In 1982 I was in my second year of med school. It was Labor Day weekend and I was headed up to Chicago from Campaign IL after seeing my GF. I had a micro test on Tue so I needed some study time. I had a fully loaded gas tank. It was a bright sunny early fall kind of day about 1 in the afternoon. As I topped a ridge of some newly plowed farm land 10 miles out of town I was greeted with something like this:
Notice how discrete the boundary is. I was much closer to the boundary than this photo running about 75mph northbound on I-57. I had about 2 seconds to decide what to do as I entered the cloud of unknowing. If I stop I’ll be a sitting duck to get hit by the next car in. If I drive on, I’ll likely hit the last car in. As I drove on I was next greeted by something like this:
Literally that fast I had no choices. I plowed into the car in front of me since that was the least likely chance of killing someone. I remember clearly the slo-mo fold up of my front end. The hood buckled giving me a view of my engine and I watched the radiator slowly smash into the rotating fan on the front of the engine. I could see the individual blades spinning as the two impacted but the engine was still turning at 1000 rpm.. I don’t know how that slo-mo thing works but it’s real.
Once stopped I immediately got out of the car and headed to the median. 5 seconds later another car plowed into the mess, into the back of my car with the fully loaded gas tank, and the car exploded. I watched that in slo-mo also but not quite as slow mo as the original crackup. My micro books and notes burned to a crisp as did my clothes.
My GF picked me up and I went to the ER as I had some leg injury and made sure I was a “non admit” decision. Next I needed a ride to Chicago so I got a newspaper and found a Ford Pinto for $500 changed my insurance and drove to the city. I did fine on the test. Drove the Pinto for a year then bought a Honda. I lost that GF (thank God) somehow managed to get my MD and left my crashed Mustang in the rear view mirror to rot in some bone yard. Life is always forward moving and the past is but a mirage, not a reality. Risk is the thing we use to discover reality, so risk is necessary.
I’ve been thinking about risk lately and I think it comes in several flavors. There is market risk, the risk necessary to determine at what price an asset goes from il-liquid to liquid. If you buy a house at 300K and sell it at 200K, 200K is when the asset became liquid and the 100K you lost is the cost of discovering reality.
There is narrative risk. FIRE is almost entirely based on narrative risk. The entire enterprise is based on a daydream. The financial industry is based on narrative risk. It’s based on products designed to get you to part with your money and invest in their reality. Vanguard is such an entity. They hawk products in a way that price discovery is lost. The rules they proclaim are false. They pretend they are not buyers and sellers when in fact they are huge buyers and sellers. The products they buy and sell are not equities but equity derivatives which behave entirely in a different way from equities because they have a different risk profile. The point of buying an index is to diversify risk and in diversifying risk you loose the focus risk provides, the same as I lost my focus when I drove into that dust storm. If you live by beta you’ll die by beta. If the story is not accurate basing your life on the story contains unknown risk.
Another aspect of narrative risk is believing the wrong narrative. “The market always goes up” is such a narrative. It is predicated on a historical narrative view. What’s the evidence the market of today is anything like the market of 40 years ago? The market is all mutual funds these days with their excessive beta exposure and high internal correlation. Index funds become their own entity as they grow larger and larger and as such contain their own risks. I listened to a podcast yesterday that said the change in risk due to passive investing is like the change in risk between a 100 year flood and a 15 year flood.
If you look at the Gaussian curve a 100 year flood is way out in the tail. A 15 year flood is probably closer to 1 SD in terms of likelihood of occurrence. Stick that in your backward looking analyzer and smoke it. The market is also now dominated by machine algorithms with do loops 83,000 times faster than a human do loop. Charlie Munger says of the efficient frontier:
“In your lifetime, the idea of the efficient frontier will go the way of the dodo bird.”
When the risk become jiggered by manipulation price discovery becomes impossible and no one jiggers risk like the FED or Vanguard or machines. That will work all the way, till it doesn’t.
What of the inevitable risk? I was watching a youtube simulation of an earth extincting event like when the dinosaur disappeared.
This is a bit how I view COVID-19. I only have one lifetime and probably less than 15 years left in that lifetime. Not sure how much fun it’s going to be spending 15 years or a significant portion of my 15 years in the aftermath.
It’s definitely a 3 body problem
FIRE typically tries to solve with one risk dimensionality “4% x 25”
I try to solve risk in 2 dimensions called the efficient frontier
what happens when there are 3 risks and 3 dimensions?
Time for a cup of coffee while I ponder the truth the risks reveal.