Don't Underestimate Risk

One of the biggest mistakes investors make is underestimating risk.

Over and over again we have seen it happen.

Commercial real estate in the 80's, junk bonds, tech bubble, commodities bubbles, China in the summer of 2007, housing market, etc.

Now it is sovereign debt, that is government bonds, of almost all of Europe, an unfortunately the U.S.

I have a sense that risk is terribly under priced in just about every class of bonds at the current moment.* Corporate, municipals, treasuries, etc.

The government has been holding interest rates artificially low for a very long time...too long. This has caused a massive miss pricing of what I call "debt risk", or the risk that the borrower will simply borrow too much, and, regardless of the interest rate, will be unable to repay what he owes. Governments, corporations, and individuals all over the world are in this position.

Think of the government holding interest rates artificially low (causing a miss pricing of risk) as a force. We know from physics that for every force, there is a counter force. Massive defaults are the counter force. They will happen, just as everything that goes up eventually comes down, defaults are the inevitable consequence of too much borrowing.

Please read the following if you are interested at better understanding of how quickly risk can be repriced, and what affect this might have on your investments:

http://www.marketwatch.com/story/no-debt-limit-deal-your-investments-plummet-2011-07-12

Don't underestimate risk.

*None of the commentary on this website is "investment advice", but mere intellectual discussion. Any positions you take are 100% your own responsibility. As always, trade and invest at your own risk.