Always look at the risks before looking at the rewards in your long term investing

In investing, always look at the risks before looking at the rewards.

Understand the risks you are taking and then decide for the potential rewards you can hope to get, whether this reward/risk ratio makes business or investing sense.

Also, determine what is the likelihood of the reward appearing, its quantum and when.

Remember, "a bird in the hand today is worth two or more in the bush tomorrow."



How to look at risks in investing?

Back to the teaching of Warren Buffett's 4 tenets of his investing method.

1.  Understand the business.
2.  A business having durable competitive advantage.
3.  Managed by people with integrity.
4.  Available at fair price (margin of safety).

His tenets are very simple, and yet so few are following these.


If the business is too hard to understand, avoid investing into it.  You need to be able to understand the business.  What are the products or services it is selling?  Who are its customers?  How are its revenues generated?  Its profit margins?  Who are its competitors?  Only invest into a company you understand.  This is having business sense.

A company with durable competitive advantage enjoys certain unique advantages that allow it to compete in its competitive business environment.  The company may be selling a unique product or service, protected by patents or it enjoys a brand that people like for a long time.  Perhaps, the business is the lowest cost producer, or the cost of switching by its customers to another competitor is high.  Some businesses enjoy networking effect.  Avoid businesses with no durable competitive advantage.

People with integrity can be difficult to judge with certainty.  In general, a reputation build up slowly over 30 years can disappear over 5 minutes.  Anyone whom you have even a slight suspicion of his integrity, just avoid investing into that company.

When all the above 1, 2, and 3 tenets are met, you can then determine the price to buy and how much to buy?  You need to be patient.  The market is volatile and stock prices are volatile.  These market volatility and price volatility reflect the fluctuating sentiments of the investors and players in the market.  Don't time the market, always price the market.  You buy when the price is right.  Avoid when the price is obviously too high.  Invest when a great company is available at a fair price or even a slightly above fair price.  Be greedy and invest a lot, when a great company is available rarely at a huge bargain price.



Managing risks

The above few paragraphs explore how you will manage risks as applied to each tenets of Buffett in your stock investing.  In a very general sense, risks can be managed in 4 ways:

1.  Avoid
2.  Retain or embrace
3.  Reduce
4.  Transfer.

Whenever you are prospecting a new stock, you will need to determine that this stock meets the 4 business tenets of Buffett.  At each stage, you should avoid this stock altogether if you determined its risk is too high.

• Note that not able to understand the company's business is high risk too and you will need to avoid investing into it.  
• Not able to determine what confers to it its long term durable competitive advantage, is also another investing risk that should be avoided or perhaps embraced sometimes, but you need to have a very good reason.  
• Of course, avoid counters managed by people whose integrity you doubt.  
• Not able to value the business either because it is too complex to understand or its accounting is too difficult to fathom, you are better to avoid investing into this company.

Eventually, you are left with those stocks which you understand very well.

• QUALITY OF THE COMPANY (QUALITATIVE ASSESSMENT):  You understand their businesses, their durable competitive advantages and their management.  
• VALUATION OF THE COMPANY (QUANTITATIVE ASSESSMENT):  And, you too understand how to value them and this gives you an advantage to buy and own them at a reasonable, fair or good prices.  

Every stock you own has gone through this thorough risk analysis and also the reward potential analysis.  For the stocks you have in your long term portfolio, you have retain and embrace the risks associated with investing in them and also have a very clear idea of their reward potentials.  You know their risk/reward ratios over the long term and the probability of their investing returning  predictable positive returns (driven by the durable competitive advantage possessed by these companies).

When the stocks in your portfolio are priced too high during certain market situations, you may, if you wish to, also reduce the risks or transfer the risks using various strategies.


Through managing your risks, you avoid losses or minimise your losses and the modest positive returns from the other stocks in your portfolio will translate into reasonable returns.

Investing is fun and profitable in the long run.

Good luck to all.

Determining the Payback Period. When are borrowings excessive?

In the balance sheet, the total liabilities exceed the total equity overwhelmingly.  What does this mean?

There are 3 possible types of scenarios when this happens:

1.  The company has excessive long term borrowings.
2.  The company has excellent business that uses very little equity and its business is funded mainly by its creditors.
3.  The low equity is due to accumulated deficit, the result from continuing losses in operations.




Let us look at scenario No. 1:  The company has excessive long term borrowings.

Companies normally borrow money from financial institutions to fund their expansion.

• This is even more prevalent in an environment where the interest rates are low.
• Some companies will also refinance their debt by taking advantage of the low interest rate so that they can enjoy some savings in the interest payable.
• Yet others will refinance their debt with a higher interest rate to extend the maturity date of the debt.

All the above make business sense, when the return on capital is higher than the cost of capital.  

But, if the business continues to suffer despite the injection of additional funds through borrowings, then the company could be in dire straits.

When are borrowings excessive?  How do you determine this?

The key is in the payback period.

Look at the amount of long-term borrowings (normally found under the heading of Non-Current Liabilities) and then the Net Profit (found in the Income Statement).

Assuming that the company can utilise ALL its Net Profits in its present financial year to pay off its long term borrowings AND the SAME Net Profit recurs every year, you have this formula:

Payback Period in years = Long Term Borrowings /Net Profit.

The resulting answer is the payback period for the long-term borrowings.

A prudent KPI for the payback period is not more than 5 years.

Yes, you can argue that the company can achieve tremendous profit growth in the next few years.  If that happens, the number of years required to pay off its debts can be reduced dramatically.  

By the same argument, what if the economy suffers and a loss is incurred?

F&N’s earnings to be driven by export growth, cost efficiency

F&N’s earnings to be driven by export growth, cost efficiency
August 20, 2018, Monday



KUCHING: Analysts project the future earnings of Fraser & Neave Holdings Bhd (F&N) to be driven by the continued strong export growth and improved cost efficiency as a result of cost optimisation efforts and better economies of scale.

Following a visit to F&N Dairies Manufacturing plant in Selangor Halal Hub, the research arm of MIDF Amanah Investment Bank Bhd (MIDF Research) highlighted that F&N targets total export revenue to reach RM800 million by 2020.

According to MIDF Research, as of the first nine months of financial year 2018 (9MFY18), export contributes 16 per cent of total revenue whilst for F&N’s Malaysia and Thailand segments, these grew 20 per cent year on year (y-o-y) and 10 per cent y-o-y respectively.

“We estimated export revenue to contribute between the range of RM642.9 million to RM710.6 million for FY18,” the research arm said.

“Assuming the same rate of growth, F&N poised to achieve its total export revenue target before 2020.”

MIDF Research noted that F&N’s two main segments, the Malaysian and Thailand segments, which contribute 57.1 per cent and 42.9 per cent respectively to total revenue (including export) are currently facing intense completion.

The research arm further noted that F&N’s domestic market share for sweetened condensed milk has slipped from 59 per cent in FY14 to 52.4 per cent as of the first half of FY18 (1HFY18).

“Despite the declining market share, revenue dropped marginally by 0.4 per cent y-o-y and 0.3 per cent y-o-y in the 9MFY18.

“Nevertheless, we expect a stronger revenue growth due to pre-sales and services tax (SST) purchase and new innovative products set to be launched in Malaysia and Thailand market next year.”



http://www.theborneopost.com/2018/08/20/fns-earnings-to-be-driven-by-export-growth-cost-efficiency/

Internal Rate of Return

Internal Rate of Return (IRR)

• is the discount rate that generates a zero net present value for a series of future cash flows
• it equates the present value of the future net cash flows from an investment project with the initial cash outflow of the project
• it is calculated by employing trial and error method
• a higher cost of capital lowers the value of NPV and vice versa
• it takes into account the concept of time value of money
• project with IRR more than the required rate of return is considered as acceptable and profitable.

IRR > Required rate of return, accept the project

IRR < Required rate of return, reject the project

IRR = DISCOUNT RATE for positive NPV  + [DISCOUNT RATE DIFFERENCE x (Positive NPV / (Positive NPV - Negative NPV)]



Example:

DISCOUNT RATE @ 18%
Initial Investment 160,000
Cash flows of constant 55,000 for year 1 to year 5.
Given that the discount rate or required rate of return is 18%.
Total Present Value 171,994.41 #
Total Investment  (160,000)

Net Present Value 11,994.41

DISCOUNT RATE @ 24%
IRR is the discount rate that generates zero NPV.
Increasing the discount rate will lower the NPV.
To generate negative NPV, we have to increase the discount rate.
Let this discount rate or cost of capital to be 24%.

Using discount rate of 24%, the values are as follow:

Initial Investment 160,000
Cash flows of constant 55,000 for year 1 to year 5.
Given that the discount rate or required rate of return is 24%
Total Present Value 150,996.15 #
Total Investment  (160,000)

Net Present Value -9,003.85



CALCULATION

IRR

= DISCOUNT RATE for positive NPV  + [DISCOUNT RATE DIFFERENCE x (Positive NPV / (Positive NPV - Negative NPV)]
= [18% + (24% - 18%) {11,994/(11,994-(-9,003.85)}] x 100%
= 18% + 3.4%
= 21.4%

As the cost of capital for this project is 21.4% and the firm will only receive 18% for each dollar invested, the company should not accept this project.




# Note:  The total present value can be calculated thus
CF1/[(1+r)^1]  + CF2/[(1+r)^2] + CF3/[(1+r)^3] + .... CF3/[(1+r)^n]

Net Present Value and Profitability Index

Net Present Value (NPV)

• an indicator of how much value an investment could contribute to the firm
• takes into account the concept of time value of money
• the Present Value Interest Factor (PVIF) Table can be used to calculate present value
• the criteria below should be considered before accepting for rejecting a project or an investment:

NPV > 0  

The investment would add value to the firm.

The project should be accepted.

NPV < 0

The investment would subtract value from the firm, that means the project reduces shareholder wealth.

The project should be rejected.

NPV = 0

The investment would neither gain nor lose value for the firm.

We would be indifferent in the decision whether to accept or reject the project.  This project adds no monetary value.  Decision should be made based on OTHER CRITERIA.

Total Present Value = sum of the discounted value of all future cash flows.

NPV =  Total Present Value - Total Investment.

Probability Index 

The project is not profitable when its profitability index (PI) is less than 1.00

PI = Total Present Value / Total Investment

Payback Period

Payback Period (PBP) is the period of time required for the cumulative expected cash flows to equalize the initial investment or cash outflow.


1.  Equivalent or constant cash inflow.

PBP = Initial Investment / Cash Inflow


2.  Unequal Cash Inflow

PBP = N + [ (Initial Investment - Accumulated Cash Inflow for Year N)/Cash Flow for Year M ]

N = the number of years for the accumulated cash flows that had not exceeded the capital or investment.

M = the year where the total accumulated cash flow is equal to or more than the capital or investment.

Accounting Rate of Return or Average Rate of Return (ARR)

Accounting Rate of Return or Average Rate of Return (ARR)

• a financial ratio used in capital budgeting
• does not take into account the concept of time value of money
• calculates the return generated from net income of the proposed capital investment.

1.  Investment without scrap value

Depreciation = Total Investment / Useful Life

ARR = [(Average Cash Flow - Depreciation) / Initial Investment] x 100%

2.  Investment with a scrap value

Depreciation = (Total Investment - Scrap Value) / Useful Life

ARR = [(Average Cash Flow - Depreciation) / Initial Investment] x 100%

Project Evaluation

The decisions of where to invest the company's resources have a major impact on the future competitiveness of the company.

Trying to get involved in the right projects is worth an effort, both to

• avoid wasting the company's time and resources in meaningless activities, and 
• to improve the chances of success.

Project evaluation is a process used to determine whether a firm's investments are worth pursuing.

Producing new products, buying a new machine and investing in a new plant are examples of firm's investment.

Investing in those activities involves a major capital expenditure, and management needs to use capital budgeting techniques to determine which projects will yield the most return over an applicable period of time.



Capital Budgeting Factors

Factors involved in capital budgeting are:

1.  Initial Cost
The initial investment or cash capital required to start a project.

2.  Cash In Flow
The estimated cash amount that flows into a business due to operations of the project or business.

3.  Investment Period
The duration of the project and when it is estimated to be completed.

4.  Discount Factor
The value of interest that will be received or charged during the period of the project's execution and it will affect the present value of cash in flows for different years.

5.  Time Value of Money
The idea that a ringgit now is worth more than a ringgit in the future, even after adjusting for inflation, because a ringgit now can earn interest or other appreciation until the time the ringgit  in the future would be received.This theory has its base in the calculation for present value.



Factors influencing investment decision

A firm must make an investment decision to improve or increase the incomes of the company in order to compete in the market.

Investment environments include:

1.  Product development/enhancement
2.  Replacing equipment/machinery
3.  Exploration of new fields or business.



Project Evaluation Methods

Common methods used in evaluating projects, investments or alternatives are:

1.  Payback Period (PBP)
2.  Accounting Rate of Return/Average Rate of Return (ARR)
3.  Net Present Value (NPV)
4.  Profitability Index (PI)
5.  Internal Rate of Return (IRR)


In choosing an investment or project, select the project which generates HIGHER ARR, NPV, PI and IRR; and SHORTER PBP.



APPENDIX:

Turning investing principles into good investing habits

So just what is a habit?

A habit is:

• a recurrent, often unconscious pattern of behaviour that is acquired through frequent repetition, and,
• an established disposition of mind or character.

As an investor,you need to not only learn to do it well but also to do it with some consistency, and do it without struggling to remember what you did last time.  

As a low volatility investor, you are not likely to be as active trading in the markets as some other investors, and you may not watch as closely.

Any investor - active, inactive, aggressive or low volatility - has a duty to keep up with his or her investments.

For the low volatility investor and others, it is important to develop certain habits, routines, or thought processes for:

• choosing investments,
• watching and managing investments, and
• selling or replacing investments.

With the right habits, you will increase the chances of success.

Turning principles into habits

Investors have obvious goals:  to produce wealth and to preserve capital.

Anything an investor does should address both goals, preferably simultaneously.

As an investor, you are motivated to succeed and, over time, you build a set of strategies and tactics to help you achieve those goals.

"Motivation is what gets you started.  Habit is what keeps you going."

It is easy to get motivated.  It is harder to learn the ropes - the skills and techniques - required to become a good investor.  

But what may be hardest of all, once you gain experience and enjoy some investing success, is to turn those skills into habits.

Habits that become built in, second nature, repeatable and predictable, and not only lead to good results but help you avoid bad ones.

Without consistent habits, low volatility investors will make mistakes and find themselves off in the weeds. 

Good investing habits are like a good golf swing: apply those habits to every investment choice and you won't succeed every time, but your chances for success will brighten considerably.

The thought processes in building a portfolio that works.

You want an investment portfolio that meets your financial objectives. 

Investors have obvious goals:  to produce wealth and to preserve capital.

You also want that portfolio to accomplish those goals quietly, with a minimum of upsets, a minimum of nerves, a minimum of complex mathematics, and most likely, a reasonable amount of effort on your part, because you are busy doing other things in life too.

The tiered portfolio is divided into three primary tiers:

1.  The Foundation portfolio
2.  The Rotational portfolio
3.  The Opportunistic portfolio.



The Foundation portfolio (80%)

This is set up to meet or slightly beat expected market returns, often with stable and somewhat defensive investments.

Dividend-paying stocks with rising dividends and growing prospects while at the same time exhibiting low downside risk and volatility are a pretty good fit.

These investments can be stocks or funds, and can be augmented by fixed-income securities, real estate, or other investments that meet this general profile.



Rotational (10%) and Opportunistic (10%) portfolio

The purpose of these is to achieve better-than-market returns, perhaps with more volatility, but these portfolios are small enough to contain risk and to avoid consuming too much of your investing time and bandwidth.



Putting together your portfolio

How your portfolio is put together is entirely up to you, not only because the portfolio needs to suit your tastes, intuitions and the facts at the time, but also because many of the investments (and the mix of investments) may not even be available, or priced right, at the time.

Building a tiered portfolio

This tiered portfolio has three segments:

1.  Foundation investments
2.  Rotational investments
3.  Opportunistic investments.


Foundation investments (80%)

These are like dividend-paying stocks that produce market (or better) returns with relatively less risk.


Rotational investments (10%)

These are mostly ETFs and inverse investments.  They add some defense and sector diversification to your portfolio.


Opportunistic investments (10%)

These employ a little more risk to boost returns.



Aim

The net result should be a portfolio that generates above-market returns with below-market risk.

The most bang for your buck

You want to select investments carefully to eke out those one, two or three extra percentage points of excess return. 

You are trying to add investments that is, at the highest possible return level for the amount of risk taken.  

You are trying actively to manage volatility and risk - avoid, reduce, retain or transfer risk.

Essentially, you want the most bang for your buck.

Smart diversification is the key. The smart investors are focus Investors.

True investors are not random stock pickers.

They take out risk by understanding the investments and their intrinsic value, rather than by spreading the risk across more companies.

Smart investors are focus investors who drive toward deep understanding of their investments without diluting possible returns through diversification.

They see danger in owning too many investments, which may be beyond the scope of what they can manage or keep track of.

Here's the paradox:  Instead of reducing risk through diversification, risk may actually increase as it becomes harder to follow the fortunes of so many businesses.

That is why Buffett and others reject diversification per se as an investment strategy.

They prefer to reduce risk by watching a few companies and investments more closely.


"Diversification is for people who don't know what they're doing."  Warren Buffett.

Volatility, Risk and You as an Investor. "Take no risk" is not an option.

As an investor, you have to know something about volatility and risk, where it comes from and how it can affect your investment performance.

If you avoid volatility altogether, example, keeping your money in fixed deposits or risk free saving deposits, you will eventually be sorry in all but the most remote black swan scenarios.



What are you to do?  

You will have to face the risk and decide how you want to go forward in your investing.  There are at least four things you can do about risk, to manage it.

1.  Avoid risk:  accept risk-free returns of 2% or less.
2.  Retain risk:  know it's there, know its dangers, and deal with them.
3.  Reduce risk:  be smart about what you are doing by taking the necessary precautious
4.  Transfer risk:  make contrarian investments or buy derivatives -another scary concept, to insure your portfolio.



The best investing approach to risk taking

The best investing approach overall is some combination of the four.

Warren Buffett's strategy was primarily to reduce risk by knowing what he was doing.  We can embrace a lot of what he has to say, though we cannot all be so masterful.

We may want to avoid risk with certain portions of our investments, like an emergency or college fund as we approach our children's college years.

We will retain risks, knowing it is hard to quantify or measure just how much risk we want to retain.

We will reduce risks by being smart, which means knowing where the risks come from and taking steps, like doing smart, forward-looking research to reduce them.

There are ways to transfer some of the risks by buying and selling certain types of options to trade a relatively more volatile future for certain cash today or to insure a portfolio outright.




"Take no risk" is not an option.

If you have money, you will take risk.

If you want your money to work for you some day, you have to take a little more risk, especially in view of long-term inflation.

If you embrace and manage the risk properly and stay within yourself, you won't lose sleep at night.  

What is risky is what makes you lose sleep at night.

This is anything that's psychologically upsetting or distracting that causes you not to be wholly focused or effective on the rest of what's gong on around you.




Risk checklist

Here is a short risk checklist:

• If you cannot sleep at night, you are taking too much risk.
• If you cannot function normally without being distracted; if you are irritable or angry or pensive or withdrawn, you are probably taking too much risk.
• If you are risking something greater than you can afford to lose, you are taking too much risk.
• If you are truly worried about your long-term financial security, you are taking too much risk.
• The converse is true too.  If you are truly worried about long term financial security, you may not be taking enough risk; you are sacrificing too much return.

Conclusion

In the end, it all depends on how much risk you want to take and how you feel about risk to achieve a balance you are comfortable with.

Low volatility investing is the acceptance and management of some investing risk to produce better-than-market returns while minimizing exposure to the wealth-destroying sharp downturns that can have long-term effects on investing performance.

Small losses versus Big losses. They are different stories.

Small Losses

Small hits or losses are alright, so long as they aren't persistent or don't last forever.  That said, we cannot take 10% or even 5%, losses ongoing and forever.  Even if we under-perform the markets by a few percentage points, we can lose out on considerable gains once the power of compounding sets in.


Big Losses

Big losses are a different story.  We can tolerate the 10% corrections and even ignore the 10% twitter, but if we are exposing ourselves to 50% losses on individual investments - or worse, on substantial portions of our portfolios - look out!  It will take a lot to turn that ship around and get it back to where it went off course.


Fluctuations, minor corrections and bear market

There is a big difference between fluctuations, minor corrections (considered to be 10% pullbacks by most market professions), and an all-out bear market, usually considered a plunge of 20% or more.  The prudent investor senses the difference between fluctuations, corrections and the more destructive bear markets.


The high cost of an untimely hit.

Volatility can be expensive, especially, if it goes beyond normal investment noise into creating a significant downturn, especially at the beginning of an investing period.

The principles and effects of compounding makes a difference not just how much we succeed but also WHEN we succeed in the markets.

The general principle is that the more we can earn SOONER - to unleash the power of compounding to a greater degree over a longer time - the better off we are.

Conversely, if our investment capital takes a hit in the early going, it takes a lot just to get back to even, let along to get ahead.

Limitations on using the past data approach. The past does not predict the future.

There are two general categories of limitations on using the past data approach:

1.  The past doesn't predict the future.

No matter how much math you apply to how much data, you're still looking backward.

Trying to say what's going to happen based on what has happened is a dangerous game, particularly with anything involving as many non-quantifiable variables as investing.

The best thing you can do with the models is to gain a better understanding of what happened in the past, but you can't be sure it will happen again in much the same way; in fact, you can be pretty sure it won't happen the same way again.

2.  There are too many moving parts.

External, internal and personal factors all come into play, and no model can take everything into account.  

A stock may have played predictably in the past (and a company's earnings may have played predictably, too, thus the stock price predictability), but what happens when something changes?

What happens when customers suddenly decide they don't like a product anymore or, for that matter, when investors decide they don't like a stock (or gold or corn or a bond or real estate) anymore, or as much as they did?

You can't predict all the factors that influence the future.  Nobody can.  Again, if you could, who would take the other side of the trade?

In investing, it is more important to be able to measure and conceptually understand what is going on than doing a lot of complex quantitative analysis..

Investing is not, and never will be, a formula.

There are no equations to determine the best investments.

There are theoretical approximations but we cannot depend on them 100%.

For a host of reasons, they don't tell all, and they don't always work.

The point is to be able to measure and conceptually understand what's going on.

You are probably better off knowing what questions to ask and making big-picture look-out-the-window risk/reward decisions than getting bogged down trying to calculate the risk of the investment yourself.

You can look at the numbers, particularly comparative numbers, to get an idea whether an investment more or less accomplishes your objectives.

You can also look at a chart to get a quick view or vision of the volatility without knowing the precise numbers within.

At the end of the day, quantitative measures are important mostly for comparison.




Summary

Some of your best investment calls will occur by simply looking out the window.

What is important is to grasp the concept and then with a few measures to help assess risk/reward and especially to compare it.

Informed common sense

Remember the past doesn't predict the future.

There are also too many variables you cannot quantify, like human behaviour and economic sentiment.

Some of the investing models are pretty cool but they are far from perfect; and they may sidetrack you from making the right decisions.

INFORMED COMMON SENSE will help you more in making the right decisions.

Housing is a volatile investment indeed, at least for most people.

Statistics show that housing on the whole is a relatively tame investment:

• Average annual percent change:  3.1%
• Number of years positive:  15
• Number of years negative:  5
• Number of years between 0 and 10% positive:  13.
• Number of years more than 20 percent positive: 0
• Number of years more than 20 percent negative: 0

[Housing is thus an example of low volatility investment, with a tame and steady 3.1% annual gain with 15 positive years out of 20 and no 20% annual fluctuations.  Also, you get to live in it.]

Two caveats.  

Caveat number one is:  the price of a house is very large.  So a 5% (or $10,000) move on a $200,000 asset is significant and a 20% (or $40,000) move is gigantic.  Volatility as a percentage should naturally attenuate as the base of an index rises.  Sometimes the opposite happens when bubbles go into correction.

The second caveat is: leverage magnifies volatility.  Suppose you buy a $200,000 house and that you, like most others do, borrowed 80% of the value.  Your equity is $40,000.  A 5% or $10,000 price decrease now translates into a 25% ($10,000/$40,000) change.  [The mathematics:  if your equity is only a fifth of the asset value, you must multiply the volatility figures by 5x.]

Here are the housing volatility figures, this time assuming an 80% mortgage:

• Average annual percent change:  15.5%
• Number of years positive:  15 
• Number of years negative:  5
• Number of years between 0 and 10% positive:  2
• Number of years more than 20% positive:  10
• Number of years more than 20% negative: 2

Note especially the decline in the number of years between 0 and 10 percent positive:  from 13 to 2.  Looked at it in this light, housing is a volatile investment indeed, at least for most people.

[Remember too the impact of leverage on volatility.  This comes into play, too, when looking at companies to invest in.  If they've borrowed a lot of to finance the business, that, too, can lead to higher volatility.]

Volatility and Leverage: A vicious circle?

Where leverage is involved, a small loss is magnified into a big one.

That bigger loss creates considerable indigestion for the losers.

They see what's happening and rush to deleverage; that is, to sell assets to reduce exposure to volatility.

That rush to the exits creates more volatility.

The cycle continues.

This deleveraging cycle goes a long way to explain the 2008 financial crisis:  the volatility that created it and that it created.

When we look at the causes and consequences of volatility, we can see how it frequently can become a self-fulfilling prophecy, particularly where leverage is involved.