Last week I wrote about the recent Goldman Sachs scandal and the lawsuit the SEC is bringing against Goldman. This week I want to explain why firms like Goldman would commit fraud. This week I want to talk about risk and reward.
When I was a kid, there was a popular game called RISK. The game is
set in the Napoleonic era, and you control an army and a section of the
board. The goal of the game is simple: world domination. It’s a game
without mercy and requires high intelligence and much planning. It’s not
a game for suckers.
Over last decade, Wall Street has been playing their own version of
the game RISK—and though the stakes are higher, the strategies are the
same. The source of all this risk? Trading.
In Conspiracy of the Rich: The 8 New Rules of Money,
I wrote about how those who play by the old rules of money—go to
school, get a job, buy a house, save money, and invest in a diversified
portfolio of stocks, bonds, and mutual funds—are playing to lose. This
is especially true when it comes to investing for retirement in the
stock market and Wall Street’s financial vehicles.
Those who invest for their retirement in the stock market and
financial vehicles made by Wall Street firms are betting on the market
rising in value. They are investing for capital gains instead of cash
flow. The problem is that the true money is made in trading—in the sell,
not the hold. In fact, traders need the middle class to invest for the
long term so that they can cash in on their financial ignorance through
trades—often highly complex trades that take advantage of market swings
and that require a high financial intelligence.
All the major Wall Street financial firms understand that the real
money is made in short-term trading, not in long-term investment. And
the reality is that the higher the risk, the bigger the return. In fact,
until recently the potential returns were so high that the big firms
were willing to risk it all for the big payoff. In a recent article in
TIME Magazine, “The Case Against Goldman Sachs”,
Stephen Gandel writes: “‘With a trader, the goal of every minute of
every day is to make money,’ says Philipp Meyer, who worked for UBS as a
trader in the late 1990s and early 2000s before going on to write about
his time there. ‘So if running the economy off the cliff makes you
money, you will do it, and you will do it every day of every week.’”
Of course, when I say that big firms like Goldman are willing to risk
it all to make a killing in trading, I don’t mean they were willing to
risk all they have…I mean they’re willing to risk all you have. These
big firms are not just experts in trading, but they’re also experts in
hedging those trades. The true victims are rarely the firms
themselves—or the executives and traders collecting big bonuses—but
rather good, hard-working investors with little intelligence.
The recent lawsuit against Goldman only exists because the SEC thinks
that Goldman hedged unfairly—not because they wiped others out. In
reality, most people and organizations are just pawns for the big Wall
Street firms in a much larger game of RISK—trading edition. I’m not
saying that is right or wrong, but it is reality.
The TIME article goes on to say: “In 1998, the year before Goldman
went public, just 28% of its revenue came from trading and principal
investments. By 2009, it was 76%.” And quoting a former Wall Street
executive, "The industry became so heavily weighted toward risk, it just
made sense to let the traders run things." The traders are in control
on Wall Street—and they love the trading game of RISK.
According to the RISK product website, the following are some
suggested strategies to be a winner at the board game of RISK. The rules
are very similar to the ones for the trading game of RISK played on
Wall Street.
Focus on the goal and the objective
In the board game of RISK, the goal is total world domination, no mercy.
The goal is the same in Wall Street trading. This is not a charity
game. It’s a chew ‘em up and spit ‘em out, high stakes game where the
winners win big and losers are toast.
You must grow to win
In the board game of RISK, you must grow a large army and accumulate large capital to conquer the world.
In the trading game of RISK, you must also grow large. By doing so,
you earn friends in the government who will overlook your unfair
advantage, and you gain insider access to make smart financial moves
powered by knowledge while the little guys go down in flames.
Make large attacks
Making small attacks in the board game of RISK is worthless. You need
to make big, large scale attacks to win. The risk is higher, but the
payoff is worth it.
In the trading game of RISK the rule is the same. Small trades with
little risk are worthless. Why? Because traders make money in the form
of bonuses based on the size of the trade. As the Time article states:
“As with everything else on Wall Street, the rise of the CDO had to do
with bonus checks. Traders' pay was based not just on how much money
they made for the firm but on the size of the bet.” In other words,
traders have financial incentive to take bigger risks and are
discouraged from playing it safe.
Don’t hesitate to eliminate a player from the game
When you’re playing the board game of RISK, there’s no room for
mercy. Whether it’s your best friend from childhood or a random
stranger, you have to treat all opponents the same—you have to take them
out whenever you have the chance.
The same holds true on Wall Street. As the old adage goes, “There are
no victims on Wall Street, just fools.” Traders are merciless and will
sacrifice you, me, the whole economy to make a buck for themselves and
for their firm. They don’t have your best interests at heart—they have
theirs.
Know the map
The game of RISK website says this about the game: “New players are
fresh meat with huge egos.” I translate that as, “People who don’t know
the rules of the game will be eaten alive.”
The same holds true for the trading game of RISK. Those who have a
low financial intelligence, who live by the old rules of money, will be
eaten alive by the traders on Wall Street.
I want to see you win. In order to do so, you must understand the
rules of the game. The only way to understand the rules is to increase
your financial IQ. For instance, now that you know the rules of Wall
Street, you can begin to learn how to play by those rules. That may mean
learning how to be a trader. Rich Dad offers classes on technical
trading and expert coaching on trading through our Rich Dad Education
and Rich Dad Coaching programs. You may want to take advantage of those
resources in the “Coaching and Education” section of this website.
I encourage you to stop playing by the old rules of money, and to
instead educate yourself financially. Understand that the only person
who can save you financially—is you. You can’t rely on the other players
because their objective is to win—at the cost of you losing. You must
rely on yourself and your mind. That’s why I preach that Knowledge is
the New Money. You can only win if you understand how to play.
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