Sunday, August 30, 2015

Ostrich Risk Management Strategy

If you don't know the risks, they don't exist.... right?
If you can't see the risks, it means there there aren't any.... right?

That is the Ostrich Risk Management Strategy (ORMS).

I have met many people who are blissfully unaware of how to deal with risks, and this is especially painful for me to watch when it involves finances.

I cannot tell you the number of times people have told me that since ETFs are diversified, they are the not as risky as other investments, and therefore are the best investment to buy.

Of course, this is completely wrong because as so wonderfully illustrated by Dilbert, being diversified doesn't mean a thing if you don't know what you're doing.

If you wear a helmet while riding a motorcycle, does it reduces your chances of having an accident? Mitigating one risk may not remove the other risks possible.

I'm not picking on ETFs because I think that they are a lot less sexy than they are marketed to be. I own and use ETFs for a strategy that I run. In fact, I think ETFs are probably one of the better investment vehicles that most people would be able to effectively use for investing. The risks of ETFs are pretty clear-cut and straight-forward, and these are fantastic things for a risk manager because the risks can be dealt with.

However, if you do not know what the risks are and how to manage those risks, ETFs can just as well blow up in your face like any other investment.

I suppose the default pre-loaded risk management strategy in humans is the ORMS. You can see this all the time in real life. How many times have you heard people "close one eye"? Ignoring risks does not make them go away, but of course since it is one of the easiest actions to adopt, it is the most common action undertaken.

Sitting down to identify the risks, evaluate their impacts and then having a proper method to control risks is something that people instinctively know how to do, but they only do it for things that they care about.

Getting a new phone? Open up everything and check for scratches. Buy screen protector. Buy phone cover. Phew, all safe now.

But buying whole life insurance with monthly $300 premiums for the rest of your life? I have to read the silly stack of papers and sign that? Fuck that! I'll just trust my agent, they are not allowed to lie anyway. Plus, she's pretty. What could possibly go wrong?

I think many people make the mistake and confuse investment selection with asset allocation, deployment strategy and risk management. Most of the time, asset allocation is 100% and the deployment strategy is single lump sum purchase, which is why you rarely hear those words. Risk management is usually just ignored or "play by ear". Therefore, most people think that the only decision that they have to make is what to invest in.

An example of a simple comprehensive strategy is: 100% allocation into the STI ETF using monthly DCA with CPFIS-SA money. Obviously this is not the holy grail strategy for investing, but it is definitely a simple one that covers all the basics and can be qualified as a decent strategy.


  1. Many of my friends still consider the stock market as risky. Take a step back and then ironically it may be more risky to leave yourself vulnerable to the devaluing effects of inflation by keeping your savings in those steady Fixed Deposits (sure loss in purchasing power!) than it is to subject yourself to the hills and valleys of the stock market.

    I strongly believe that stocks, although volatile, are still the average person’s best bet for long-term capital appreciation when some risk and money management is in place.

    Unfortunately people are - as you rightfully mentioned - a bit lazy or blinded by beauty. They spend more time planning their next holiday than funding their retirement.

    1. Hey Tacomob,

      I agree that stocks are the average person's best bet for long-term capital appreciation. However, I think too many people miss the "long-term" part and expect immediate returns and gets frustrated if their portfolio goes into unrealized losses.

      I took quite some time myself to be able to overcome the hills and valleys of the stock market. I was definitely skittish at the beginning of my journey. I wonder if there's any good way or exercise to help train or teach people be able to be comfortable with temporary losses and remain confident through rough patches! It seems like a human condition though, haha

    2. Hi GMGH,

      One trick to manage my emotions is to set the right goals. That is to have predominantly long-term goals (like I want to grow my portfolio x% above the inflation rate over the next 10 years).

      Reading about history and statistics on the stock-markets helps as well. It puts the recent correction into context and confirms that the movements were not that unusual at all.

      Incidentally I have just published a new post on how to cope with ones emotions in investing. It is titled "Hot-Cold-Empathy-Gap". Have a read.

  2. Yeah, totally agree... Passive ETFs are great and all, but I wouldn't consider the STI ETF diversified. I mean, 30% in banking sector? And the 30 stocks are not unrelated too. Jardine, Capitaland...

    1. Hi owq,

      Yeah I feel that the STI is not a very balanced exactly because of what you have highlighted.

      The top 5 holdings are more than 50% of the index....

      However, it is well-known and has plenty of liquidity, so I guess it an appropriate benchmark to gauge market returns.

      I still believe that with some tweaks, it is possible to outperform the STI. This could be done by creating a similar index and reallocating weights, or even just buying the STI and then increasing the weights of the smaller holdings by buying those stocks directly.

      I don't have the capital to do that or the resources to backtest such a strategy though, haha!


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