Thursday, February 26, 2009

Lessons and Strategies from Our Current Crisis

Risk Managers have always been seen as people trying to halt deals. Not necessarily the most popular people in the office, they seem to be the "boys that cry wolf" only this time the wolf was there and the economy crashed. Skeptics (aka the cowboys) will decry the predictions, often saying something similar to: "If you say the end is coming enough, you'll eventually be right".

So how can we balance the knowledge that a potential bubble is building with the understanding that it will eventually burst? Although you can closely monitor the "warning signs", it is tragically difficult to predict the bursting of bubbles (such as Warren Buffet's correct, but poorly timed shorting of tech stocks just before the tech bubble burst).

As portfolio managers and equity analysts will attest, it is becomes difficult (near impossible) to know when the burst will come. From their perspective, they need to always find places where their capital will provide good returns.

As a result, I think it is incredibly important to diligently use asset allocation (*AND* re-balancing) as a strategic method of pre-determining your level of volatility tolerance (conversely known as your aggressive greed level).

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