How I Lost My Entire Investment!

May 2023 Newsletter

If you read my last newsletter, you will know that I made a speculative stock bet with First Republic Bank (FRC).  Banks are normally not speculative, they are usually pretty safe, but not in this case.  As mentioned before, banks exist almost solely based on the confidence that if you deposit your money with them, you can withdraw any or all of it at anytime. The problem is that if everyone asks for all of their money back at the same time (classic bank run), well, there is not enough money to go around.  You see, our fractional reserve monetary system allows banks to lend out most of your deposit money to someone else.  This is how most banks make money. It only keeps a fraction of your deposit on hand for day-to-day cash withdrawals.  It does that with all of its clients, knowing that by average, most people only need a small amount of their funds in cash at a given time.   

So what was the problem at FRC?  A bank run is a confidence problem. It can be based on something real or not, it does not matter.  In this case, FRC’s bonds fell in value with rising interest rates (like most banks) and this was perceived as bringing the bank to near collapse.  The reality is that bank assets change in value all the time.  In addition, FRC’s model catered to wealthy clients who by average had assets above the 250k federally insured amount.  Meaning that if these clients smelled weakness (and they did), they were more likely as a group to move those funds somewhere else.  If it were not for the run on deposits, FRC would not have had a problem.  This was a perfectly good bank that for right or wrong reasons, lost the confidence of its clients.  The story ends by the Federal Deposit Insurance Corporation (FDIC), also known as the Government, seizing FRC’s assets and selling them to JP MORGAN, leaving FRC stock holders out of luck.  This was a total investment loss.

Speculation 101

Ok, I know some of you will point out that there is no clear understanding of what a  speculative position is and that it’s kind of subjective.  This is true. There is allot of grey area here and it also depends on an individual’s ability to accept risk.  That being said, I can provide examples of what I feel is speculative.  Note the word “feel” in that last sentence.  In my opinion, speculative positions, no matter what form they may take, have an inherent danger of losing all or most of your money.  These may include: 

• very small companies;
• companies that lose money year after year;
• leveraged companies that only survive with borrowed money;
• some cyclical companies, like small gold miners; 
• small pharmaceuticals with only one product or one product still in development;
• technology innovation companies that may have a new product, or one day expect to, but may not;
• most Initial Public Offerings (IPOs); 
• resource explorers;  
• commodities, like metals, sugar, etc.;
• the use of option contracts and future contracts;
• the list goes on.  

You can see a few commonalities in the list above… small, makes no money, only one product, based on promises, etc. Everything has to be perfect in order to justify the values, but only a few will actually become successful. 

So was speculating on FRC dumb?

The answer to this question in hindsight is yes, but there is more to it than that.  There is room for speculation in investing as long as you keep some basic rules to protect yourself: Never bet the farm on a speculative position; never borrow money to make a speculative bet; and make sure you understand the risk when going in.  Speculative bets tend to be more often losers compared to investment grade stocks, so the odds are against you at the outset.  So why speculate?  Well, you have to look at it as a probability game.  FRC’s bank run was going to end in one of two ways: it survives and everything goes back to normal, or it dies. No one was sure what was going to happen as the situation unfolded, so I figured I had a 50/50 chance either way.  But here is the thing, if I was wrong and FRC dies, I lose 100% of my money, on the other hand if FRC survived, I could triple my money.  In game theory, you would want that bet and play all day and all night, because you win more money than lose in the long run.  Think of it as flipping a coin, heads you lose a dollar, tails you win 3 dollars, it’s the same thing.

The problem in these situations is that maybe it was not a 50/50 probability that FRC survived, maybe it was less.  Since no one knows for sure, you have to make a call on that yourself.  I knew that banks don’t often go under, I knew that FRC was a good bank, and I knew that other banks and the government did not want it to fail.  A pretty good argument for a 50/50 bet.  In the end I lost and that is the way the cookie crumbles, you win some and you lose some. Let’s not get emotional about it.

When Things go Right

Here is an example of a speculative bet that worked out well for me. In 2012 I started to like Apple due to their new higher quality products, great design and innovation, etc. At that time, Apple was out of favour and the argument was that as a small player, it could not compete against Microsoft and other similar companies. I bought 3,000$ in one apple option. This leveraged bet worked against me at first as the stock continued to fall and my 3000$ position became 1800$.  Then things turned around, and within 4 months, my position grew to 22,000$.  I exited the position with 7 times my initial return (a seven bagger).  But that is not all, I then bought a brand new IPad, and took a full position in Apple by buying the stock.  Over the next ten years that position continued to compound for a total of a 42 bagger.  So the moral of the story is that speculative positions, if done right, can pay well.  I keep speculative bets as a very small portion of my portfolio, maybe 1-3%, because they are generally losers. Another example is Bitcoin. Had I speculated on Bitcoin early on, I could have made lots of money with a very small bet.  Another speculative bet I have ongoing is in (KRBN) carbon credits, which is just as weird as Bitcoin. Could it end up being a 5 bagger or more?  Maybe?  Who knows.  Do you have a speculative position? Let me know in the comments.

What Does a Total Loss Mean to the Portfolio?

As a result of having a 1-3% maximum speculation position, a total loss is not the end of the world.  The position fell apart before I could even consider buying more shares so in the end, the FRC position did not even register a 1% weight.  In fact, I have already made up for this loss through the gains in other positions. My investment rules saved the day. Even with FRC being a total loss, the portfolio has recorded a small gain versus the SP500 year to date return.  

Looking Forwards

Markets are hovering around the long term annual average return of 7-10%.  As some of you know, average returns are rare because most of the time markets are up much higher or down much lower. So I predict that the year will end much higher than average, but no one knows for sure. Short-term calls on the year are usually very difficult to predict.  I nevertheless remain bullish, understanding that there will continue to be lots of volatility and nuttiness out there.

Marc’s Monthly Moves

• No buys or sells this month.

Marc’s Portfolio YTD Performance

My portfolio page is LIVE! I will continue to update it monthly. It contains a full list of my positions and the performance information that I’ve included below.

• Portfolio return: 7.3% (including currency losses)
• Portfolio return: 8.6% (without currency losses)
• S&P 500 return: 7.73%
• TSX: 5.97%

The portfolio over performed the S&P 500 by .87 percentage points.