4 Important Lessons We Learnt From FTX Blow-Up
As we enter 2023, one of the biggest investment news would definitely be the collapse of cryptocurrency exchange FTX. The company, led by Sam Bankman-Fried (SBF), went from US$32 billion valuation to almost $0 because of a single tweet by Binance founder CZ who sparked a bank run on FTX. Our heart goes out to those who have lost their savings in FTX.
Like every other major event in our lives, we sought to learn what we can from this incident so that we can become better investors. After digging deep, here are four important lessons that we ourselves have learnt from the FTX blow-up and we hope to share them with our readers.
1. Diversification: Never Put All Your Eggs Into A Single Basket
Diversification is the concept of allocating your hard earned capital into different types of asset class to achieve the goal of reducing risk exposure to a single asset class. This is so that, even in the event that one of the asset class that you invest in screws up, your portfolio will still be able to recover albeit suffering some losses.
This is a simple risk management strategy that everyone should be doing, be it whether you are a retail or institutional investor. However, because of how well crypto assets were performing in the past few years, many failed to consider this. We simply pumped in more money into crypto assets thinking that prices of crypto assets will continue skyrocketing. The unfortunate event came when SBF “rug pulled” everyone, a commonly used lingo in the crypto world to indicate a crypto scam.
If you want to achieve the right kind of diversification, it is important to consider a variety of asset classes. Besides crypto and stocks, other asset class like bond, property, insurance, and deposits can help you to diversify your portfolio. You may want to consider getting a personal financial advisor like Moneyline to do a free comprehensive financial planning session for you. This will help you better understand your own risk appetite and how you should diversify your capital.
2. Even Big Name Investors Fail, So Don’t Follow Them Blindly
For some of us, the way we invest is to follow the “smart money”. This is a term used by Wall Street that refers to professionally managed investment funds from fund managers. Because these fund managers do this day-in day-out and are privy to more news on the ground, they are smarter and should achieve better results than retail investors like you and I (theoretically).
But when FTX failed, it exposed this fallacy that big name investors are smarter than the rest of us. In fact, they are just as vulnerable as each of us. Sometimes, even the so-called insider information that they receive may not be that exclusive anyway. Case in point, Temasek, Sequoia, and Lightspeed Venture Partners were among the big name investors in FTX. None of them could sus out the suspicious behaviours of SBF and his partners in crime.
Thus, when it comes to investing, make sure you don’t follow these big name investors blindly. They too can fail so make sure you do your own diligence (DYOD).
3. Understand Your Own Risk Appetite
According to Benjamin Graham, the investor’s worst problem is likely to be himself. For those of you who don’t know Benjamin Graham, he is the guy that inspired the greatest investor in the world Warren Buffett. But why did he make that statement?
It turns out, when humans make investing decisions, we aren’t as rational as we think. Each of us bring our own set of biases and assumptions that affect our decision making process. One of which is our assumption of risk.
For some people, taking on risk is a huge endeavour. We lose sleep knowing that the money we have invested in the stock market has fallen by 5%. For others, it doesn’t matter even if the whole investment amount is lost.
If you take on more risk than what you can stomach, you may end up making subpar investment decisions. For instance, if you see your investment falling by 10%, you may be tempted to cut short your losses. This may not be the wisest move because some investments are inherently riskier and takes a longer investment horizon than others.
If you need help measuring your own risk appetite objectively, you can schedule a financial planning session with Moneyline.sg. As a professional financial planner, we have a set of tools to help you understand your own risk appetite.
4. Be Prepared To Lose It All, So Invest Only Money You Can Afford To Lose
Beyond just knowing what’s your risk appetite, it is important to complement this information with the riskiness of an asset class. Every asset class is fundamentally different. The amount of risk you take on is also correlated with the potential amount of return that you can gain (or lose).
For example, bonds and cryptocurrencies are on two extreme ends of the spectrum. Bonds are safe assets where you will not lose your capital if you hold till maturity. You also receive a decent coupon (2-5%) on your investment every half yearly or yearly. On the flipside, cryptocurrencies are very volatile. You might be making 200% in a single day and losing 75% of it the next day.
Thus, when investing in cryptocurrencies, the volatile nature of cryptocurrency means you need to be prepared to lose it all. When investing in such high risk assets, you need to make sure you invest only money that you can afford to lose. If you are not prepared to take the risk, consider bonds or endowments. These asset classes offer guaranteed returns. In fact, endowments also come with a variable bonus component that can bump up your returns.
Not sure how bonds or endowments can fit into your investment portfolio? Sit down with a Licensed Financial Advisor for a cup of coffee to find out more.
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