A reader asks:
It seems like investing in boom times should be easy. But investors are dealing with opposing forces such as FOMO and loss aversion. On the one hand, no one wants to leave the party too early. On the other hand, most rises are followed by a crash. How do you strike a balance between continuing to invest in a bull market and understanding that trees don’t grow all the way to the sky?
I’ve been having a lot of conversations around this topic lately.
In times of upswing, you balance the desire to continue investing with the fear of the pain that may be waiting just around the corner when it ends.
Actually, that’s one of the reasons why I write. Risk and Reward in the first place. Investment is a matter of balance.
I love how Charlie Munger turns these types of topics on its head and discusses what you’re thinking. don’t do that I want to do it while investing in a boom.
Warren Buffett once said: “You never know who’s swimming naked until the tide goes out.”
If that’s the case, there are plenty of underwater nudist beaches in South Korea. FOMO around AI trading in South Korea was unusual.
This is one of the hottest and most volatile markets on the planet right now, as companies like SK Hynix and Samsung, which account for roughly 50% of the South Korean stock market, are moving into vertical positions.
Now they’ve come back to Earth for a bit. The South Korean stock market is up more than 130% in the last 12 months but has fallen to around 25% in the past month.
Such losses should be expected when earnings are this strong. But when you add leverage to the equation, you can turn uncomfortable losses into margin calls. Many investors in South Korea have done just that.
Margin debt has reached an all-time high. The use of leveraged ETFs has become so widespread that regulators had to triple margin requirements to restrain them.
Reuters recently profiled a handful of new traders in South Korea. I pulled out my favorite:
Lee Seung-ho watched his stock trading fortune of nearly 300 million won ($202,515) evaporate in just four weeks in May, which he made with a 500% margin loan, but he plans to borrow again and get back into the market as soon as he has enough capital.
A 24-year-old South Korean college student in Seoul used the 20 million won he saved during his mandatory military service to quickly realize a 15-fold windfall by tapping the “little circle button” on his trading app, which instantly unlocks five-fold leverage.
Five times leverage!
What happened after the market’s return was as follows:
Wild swings in South Korean stocks triggered a series of forced liquidations by the brokerage, erasing gains. Within weeks his account fell below his initial investment, leaving him under such pressure that he said: “I literally couldn’t breathe.”
Did he learn his lesson? In a word… no:
“But I’m sticking with margin loans,” Lee said in his studio apartment, little more than a parking space, next to an empty bottle of Hibiki whiskey and an unboxed electric fan gifted by his broker after he qualified as a VIP client.
“Since stocks are volatile assets, this volatility allows for rapid wealth creation if it moves upwards,” Lee said. When asked why he took on more debt despite the stress he endured, he added, “If I add five times leverage, I can create wealth five times faster than anyone else.”
Ah, leverage spreads forever.
The number one rule of investing in boom times: Don’t put yourself in the position of being a forced seller when the good times are over.
Some questions to consider when navigating an eruption:
Are you diversified? Technology stocks make up an increasingly larger share of the U.S. and global stock market.
But if you’re worried about AI trading, there are many other stocks, asset classes, and strategies you can invest in.
Diversification is much easier to achieve than market timing.
Do you have a plan? The beauty of setting investment rules in advance is that it takes the guesswork out of your investment process?
If A happens, I will do B. If X pops up, I’ll do Y.
If this happens I won’t do anything. If this happens, I will do something.
If the boom continues, this is what I’ll do.
If the boom turns into a bust, I’ll do this instead.
Having rules in place won’t help you expertly navigate whatever happens next. But it may lead to better decision-making.
Are you taking too many risks? The stock market is still around 2-3 percent of its all-time highs. Now is the time to re-evaluate your asset allocation and risk appetite.
Did your 60/40 portfolio turn into a 75/25 portfolio due to the bull market? Has your 80/20 portfolio moved to 90/10?
Are you 100% invested in stocks? Can you handle this much risk in a bear market?
You want to answer these questions while stock prices are still high.
Can you balance your emotions? How did I like it? Jurrien Timmer put this in your last post:
The first issue, regarding the paradox of profiting from a burst while hedging a bubble, is of course an existential issue and reflects the duality of profit-seeking polarity juxtaposed with loss aversion.
No matter how this cycle turns out, it will be clear when we look back.
When we are in boom times it is almost impossible to predict how long it will last.
A little humility goes a long way.
Jury Join me on Ask Compound this week to tackle this question:
We also discussed stock market concentration, the two biggest market risks right now, earnings growth, and where fast money is going next.
Further Reading:
How Do You Invest During a Bubble?
