"Safe and Predictable" May Not Be

A comment popped up on an old post on Seeking Alpha whereby a retired reader shared he had 40% of his portfolio in ten MLP and he was looking for feedback. I think this is a clear case of not really understanding the risk being taken. Vehicles that are generally high yielding and that generally have a predictable volatility profile make for a good hold—no doubt about it.

However, every so often the “safe and predictable” parts of the market do run into trouble, sometimes serious trouble. The point here is not to try to predict some sort of meltdown in the MLP space because the probability of such a thing is quite low but if it happens then the reader in question will get crushed.

An example I've used to make the point involves Amazon (AMZN). If you put 100% of your portfolio into AMZN in May 1997 at $1.50 and then sold it all in April 1999 at $105.00 you obviously would have had one of the greatest trades of all time but it also would have been a wildly risky trade. The word “wildly” would actually understate the risk taken. In this instance there would have been no negative consequence for the risk of putting everything in to AMZN but “no negative consequence” is not the same as not having taken the risk. Taking risk can work out fantastically well sometimes and sometimes not but people get into trouble for not realizing the risk they have taken.

The reader is taking a big risk with his retirement portfolio, this is undeniable. What we don't know is whether he will ever have to face a negative consequence for taking that risk. Unfortunately this is a behavior that repeats over and over. With every scary event people find out the hard way they had too much exposure to the wrong part of the market.