Skin in the game | Dealing with asymmetric outcomes

The world is not fair

Personal finance is like peanut butter. You can’t spread it too thin.😀
That’s why there are consequences for taking risks.
But sometimes people can reap the rewards for their actions, but not accept any of the risks.

Wall St. executives walk away with millions of dollars while their clients lose money.
Pro war advocates profit from selling weapons, but do not face any risk themselves of dying in a war.

Risk analyst Nassim Taleb wrote a popular book, Skin in The Game.
In it he says that accepting risk when making decisions is necessary for fairness.

Otherwise it creates a problem of asymmetry; one gets the rewards, while others are stuck with the risks.

Individuals make decisions based on incentives. A fund manager that gets a percentage on wins, but no penalty on losses is incentivized to gamble with his clients funds.

In order to have social justice Taleb advocates focusing on fair symmetry and risk sharing.
Forcing skin in the game corrects asymmetry better than thousands of laws and regulations.


Picking a side

Persuading the government to force bad actors to put skin in the game is a noble cause.
But I’m doubtful it will be effective.
Politicians themselves enact asymmetric policies all the time. Party leaders can offer voters particular monetary benefits or services if elected. Of course the leaders don’t directly pay for these benefits themselves. The cost will be paid either by taxation or inflation.

So perhaps a more practical approach is to position yourself with those who get the rewards, not those stuck with the risks. 🙂

Policy makers won’t increase interest rates now as doing so would kill the economy. But the longer they wait, the worse an economic crisis will be. So if rates aren’t going up meaningfully now, they never will unless there’s a currency crisis first.


What to do about it

Currency devaluation isn’t just a likely outcome in the future. It’s already been happening for decades.

The dollar lost 50% of its value over the last 30 years. It’s just been a gradual decline – not very noticeable from year to year.

A currency crisis simply means an acceleration of what has already been going on.

The latest data suggests Canada experienced 3.7% inflation year over year. The idea that money can lose 50% of its value from today in the next 10 or 15 years is a real possibility.

So how can you protect your purchasing power?

Hold onto low interest debt if you have it. Do not pay it off.
Inflation should cover the carrying cost and then some of any mortgage debt.

Why pay down your debt today when you can use devalued dollars in the future to pay it down?

You should also be investing in assets that will outpace inflation over time, such as value stocks and real estate.

Back in 2008 central banks bailed out mostly institutional investors.
But this time, if there is a crash, retail investors will need a bailout as well.

This means investing now is less risky than before.

And people are catching on. Margin debt is near all time highs.

See the moral hazard here?

Market speculators no longer have skin in the game.
Today we are witnessing a huge wealth transfer from innocent savers to savvy investors.



Random Useless Fact:


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08/23/2021 9:12 am

Good article Liquid. Moral hazard due to information asymmetry is a huge issue. And it will cause problems. For sure.
I guess the world financial system as we see it might be unique. The tough thing is that people will get hurt financially for not taking risks. In fact, it’s risky for not being in „risky assets“. Such as stocks, ETFs which in my view are must-have positions. And there is so much disruption going on. For instance can a diversified portfolio really afford not being in cryptos, at least at a small percentage?
Many topics and questions. I guess investing has never been that interesting and that challenging.

09/03/2021 8:59 pm

Yes. Missing out or standing at the sideline has its risks and huge costs (opportunity costs, inflation etc.).

David @ Filled With Money
08/23/2021 7:32 pm

It’s mind boggling that a system where overpayment for underperformance exists. However, what got me more fascinated is that people are actually agreeing to pay for these kinds of underperformance all the time!

People know that Vanguard index funds have very little fees yet refuse to invest in them. they would rather invest in the hedge funds that underperform the S&P 500 year over year. I will never understand.

Money Mechanic
09/15/2021 9:39 pm

On point as always!