The last eight months have been a trying time for large and small investors alike, if only because we thought we finally learned how markets worked the last time around during in the tech bubble. As the portfolio results for year end 2007 and the first quarter of 2008 trickle in, we are learning - oh yes, we are - that this time there were different reasons for the temporary volatility in capital markets.

Six Sigma Events: Capital markets experienced a six-sigma event last August. According to www.financial-risk-manager.com, a six-sigma event is characterised by a price drop of six times the volatility (or standard deviations) of an asset, index, or market, thus the name sigma, which is the Greek letter representing volatility.

Bell-curve: For those of you — like me — who can but barely remember that they hated statistics in undergrad and university, think of the Bell-curve marble experiment. Each marble is dropped into a tiny hole in the middle of a wooden box containing a series of columns. Most of the balls will fall down the centre, some will fall to one side or the other of the centre, and a few will come to rest at the extreme edges. If you count the marbles, and perform the test several times, when you graph the results you will find an almost perfect bell-shaped curve. This is a living example of a standard deviation distribution — 94 percent of the time, results (and marbles) are within one deviation of normal.

To have an event that is six times the distribution away, is generally unusual, unpredictable, and infrequent, yet we have had several of these in the last two decades: the crash of 87, the Russian Devaluation, Asian Crisis and the Internet speculative bubble.

Our marble example probably does not make statistics any less boring, but trying to predict the probability of these types of events is a full-time business for mathematicians, analysts and scientists. If only¿..we had a crystal ball, we would all be well prepared and possibly wealthy!

Liquidity Crunch: This most recent spate of market volatility was also driven by lack of available cash in many financial institutions and investment vehicles, causing random and uninhibited selling of both good and not so good investments, unavoidably necessary when investors and lenders are demanding their money back.

Indefinable market values for securitized investment vehicles: The cash crunch was further exacerbated by the inability to properly value (and credit rate) many of these more esoteric instruments. How can you buy or sell something when you don't know what it is worth? This produced a causative effect whereby financial institutions became unwilling to lend to each other (something routinely done every day by the billions) because they were unable to compute inherent balance sheet (or off) liabilities.

Losses (on paper) may still occur. As the need for liquidity (and some uncertainty) hovered, investment indices across the board, such as Dow Jones reflected this volatility. For every seller, at the right price, there is an interested buyer; accelerating momentum is generally greeted with relish by opportunists, such as long/short managers, turning negative returns into profit.

While the rest of us got to listen ad infinitum to financial media stars warning us of fear in the streets, wiser experienced heads prevailed with the United States Federal Reserve and the Bank of England ultimately buying /exchanging sub-prime vehicles for sovereign (Treasury) debt from many of the largest financial institutions in the world.

Volatility is still prevalent, but underlying there appears to be an implied collective sigh of relief. Will these pre-emptive moves generate longer term stabilisation? Certainly, the average investor hopes so, the investment capitalist will just seek out the next advantage to exploit.

Leverage means that outside positive returns can also generate outsize negative drops in performance. What is never realised by individual investors until negative investment numbers are reported, is that those wonderful positive returns of 15-20-25-35 percent may have been generated by leveraging security positions.

The marble Bell-curve example clearly demonstrates that for every high return, there can just as easily be a similar negative return when random events impact investments. Add leverage to that equation and you have the classic case of the Carlyle Capital Group, established in August 2006 for the purpose of making investments in US mortgage-backed securities.

Wickipedia reports that CCG defaulted on about $16.6 billion of debt as the global credit crunch brought about by the sub-prime mortgage crisis worsened. The Guernsey-based affiliate of Carlyle was very heavily leveraged, up to 32 times by some accounts. Magnified negativity indeed. Almost all hedge funds employ leverage, some in very conservative and others in accelerated strategies. Anecdotally, individual basis investors far too often are quite astonished that a fund they purchased uses leverage, i.e. XXX fund levers say five times, seven times, or 10 times each position.

Fees are conveniently forgotten when gains are great. Behavioural finance is always interesting. In retrospect, no one minds paying fees when markets go up; for instance, some highly desirable hedge fund managers have charged as much as 40 percent, annually, on the assets for outside performance.

When losses occur, the statement is often made: "I am not happy paying you (or some fund firm) to lose my money even if you managed to hold my losses to far, far less than the general market trend, and even though your fees are market competitive."

Even more remarkable is how emotionally we investors react to three to six months of "paper negativity" compared to five years or more (count them) of consistent portfolio gains. Loss aversion means that investors always feel any loss, no matter how insignificant, more than massive gains.

Literacy: Understanding your finances is key. Don't be the investor who has no idea how much the management fees are, how the financial salesperson is compensated, what the range of gains and losses are, the amount of leverage used, if any, and many other criteria.

If you have been caught in this lack of knowledge trap, I urge you this time to learn everything that you can about your portfolio. Do not leave it up to trust, or good relationships with your financial salesperson, or as one individual said: "He had to be a good advisor, he was wearing a suit!" Make us all earn your respect by helping you become more financially literate.

Key questions: do you have the four components necessary to weather short-term investment storms?

1. Adequate liquidity in easily accessible accounts.

2. A core stable, globally diversified, capital-preservation-focused portfolio.

3. A smaller component (or none for the most conservative) of a high-grade global equity index fund.

4. Good working knowledge of investments that you own, with experienced assistance provided by a qualified financial salesperson.

Financial Instruments carry many risks.... and rewards for those who master them!

Martha Harris Myron CPA-NH#1929 CFP®#67184 TEP#203510 is a Senior Wealth Manager at Argus Financial Limited specializing in investment advisory services focused on capital preservation and comprehensive financial solutions for clients considering lifestyle transitions and rewarding retirements. Confidential email can be directed to marthamyron@northrock.bm or 294-5709 CFP®, CERTIFIED FINANCIAL PLANNER®, and are certification marks owned in the US by Certified Financial Planner Board of Standards Inc. (CFP Board) and outside the United States by Financial Planning Standards Board Ltd. (FPSB). CFP Board and FPSB permit qualified individuals to use these marks to indicate that they have met CFP Board's and/or FPSB's initial and ongoing certification requirements.

The article expresses the opinion of the author alone. Under no circumstances is the content of this article to be taken as specific investment, legal, tax or financial planning advice, nor as a recommendation to buy/ sell any investment product. The Editor of The Royal Gazette has final right of approval over headlines, content, and length/brevity of article.