Allergic to Getting Rich

Key Concepts

• Compounding: The process of reinvesting earnings to generate further earnings.
• Stop-Loss: An order placed with a broker to buy or sell a security when it reaches a certain price.
• Position Sizing: Determining the appropriate amount of capital to allocate to a specific investment.
• Rebalancing: Adjusting the allocation of assets in a portfolio to maintain a desired risk level.
• Volatility: The degree of variation of a trading price series over time.
• Side Pocket: A separate account within a fund used to hold illiquid or distressed assets.

Defense of Letting Compounding Work

The core argument presented is a defense of Charlie Munger's principle: "Never interrupt something while it's compounding." This means allowing successful investments to grow without premature trimming, even if they become a larger percentage of the portfolio than initially intended.

• Argument: Trimming a position simply because it has grown significantly (e.g., from 5% to 10% of the portfolio) is akin to being "allergic to getting rich." The speaker acknowledges that this strategy might stem from a desire to avoid over-concentration or to manage risk, but argues that it can hinder wealth accumulation.
• Supporting Evidence/Reasoning: The success of compounding relies on allowing investments to grow over time. Intervening too early, based solely on a position's increased weight, can cut off potential future gains.

Risk Management Strategies and Their Nuances

While advocating for letting compounding work, the discussion also explores alternative risk management approaches and their potential drawbacks.

• Stop-Loss Orders:
  • Application: A stop-loss order is suggested as a method to manage risk when an investment has performed exceptionally well and its proportion in the portfolio increases. The idea is to "trail it with a stop-loss."
  • Critique: The speaker questions the efficacy of aggressive stop-loss levels. Using the example of a 50% drop as a stop-loss trigger for an Uber investment, the speaker points out that if the stock crashes by that much, a stop-loss would have exited the position, potentially at a significant loss, and missed any subsequent recovery.
• Banding and Rebalancing:
  • Concept: An alternative to strict stop-losses involves setting "bands" or target ranges for individual positions. For instance, if a stock reaches 10%, it might be trimmed back to 7-8%. Conversely, if it drops to 5%, it could be bought back up to the target range.
  • Benefit: This approach provides a more structured rule-based system for managing position sizes and can be less detrimental than a hard stop-loss that might trigger prematurely.
  • Improvement Suggestion: The speaker suggests that if this banding strategy is used, the "bands" should be widened to reduce the frequency of rebalancing, especially when dealing with individual stocks where volatility is a factor.
• Volatility Trading:
  • Strategy: Some investors aim to "play the volatility" by buying more of a stock if it crashes significantly (e.g., 50%) to bring their average cost down and rebalance their position.
  • Speaker's View: While not entirely dismissed ("I don't hate it"), this strategy is described as "bizarre" if the volatile asset is not considered a core part of the portfolio.

Treating Individual Investments

A key distinction is made between core portfolio holdings and individual, potentially more speculative, investments.

• Principle: If an investment is treated as a "side pocket thing" (i.e., separate and distinct from the main portfolio), it should be managed with fewer rigid rules.
• Contrast: Conversely, if it's part of the core portfolio, it should be managed with more discipline. The implication is that the rules applied to a core holding might be too restrictive for a more opportunistic or speculative individual investment.

Conclusion

The overarching takeaway is to be cautious about prematurely interrupting the compounding growth of successful investments. While risk management is crucial, rigid stop-loss orders can be counterproductive. Employing wider rebalancing bands or treating individual, volatile investments with a different set of rules might be more effective strategies for wealth accumulation. The emphasis is on allowing successful investments to run their course while having a thoughtful, rather than overly restrictive, approach to risk management.