Keep it simple money: Part 1
Relationship with money is best simple. The tricky part is how.
It’s incredible how our relationship with money changes over time, but so few people have the right models to think about it.
The base model is of course Maslow:
Start with it as a means to an end for basic livelihood
Then use it as a safety net for a rainy day
Build up more luxury and status
Use it for self-actualization (whatever that means for you)
Here are some things people get wrong about money:
💰 Operating at a different Maslow level:
Taking personal loans for keeping up your luxury and status needs is one example. Another side of the spectrum is ‘framing’ it as basic livelihood even if you’re well past it. All of these usually stem from some form of social / peer pressure, which is important to recognize and do away with.
2. 🙌 Being too hands-off:
Everyone knows that most of your money should be beating inflation, however, very few try to monitor it. Passive approach is great, but you still need to allocate capital well.
3. 👐 Being too hands-on: This is generally a symptom of get-rich-quick mindset. The weird thing about money, or more specifically investing, as a domain, is that more action doesn’t always mean more returns. This is actually counter-intuitive, because almost other domains have strong relation of action to rewards.
The reason for this is actually that the asset generating the returns is actually determining the pace, and since you aren’t managing that asset actively, you can’t influence the returns with more intervention.
There are exceptions to this rule e.g. day-trading
4. 🔍 Survivorship bias:
Very common as the peer influence increases, directly and indirectly through social media etc. How I got rich in X years using Y - is generally not copyable. And by definition, you dont know about all those that failed.
🏦 Not understanding leverage
For companies, debt is a means to increase return on invested capital and hence, plays a very important role as a capital source. For individuals, ‘mostly’, debt is taken to upgrade lifestyle and not really building investible assets. This puts unnecessary medium to long term on a lot of people and constraints life choices. This doesn’t mean debt is bad for individuals, but it should be taken with extreme caution and regard for your personality and future aspirations as well.
Ultimately, whether money buys happiness or not is beside the point, but it does give you some freedom and that’s a pretty big deal. But you have to keep it simple.
I’m writing this as a series of short posts clubbed together, rather than a single essay. Let me know if you like it or not.
But the question is how to keep it simple 🤔
Part 1:
Essentially, there are two objective functions:
Make money
Don’t lose money
Yeah it’s obvious, what’s not obvious is the micro execution of the same.
I’ll start with the second one as that’s easier to explain.
Firstly, don’t lose money doesn’t mean don’t lose any money, it means don’t lose all money.
The best explanation here is probably by Nassim Taleb in his book Antifragile. The first characteristic of being Antifragile is to avoid being fragile. This means, not getting into investments that can take you to complete ruin.
Let’s examine some assets and their potential downsides as a % of capital:
🏦 Savings accounts / Secured Fixed income: Capital protection is high, you generally don’t lose any money here.
📈 Equity: Except for very high volatility, you don’t lose more than X% of your capital. More often than not, that X is under 15% but varies on large cap vs small cap stocks . E.g. Max 1-yr negative returns for Indian index funds have been y%.
📱Startup investments: There’s a famous line by most VCs, including Vinod Khosla here, that you only lose 1x of your capital.
💸 Options selling without hedging: The potential downside here is infinite, and can take you to complete financial ruin.
Now if you have a portfolio of all of the above, just one wrong event in the last asset class will wipe you off. So, it’s better to invest in assets which cap your downsides.
Taleb even takes an extreme view here and says to put 90% of all money in cash and the rest in infinite upside outcomes. That’s a sure shot way of assuring you never lose more than 10% of your capital, but you will also not get the benefit of linear and semi-linear upsides and will not even beat inflation. Hence, modern portfolio approaches generally index on diversification across different asset classes.
Whichever allocation you follow, bottom line is: always cap your downsides.
The biggest way people lose money is uncapped downsides. But there’s a close second — half-measured bets.
There are various terms being thrown to describe this - gambling, impatience etc. But none of them fully capture the phenomenon.
This is most evident in public markets. You read a piece of news, develop an opinion on a stock ‘for near-term’ and then put your money. And often, you see that the stock doesn’t go as much in the direction you want.
Why?
Because it’s already priced in. Similarly, if you are looking at a real estate deal when most brokers are telling you to do it, usually the asset price has already gone up. And often in the near-term horizon, you may not see any gains. If the asset is fundamentally strong though, you will still see gains in the long-term.
The reason they are half-measured bets is that they are not completely wrong. There’s definitely truth to that news / real estate development and your interpretation of it. So yes, the action on it is not wrong, per se.
Just that the impact of the action has also been affected because of its viral nature and you, as a retail investor, being among the last ones to hear it. So unless you have a ‘real’ informational advantage, you will most likely lose money.
There’s more to the topic of not losing money, but there’s another topic which requires more coverage - making money.
Have you read Beginner’s Mind and Opportunism & Conviction yet? You may like them!