Avoiding Unnecessary Risks In Firefighting & Investing

Learn more about this firm

Over the President’s Day weekend, I saw a big chunk of the movie Backdraft. This is the 1991 firefighting movie with Kurt Russell, Billy Baldwin and Robert De Niro. I was not involved with firefighting back then, so I don’t know how unrealistic the fire ground scenes were, but I can tell you that firefighting has changed dramatically versus how it was portrayed in the movie.

There were a couple of different scenes where the crew went into burning buildings where there were no people believed to be, including some sort of chemical facility. There is a phrase in firefighting; risk a lot to save a lot, risk a little to save a little, risk nothing to save nothing. There is no empty building that is worth more than a firefighter’s life, going into a burning chemical factory (with no breathing apparatus mind you) is a totally unnecessary risk.

The idea of suitable risk is obviously an important part of investing. About eight months ago I was on CNBC with the bear case for a newly IPO’d stock that I would describe as being a trendy gadget. The gadget itself is pretty neat and I have no doubt about the gadget’s ability to do what it is supposed to; my wife wants to get one.

My main thesis was that from the top down the risk associated with buying a very expensive stock that produces a faddish item that had already enjoyed tremendous growth in sales before the IPO was simply unnecessary given how late we were in the market cycle.

There was no attempt to predict what the market would do but six years into a bull market is late based on past market cycles. After five or six years or longer of rising markets it makes sense to avoid added risk or volatility in the portfolio. While there can be no absolutes it is a good bet that Giant Soda with 40 straight years of dividend increases is less volatile and less risky than Social Media Gadget Dot Com with a PE of 100 (neither Giant Soda or Social Media Gadget Dot Com are real companies).

If there is a time to take on added volatility and risk, and for some investors this is totally unnecessary at any time, it would not be after years of a rallying market but when participants are most fearful after a large decline with media questioning why even own stocks. While most people know that buying low is the right thing to do, actually doing it is very difficult.

An investment plan is unlikely to be derailed by being unable to pull the trigger in this manner but can be derailed by succumbing to greed at the market’s high and buying too much stock in a company that makes a trendy gadget. The one from my CNBC visit is down 46% from its first day of trading and down 68% from its peak. Even if it had gone up it would have been an unnecessary risk for most investors.

The bigger point here is about probabilities. These things are obvious and plainly stated but are often lost in a forest for the trees type of perspective on markets and investing.

© AdvisorShares

© AdvisorShares

Read more commentaries by AdvisorShares  

Learn more about this firm