There’s a great new movie out called The Big Short, which explains how the financial crisis occurred, as seen through the eyes of hedge fund managers who shorted the housing market. The Big Short even manages to explain some complicated financial derivatives in clever and concise ways to help the audience understand what happened.
However, The Big Short is also a fantastic lesson in investing.
One of the first moments comes early in the film: When Christian Bale’s socially awkward fund manager (with a glass eye) is looking over information about mortgages, he realizes that tons of these mortgages have adjustable rates, and after a few months they are going to spike, and people won’t be able to pay.
He drills down even more and realizes the whole market is going to collapse. He is 100% convinced of his position, and essentially invests the entire fund into shorting this market.
That is what “The Big Short” refers to.
Then a big moment happens later. Even though defaults are rising, the complex derivatives he is trading are not falling in value. His big short is not reaping rewards. His biggest investor comes in and demands his money back. Bale tells him to pound sand. He does this despite getting nervous himself, and amidst mounting paper losses.
The Big Lesson
Here’s the lesson — he sticks to his convictions. He did his research and he knows he’s right. When you look into a stock, you must do your research. Articles like mine are just starting points — it’s on you to get your hands dirty and find conviction in your position.
A different sequence illustrates both of these points: Another set of managers goes to visit a massive development in Florida where they find abandoned houses where the owners defaulted and just left. As in, there are literally tumbleweeds blowing across the front lawn. Nothing is left in the house. Then they talk to mortgage brokers and bankers, who are bragging about how easy it is to get people into mortgages and how much money they made.
This hands-on research convinces the managers that they are right, and they load up on The Big Short. That becomes important later for the same reason as I mentioned — when their position isn’t improving when it should, they stick to their guns and hold on. Why? Because they did their research.
This can happen on both sides of a trade — going for the big long or the big short.
How You Can Follow The Big Short’s Example
Here’s a personal example: In late 2007 and early 2008, while the market was struggling, a payday lender and pawnshop operator called First Cash Financial Services (FCFS) lost two-thirds of its value. It actually had more to do with regulatory issues than the overall market. I was, and still am, an expert in consumer finance. I’ve seen it all. I’ve been in the stores. I’ve spoken to lenders and borrowers.
I understand how the subprime consumer thinks and behaves. I knew its management because I reported on the company. I was at a conference where I had access to other members of the industry, lawyers, lobbyists, bankers, regulators, you name it.
That was research. Hands-on research. And it worked. I bought the stock at $9 and exited at $48 many years later.
You can do that, too. Identify something you are an expert in. Pound the pavement. Talk to people in the business. Most people are thrilled to talk about what they do. You will learn tons. It only takes one big trade like this to make a lot of money.
