a different outcome to another driver with less experience etc.

--------------

I did a 4WD course years ago and vividly remember driving slowly toward a small vertical rock wall, i told my instructor that there was no way i could drive over that wall, he told me i could, explained how to do it and to my amazement he was right.

 

[Judd]

Some may be interested in reading "The Book of Risk" by Dan Borge (not to be confused with "The Book of Risks" by Larry Laudan which is an interesting read in itself - as are Shakespeare, Milton, Keats, Longfellow, Donne, Auden and a host of others, if you please bunyip; it's not all about money.)

Anyway, the Borge tome has some fascination concepts regarding risks. While printed in 2001 it is readily available in paper form or Kindle (yuck in my view but then I regret the passing of button up boots and quills.)

 

[NewOrder]

I am very conservative with my investments because I if I lose money I will have to leave the house and go to work 9-5 *shudder*.

I ride my bike like a complete idiot because it is fun and I enjoy taking risks like that. I have been riding with the brakes functioning at only 10% until my friend forced me to let him fix them. Although as I get older I take fewer personal risks, the body does not bounce back like it used to.

There is something very backwards in this think I guess but I just don't care. I would rather participate in some mildly risky behaviours to get a small thrill than to risk my money and have to be tied to the mundane life of working hard for the next 20 years.

 

[Julia]

I am very conservative with my investments because I if I lose money I will have to leave the house and go to work 9-5 *shudder*.

I ride my bike like a complete idiot because it is fun and I enjoy taking risks like that. I have been riding with the brakes functioning at only 10% until my friend forced me to let him fix them. Although as I get older I take fewer personal risks, the body does not bounce back like it used to.

There is something very backwards in this think I guess but I just don't care. I would rather participate in some mildly risky behaviours to get a small thrill than to risk my money and have to be tied to the mundane life of working hard for the next 20 years.

+1. I completely agree with your thoughts, particularly with respect to not risking your home, necessitating a return to the grind of work.

 

[Klogg]

+1. I completely agree with your thoughts, particularly with respect to not risking your home, necessitating a return to the grind of work.

I wish I had the luxury of staying at home and not working! Then again, I am only 25, so I might be able to catch-up in time