Building Wealth is Negatively Scored
“The ease of online dealing makes many people act as if investing positively scored, but the arithmetic of compounding dictates that it is negatively scored. Success in investing consists mainly of avoiding big mistakes.” - Guy Thomas
If you’ve been following the markets at all or perhaps some of fin-twit (financial twitter). You may have noticed that there have been a lot of blow-ups in certain areas of the market. Stocks that have been lockdown favourites like Zoom or Peloton have both scored near 80% declines. The crypto universe saw Luna crash to a near-worthless value for most holders. Who would have thought that speculative financial trash with no clear use case could end up being such an unreliable investment?
“The first rule of compounding: Never interrupt it unnecessarily."- Charlie Munger
Compounding is the greatest force for any investor. The ability for a steady return to turn near exponential over a very long period of time. The more you look closely at the great investors such as Warren Buffet, the more you see that their success has been built more upon risk management and consistency than any single deal or individual decision.
Building wealth over the long term relies upon your ability to avoid devastating mistakes. In that regard, wealth building is negatively scored. You can compound perfectly over 30 years, to see that good work be destroyed overnight on 1 wrong speculative bet. After all, trying to achieve 10% growth in the face of a permanent capital loss is a great equaliser. Whether you previously managed multi-billions or this is your first investment. 0 is still 0. Therefore removing the spectre of total capital loss has to be our utmost priority.
We have to avoid the very human fears of missing out on the next big thing and maintain a long term mindset. This can be incredibly difficult when it seems, thanks to social media, many others are becoming near millionaires overnight by speculating. Building real wealth over the long term by definition means never being part of the headline-grabbing investment for that year. Reduced down to its simplest parts, a well-diversified portfolio is a mixture of companies and assets spread across the world.
“The key to investing is having a well-calibrated sense of your future regret.” - Daniel Kahneman
We have to understand that what we are rewarded for with investing is taking a level of risk. The world will change, and things will perennially become more uncertain. However, at its heart, a well-diversified portfolio is just owning a very small amount of all the things we interact with every day. Part of the company who produced the phone we are scrolling through, the items we bought this week for our shopping or the streaming service we watch before we go to bed. While the future can never be guaranteed, all of history has shown us a well-diversified portfolio has always recovered from any temporary decline. Why wouldn’t it? Even an index of companies by its own nature is ‘self-cleansing.’ The General Motors of this world go from current stars to yesterday's winners, however, they are replaced as the larger holding by IBM, IBM fades from glory to be replaced by Microsoft, and this repeats again with Apple/Google/Amazon... the list goes on across thousands of companies which can be held in a single portfolio. All the while you remain relatively oblivious to these changes that are happening as part of the dynamics of a functioning market. This is why real diversification remains one of the only 'free lunches' in investing.
It can be worth considering introspection before making these more speculative investments. Especially if it is money that you would not be fully comfortable to see lose entirely. Whether it’s the new hot technology or the allure of the charismatic and outperforming fund managers who ‘seem to have it all figured out.’ We have to adjust our perspective, to keep the focus on our own score.
