What Can You Absorb?
It is often said that “it takes money to make money.” While this statement often comes from a cynical point of view, there is certainly some truth to it. Looked at from a different angle and more broadly: It’s not just that it takes money to make money. It’s that it takes sufficient resources to endure and/or benefit from volatility. Volatility of all types. — Good and bad. Resources of all types — Financial and otherwise.
Americans Don’t have enough cash on hand
A 2018 study by the Wall Street Journal revealed that 40% of Americans didn’t have the cash to deal with a $400 emergency. That means that many relatively common events that can take place at any time can be ruinous for much of the population. It means that the frequent and random events of weather, wear-and-tear, and a myriad of others can be devastating.
When one can’t absorb a $400 dollar hit, he is much more likely to have to use a “payday loan service” at exorbitant rates. When one can’t handle a 400 dollar hit, then she is likely to be hit with late fees or penalties. Extended warranties, gap insurance, and replacement plans will be bought at every offer. The 2nd order effects of not being able to absorb 400 dollars of volatility are enormous.
Someone that cannot scratch together 400 dollars for an emergency will typically always need to buy insurance with the lowest deductible. Insurance is not a free lunch. It’s the value-at-risk being insured plus the overhead, profit, and contingency for every layer and organization involved in the insurance. It is a net cost to the buyer of the policy. Being able to “self insure” as much as possible is being able to absorb volatility at a lower overall cost.
Volatility comes in many forms
Cash is easy to count, and people understand it. The more cash one has, the more volatility (of the sort that cash can assuage) one can endure. However, volatility can come in forms where cash isn’t the coin of the realm.
Volatility can come in forms where upside can be harvested if one has non-cash resources to absorb the positive volatility. Resources such as time, shelf-space, skills, or social capital, can be more useful than cash.
As an example, in the summer before I started college, two of my friends had an outing planned with their Dad to attend a sold-out, out of town, Fleetwood-Mac concert. An unexpected work obligation arose, and the Dad suddenly was unable to attend. They called around to see if anyone wanted to buy the ticket, but they were unable to find a taker on such short notice. At the last minute they called me and asked if I wanted to attend the concert for free as the ticket would otherwise just be wasted.
I was able to absorb this positive volatility because I had flexibility with my time. Because I had abundance in my time resource I could embrace the serendipity that came my way.
I like to go to Old Navy at the end of Summer and the end of the Winter seasons. I like it because that is when one can sometimes buy the articles of clothing for the closing season for 20 cents on the dollar. Old Navy doesn’t have the floor space to keep inventory for a season that starts in six months. Old Navy needs to unload this inventory and they are selling into a market that is shopping for the opposite of what they are trying to unload.
Old Navy is on the losing side of volatility and up against a hard space and time constraint. For someone who has a little spare cash, room in their closet, and can plan forward 6 months into the future, there often is a good deal to be had. To get the deal one needs some slack cash, slack closet space, and slack time (not buying for only now).
Someone with a deep pantry containing most of the things they’d need for a month is able to absorb many kinds of volatility. Disruption of supply chains, failure of payment systems, the hacking of their bank accounts, natural disasters, an act of terrorism, a break down in the rule of law, -just to name a few. The deep pantry is one of the best cushions one can have.
If I own a second automobile the impact of my car not starting is much less than if I only have one automobile. If I’m good friends with my next door neighbor the impact of my car not starting is much less than if I don’t know my neighbor. If I’m in a foreign country where they dislike my kind, I have no cash, I know no one there, I don’t speak the language and I don’t know a damned thing about the inner workings of an automobile, my car not starting is a major big problem! — My ability to absorb volatility in that situation is vanishingly thin.
Cash can smooth out the volatility in investing
Sometimes investors try to leverage their positions by buying stocks on margin. When things are moving up they can greatly magnify their gains. But when things are going down they can receive a “margin call” and if they cannot cover the margin, get forcibly washed out of their positions at massive losses. Leverage can do the opposite of allowing one to absorb volatility — it can make one more vulnerable to it.
Typically, the best performing investments are also those that have the most volatility. And conversely, the investments that return less are those with less volatility. One without the resources to endure the ups and downs will miss out on better opportunities.
Redundancies and resources of all types allows one to endure the downside of volatility at lower cost and gives one the optionality of harvesting the upside. One needs to be able to buy when she doesn’t HAVE TO BUY and sell when she don’t HAVE TO SELL. Cash is certainly useful in this regard, but other resources can do the same. Saving for a rainy day is good advice, but the same can be said for building relationships and networks(social capital), discretionary time (say no to some things), and a developing a variety skillsets.
Volatility is a fact of life
Volatility is with us in every aspect of our lives: The weather, the markets, our own bodies, geo-politics, the economy, the climate, solar cycles, our employer, currencies, -you name it. Everything is degrading or rebuilding all the time. Everything is discovering new information and responding to it. It is moving from chaos to order or from order to chaos. And we are swept up in it, we can benefit from it, and without a cushion we can be crushed beneath it.
Can you absorb and handle the bad luck that comes your way? Up to what point? Can you absorb and embrace the good things that come your way? The attributes that give you the ability to absorb and endure volatility are not just financial. When reserves such as time, space, money, or mental bandwidth become too thin one can lose the ability to absorb or endure volatility.
How can you reap the benefits of volatility? Think about what resources you need to take advantage of unexpected opportunities. Think about what resources you need to survive downturns and nasty surprises. The one with ample resources can let the deals come to him. The person with sufficient resources lives in a structure that is geared to cost less. When one is properly set up, volatility is a net benefit.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.
