As the last month of 2020 approached, I tucked myself into the warmth of my cozy blanket and spent almost the whole month completing unfinished tutorials, unread books, and unheard podcasts that I had thought of finishing long back. The more I read and reflected, the more I became convinced about the two most powerful tools in personal finance – Diversification and Compounding which have been my guiding posts.
We have often come across success stories of illustrious investors and their best bets that made them so, how their concentrated bets returned 100x and upwards getting them into the coveted billionaire club. However, what gets missed are the below two points –
- Ability to play concentrated bets comes with experience
- Once it plays out other assets fade in comparison putting single bets in limelight
While hitting a multi-bagger asset is what most of us dream about, but often forgetting that we should not risk the capital for our basic needs in that chase. Thus, maintaining diversification whether across assets and classes – some of which will give moderate returns is important to provide basic financial protection in a scenario the concentrated bet does not work out as well as it did for Brandon Smith or Jason DeBolt or many others who have not yet declared their fortunes on twitter. In such a scenario one could end up risking money he needs for his future requirements for something which may have 1-in-100 chance of success.
The concept has been explained by many smart investors of which what I like the most is how Morgan Housel puts in his book The Psychology of Money :
“Growth is driven by compounding, which always takes time. Destruction is driven by single points of failure, which can happen in seconds, and loss of confidence, which can happen in an instant.”
Speaking of compounding which is often touted as the eighth wonder of the world – the basic tenet is premised around the fact that its the time in the market which is more important than timing the market. For legendary investor Warren Buffet, nearly 90% of his total wealth has accrued after the age of 65.
Despite an envious investing record, Buffet too comes under public ire for missing out on technology boom and thus the opportunity to compound his wealth at an even faster rate than ~25% CAGR he clocked since his first investment at the age of 15 years. In this context, I base my learnings on the insightful memo of Howard Marks titled Route to Performance in which he quotes a money manager as saying – ” If you want to be in the top 5% of money managers, you have to be willing to be in the bottom 5% too” but Marks caveats that such a combination of far above-average and far below average years can lead to a long-term record which is characterized by volatility and mediocrity. Rather, striving to do a little better than average every year and maintaining discipline can give highly superior relative results in bad times. Something that consistent compounding track record of Buffet emulates.
My learnings for managing personal finance is thus premised on pillars of diversifying across assets such that overall portfolio is able to generate consistent return across good and bad times. And not give into the temptation of supernormal returns thereby breaking the cycle of consistent compounding. Hope this rings some bell for you too in the New Year!!
Disclaimer : I am not a SEBI registered investment advisor. The above views are personal based on my understanding of managing my own finances and learning from the experiences of others.