The Worst Case Scenario

At some point, I was contemplating renaming my blog to Trading for the Benefit of Others. Getting into the Great Recession, my portfolio was really undiversified. I had mainly financial stocks, some luxury stocks, and some second runner-ups such as AMD in some pretty odd sectors I knew little to nothing about. My portfolio was basically all over the place. I guess my saving grace was that I had been saving cash for about a year prior to the Lehman bankruptcy and at the time, it looked like I had made some pretty smart moves with some corporate bond purchases that were adding to my bottom line, which now don’t appear so smart since many of these companies are filing for bankruptcy. I didn’t have much saved up, but it was an amount that I appreciated having at the time. I can’t say much about my savings now after my Big Holiday this year, though.

Anyway, it turned out my pre-crisis portfolio wasn’t prepared for The Worst Case Scenario.

I was discussing portfolio diversification with an acquaintance recently and he was all international prior to the Great Recession and said diversification doesn’t necessarily help in a situation like this.

I’ve been thinking about this more and really feel there is so much truth to Warren Buffett’s “Be greedy when others are fearful. Be fearful when others are greedy.”

The best time to buy the traditional safe-haven asset classes is not when everyone’s already scared – it’s prior to that inflection point. Likewise, the best time to buy risk is when everyone shuns it.

Where does that leave us now? I’m not sure. But if it’s a trend, then I’ve got risky assets in my portfolio already and if it’s a fakeout, then I’m ready to move my stops. I didn’t get in at the best prices, but at least I’m in.

Do I have trading conviction? No, but it hardly matters at this point, especially if you’re at least semi-diva / semi-alpha-male about your money management.

On the flip side, in my diva opinion, here are some really bad things that can happen to a portfolio (aka it has at some point happened to my portfolio) and the lessons learned.

1. The Reverse Split. They’ve sold you something. It’s gone down in price. Now, they want to take some of it back and charge others more for it. Do you see any logic in this? The worst part about this is that in the odd event that the share price starts going up, you’ll end up less profitable because your number of shares have gone down drastically. Avoid at all cost.

2. Share Dilution. Any time a company wants to issue more shares would result in share dilution. Always vote against it. What they are doing is issuing more shares, which dilutes equity. Moreover, if demand was unhealthy to begin with, share prices will continue down a downwards trajectory.

3. New Bond Issues. This would most likely decrease the book value of a company by increasing liabilities. The only potential winner is the bondholder if they can buy in the secondary market at below par levels, which carries its own level of risk.

4. Bankruptcy. Luckily, I haven’t been in a situation where I ended up holding shares in a company that has filed for bankruptcy. I do actively buy bonds in companies that have already announced a bankruptcy. I have also ended up with bonds in companies that afterwards filed for bankruptcy. It’s not necessarily bad unless their book value was negative to begin with. However, I would suggest to never buy shares in a company that has a negative book value. I have a pretty iffy stock now – ABK – but it’s a small position. Do your due diligence and first check the book value of a stock prior to buying anything. If you’re into shorting stocks, I’d say a negative book value would be what you want to look for.

I suppose the biggest lesson we've got to learn is never trade for the benefit of others.