Carlos Velásquez · Medium · 17 min read · Photo by Glen Carrie on Unsplash
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1. Understanding the career risk professional investors face can help individual investors: professional investors often become forced sellers due to liquidity concerns, stop-losses, or bumping up against their portfolio’s risk budget. During market uncertainty, career risk hedging (i.e., not losing clients) can drive professional investors’ actions more than the results of their fundamental and/or technical analysis.
2. Your beliefs of how the stock market should behave are irrelevant: staying out of the market based on a belief that it is acting irrationally does not give an investor an edge. Plan for the market not to make sense most of the time. Implement your investment strategy according to what is actually occurring. A lot of uncertainty in the market? Decrease your position size for peace of mind — but understand that the market has already priced in that uncertainty.
3. Company insiders’ buying activity can provide helpful insight: company insiders know a lot more about their company than outsiders. The bullish among them will buy shares of their company’s stock. Simultaneous buying by multiple insiders — CEOs, COOs, CFOs, and Directors — can serve as a useful signal to outside investors, particularly when corroborated by other metrics. Large stock purchases, relative to an insider’s annual salary, is an even stronger signal.
4. Investors can learn from the book, movie, and biotech industries about moonshots: a small percentage of movies, books, and biotech discoveries account for most of the profits. Investors and capital allocators rely on trial and error, making many small bets on many authors, producers, and research projects as they are incapable of knowing which bet will be a winner. Investors managing personal accounts should take notice of the role that moonshots have on the profits of these industries.
5. Animal spirits — fear and greed — drive markets: on March 20, 2020, nearly 90% of 5,071 respondents to an ad-hoc poll thought it would take the S&P 500 longer than one year to reach a new all-time high; more than 55% thought it would take 2+ years. Five months later, the S&P 500 had reached a new all-time high…
6. Most investors have a FOMO threshold: …since reaching a post-pandemic all-time high in August 2020, the S&P 500 has gained an additional 18.9% (reaching 4,019.87 as of April 1, 2021). Investors’ Fear Of Missing Out has partially fueled the latter stages of this rally. They could have circumvented their FOMO by carefully calibrating into positions, even if they had little conviction, in Q2 2020 using the VIX Volatility Index…
7. The VIX Volatility Index is a good indication of when the market has bottomed: …in 2020 (as in 2008–2009), the VIX Volatility Index moved to extreme highs as the market dropped; it fell precipitously as the market recovered. Investors can use the VIX Volatility Index as an indication of when to begin establishing small positions during significant and sudden drawdowns.
8. Rough time-symmetry exists between the creation of a market trough and the subsequent recovery: Bear markets that take a longer time to trough take a longer time to recover: see 2001–2005. Quicker drawdowns have resulted in quicker recoveries (and greater volatility — refer to the VIX). The chart below graphs the SPDR S&P 500 ETF Trust (SPY) dating back to 1995. Individual stock prices were even more volatile than the S&P 500 Index during the denoted drawdowns. Full recoveries are not necessary for investors to make money in this context.
9. Rules-based investment strategies help investors mitigate behavioral biases: we tend to underestimate risk during stable markets and overestimate risk during volatile markets. Establishing a rules-based investment strategy that is set to calibrate into/out of positions using predefined criteria — i.e., insider purchasing activity, VIX Volatility Index momentum, systematic deleveraging periods, etc. — can help investors mitigate behavioral biases that can lead to investment mistakes.
10. Opposing views to your own are worth considering: this is true in many disciplines, but especially in investing. Worse case: you can use the opposing views to stress test your investment thesis. Best case: if opposing views prove your thesis wrong, you can act upon this insight and perhaps avoid losing money. Listening to people that only reinforce one’s beliefs is not necessarily helpful when seeking investment alpha.
11. Winning positions can be held longer when portfolio volatility is dampened: a barbell portfolio consisting exclusively of ultra-safe assets and many risky investments lowers its overall volatility while optimizing its risk-adjusted return potential. Lower volatility helps investors stay invested in winning positions longer — important when, in the long run, 90% of a portfolio’s returns are driven by 10% of its holdings. By contrast, the higher volatility associated with concentrated portfolios makes holding on to winning positions increasingly challenging.
12. We overestimate 1-year ROR potential but underestimate 10-year ROR potential: the benefits of long-term compound returns are hard to internalize, while headlines that overhype short-term market activity induce investors to chase recent winners. Moreover, concentrated portfolio positions that grow exponentially are often prematurely trimmed as a rebalancing/risk-mitigation measure — the counterfactual evidence of a buy and hold strategy is therefore lost. Investors need to develop investment rules that enable them to hold on to long-term compounders.
13. Longer investment horizons should help investors feel more confident: bearish investors often cite Japan’s stock market performance post-1990. Despite Nikkei’s Lost Decade (1991 to 2001), long-term investors that dollar-cost averaged into a Nikkie indexed fund during the past 30 years have earned a profit. Since 2009 the Nikkei Index has closely matched the S&P 500. If an aging, landlocked, and closed society enabled investors to reap profit, investors should be optimistic about the long-term opportunities in the U.S./emerging countries.
14. Billionaire investors are more diversified than the small investors trying to mimic their strategies: we celebrate investors that have become billionaires managing concentrated positions. Less understood, however, are the hedging strategies they implement (e.g., rolling options/futures contracts of varying durations to make directional bets on many stocks and asset classes) amounting to hundreds of additional financial positions. Moreover, their personal wealth is diversified among other hedge funds, private equity, CTAs/managed futures, offshore accounts, art collections, cryptocurrencies, and multimillion-dollar homes in various continents. A 2-and-20 fee structure earns a profit regardless of their fund’s performance. Their lawyers are constantly looking for tax loopholes, and they have a prenup with their 3rd wife…
15. Individual investors with concentrated portfolios underestimate their risk: …individuals investors with 10–20 concentrated positions frequently rely on stop-losses to mitigate risk, which can clear at lower prices during drawdowns. Their cash flow may hinge on a single income (two if married), six months of cash reserves (if that), and any real estate (net of the mortgage) they may own. These investors are unknowingly taking on much more risk than the professional investors they attempt to emulate. Even Warren Buffett — known for holding concentrated positions — owns 70 or so independently operated companies and 30 or so publicly traded companies via his Berkshire Hathaway (NYSE: BRK-A/B) holding company. Insurance premiums (the “float”) have helped Buffet optimize his BRK returns by effectively leveraging free money. Berkshire Hathaway also holds $140 billion in cash reserves.
16. Simple safeguards can mitigate portfolio risk better than sophisticated models: complex systems cannot be modeled with a high degree of accuracy. Luckily, using a few key variables and simple safeguards, investors can create robust — even Antifragile— investment strategies that limit risk (such as a barbell portfolio strategy). Safeguards and hedging strategies incorporated in sophisticated models, on the other hand, often fail to protect a portfolio from fat tail risk/Black Swan events.
17. Investors can front-run Black Swan events utilizing moonshot bets: unexpected swings in the price of stocks, asset classes, and the overall stock market are driven by Black Swan events — i.e. 1987 Black Monday, 9/11, 2008 GFC, and COVID-19. More recently, GameStop Stock: $3-$483, Bitcoin: $3.5k-$60k, and negative oil prices in April 2020. Positioning one’s portfolio to benefit from Black Swan events by systematically betting on moonshots that embed cheap-optionality can optimize risk-adjusted returns.
18. We have always lived in a dynamic, creatively destructive economy: industries such as construction and financial services and sectors such as transportation and healthcare did not exist 100 years ago (many people still worked on farms). Investors can benefit from observing the trajectory of business and technological innovations that are, today, occurring increasingly faster. These innovations will redefine the economy and create investment opportunities…
19. Breakthrough technologies follow an Adoption S-Curve that now occurs faster: …from the 1900s adoption of the telephone to the 1990s adoption internet, the early market phase of innovative products have started as fads with uncertain market value. When the mainstream discovered their use-case, adoption grew, often exponentially. Bitcoin, and blockchain technology in general, is undergoing a similar adoption trend.
20. Bitcoin is entering the growth phase of the Adoption S-Curve: the adoption of the Bitcoin blockchain network bears a resemblance to the internet adoption of the 1990s. The internet took a while to catch on but revolutionized the world. Skeptical investors should heed this historical lesson.
21. Bitcoin is also an ideological movement that is building momentum: Bitcoin’s non-sovereign store of value characteristics made libertarians among its earliest adopters. Its recent broader adoption by the early majority— from millennials to city mayors (i.e., Miami) to wealthy individuals — has added to its momentum. In fact, a bitcoin exchange (FTX Crypto Exchange) recently acquired the naming rights to Miami’s American Airlines Arena. Investors that have bet against assets with fervent backers typically lose. Worse still, they miss out on profits.
22. Altcoins are not as antifragile as Bitcoin but are asymmetric risk-reward bets nonetheless: altcoins can explode to the upside on Bitcoin’s coattails. Some already have. When unsure of which altcoins to invest in, consider establishing a diversified altcoin portfolio. Their prices tend to correlate, but holding a diversified basket of altcoins helps investors mitigate unexpected risk (refer to the SEC’s lawsuit against Ripple).
23. It helps to ask, “do I want to be right, or do I want to make money?”: investors that put their ego aside and admit when they are wrong are better able to course-correct. When the facts have changed, inflexibility of opinion/action can be a nemesis to investors that want their thesis to be proven right. Successful investors change their views when the facts change. And in complex systems, such as the stock market, the facts are constantly changing.
24. Professional investors can have opposing views based on the same set of facts: professional investors can study the same set of facts and reach opposite conclusions; one (or both) will be wrong. Are we in a “risk-on” or “risk-off” market environment? Depending on which expert you listen to, you will hear a different answer. The range of opinions regarding such questions highlights the challenges investors face. Small position sizing enables investors to take action despite uncertainty while limiting the associated risks even the expert cannot agree on…
25. Trial and error can help you become a better investor: …investment mistakes are to be expected. Luckily, they can be invaluable sources of information that inform investors of what does not work in the given environment. A measured trial and error investment strategy affords investors the ability to learn from their mistakes and tweak their heuristics accordingly. Zero commission trading makes implementing a trial and error investment strategy via small position sizing feasible.
26. Do not invest money earmarked to fulfill a financial obligation five to ten years out: this is common sense advice for most but surprisingly inadequately implemented by many. Investing money needed to meet a future obligation can turn investors into a forced seller during market drawdowns, especially if the investor also losses his/her job. During the last 60 years, there have been ten S&P 500 drawdowns greater than 20%, peak-to-trough. For younger investors, chances are there will be several significant drawdowns in their lifetime. Allocate money accordingly.
27. No asset is too volatile for a portfolio if it is sized appropriately: if an asset is too volatile, include it into your portfolio as a reduced position size. Volatile assets can lower a portfolio’s overall volatility since they may not be correlated to other positions. Importantly, volatile assets’ risk-reward profile can expose investors to 10x-100x, or greater, returns. Appropriate position sizing will mitigate the associated risk.
28. Holding cash is an under-appreciated risk management strategy: cash positions help mitigate portfolio volatility/risk. Holding cash is also a prerequisite to systematically establish positions during oversold market conditions when credit is dear. A significant cash/cash-equivalent position is central to implementing a barbell portfolio strategy and favorable to rules-based investors that patiently wait for an increase in market volatility to trigger their resting limit orders…
29. Improve your risk management skills if you want to be a better investor: …most investors are familiar with Warren Buffett’s Rule 1: “Never lose money” and Rule 2: “Never forget Rule 1”. Implementing a barbell portfolio strategy represents a straightforward way to manage risk: investors sit on a lot of cash while simultaneously swinging for the fences with 10%–15% of their portfolio. The downside risk is known and bound, but the portfolio’s upside exposure to convex returns is not.
30. Being a skeptic is riskier than being an optimist: skeptics become more (not less) bearish during market downturns. Ironically, their increased skepticism makes them lose out on the very buying opportunity they expected (resting limit orders in a barbell portfolio construct can help mitigate this psychological problem). Skeptics should offset their beliefs by considering that there is too much innovation for the markets to stay depressed for a very long, even after the next market crash…
31. Betting against technological advancement is risky: …avoid betting against advances in material sciences, genomics, self-driving vehicles, robotics, blockchain technologies, and AI whose benefits will permeate the economy. Staying invested in a diversified basket of assets, ideally containing a fair share of convex return exposure (while also holding on to cash), provides investors with an opportunity to create wealth (and opportunistically buy dips) during the next 20 years in light of these emerging technologies.
32. The playing field has leveled for retail investors: the informational, size, and cost advantages institutional investors historically benefited from have deteriorated. Forums such as Reddit’s r/wallstreetbets laid bare the extent to which institutional investors’ informational advantage has diminished. Fractional share purchases have diminished institutional investors’ size advantage. The zero-commission brokerage model eliminated any remaining cost advantage in 2019. Retail investors now have access to much of the same information as institutional investors, often for free.
33. Volatility is the price investors must bear when seeking alpha: investors with a long-term investment horizon need to detach themselves from the stock market’s emotional rollercoaster ride in order to benefit from long-term appreciation. Asset diversity and sound risk management can help, as will perspective: take any 10-year S&P 500 performance period post-1932; 90% of those periods have been profitable. Investors that implemented a dollar-cost average investment approach beat the market. Those that opportunistically bought dips fared even better.
34. Buying beaten-down small-cap stocks can give investors an edge: buying small-cap stocks during market drawdowns can be an excellent long-term strategy. Institutional investors often exclude small-cap stocks from their portfolios due to their relative illiquidity, favoring the more liquid large-cap stocks. Fewer analysts consequently follow smaller companies, creating pricing inefficiencies in the small-cap space.
35. The potential payoff on speculative bets increases when there is more uncertainty: uncertainty causes investors to discount asset values, accentuating their upside when a recovery occurs. True, the more uncertainty that exists when an asset is purchased, the greater the investment risk — but also the greater positive convexity embedded in the position. Volatile markets, therefore, lend themselves to making many small speculative bets. The upside of one winning bet can make up for many losers.
36. We know 1–10% of what is knowable but think we know 90–99%: if we are honest with ourselves, we will admit that we are clueless about most things. Investors, however, can be hubristic about the stock market; the smarter the investors, the more hubris they can have. Yet, the stock market is a complex system with thousands of feedback loops that even the smartest investors may not fully comprehend.
37. Investors benefit from being opened-minded in a world void of gatekeepers: investors should think twice before dismissing people with varying opinions or novel investment ideas. Unchallenged beliefs can increase investors’ confidence, but they will more likely end up being detrimental to investors in a world that makes gatekeepers obsolete and has given society the keys to the digital marketplace. Luckily, investors’ hubris can be offset by adopting simple heuristics: making many small speculative bets in an increasingly global and digitally connected economy.
38. People fall in love with being wealthy, not the wealth creation process: being good at anything requires falling in love with the craft’s process. Becoming a good investor entails (among other things) many hours dedicated to developing a sound investing strategy and building the psychological fortitude necessary to stick to it. Warren Buffett reads financial statements most of the days; he has been doing so for 60+ years. Buffett loves the process more than his money, which he is giving away.
39. Educational content is easier to access than ever before: the best investors can be followed and listened to on blogs/Twitter and podcasts/Youtube. Individual investors can synthesize the very best ideas with their own and test them via trial-and-error. For curious, open-minded, and motivated learners, world-class investment content is at their fingertips 24/7.
40. Money creation and an increased savings rate can further drive up the market: Modern Monetary Theory is pumping money into the economy. Moreover, the personal savings rate in the U.S. has increased markedly since early 2020. Combining MMT and increased savings with the pent-up demand from the COVID-19 lockdown will likely increase demand for goods and services when the economy fully reopens (which the stock market has already priced in, but perhaps not fully). Rising equity and real estate prices will increase consumer confidence, helping drive up demand for goods and services which will further propel the bullish narrative.
41. The stock market’s risk-reward profile is misunderstood: a $25k-$50k investment risks three-six months of a $100k salary. Yet in March-April 2020, workers earning even more than $100k hesitated to invest in the stock market. They did not rationalize that in the (unlikely) event of 100% loss scenario, working three-six additional months at the backend of their careers would recover a $25k-$50k investment, while the long-term benefits of investing in an oversold stock market could be much larger than their initial investment…
Risk: $25k-$50k (a 100% loss was unlikely if diversified, even in March 2020)
Reward: 50%-10x (some small-cap stocks have 10x-ed since March 2020)
42. Grad school’s risk-reward profile is also misunderstood: …now contrast the above example to the fact that a large portion of the U.S. workforce forgoes two or more years of a salaried job while paying yearly graduate school tuition (currently $25k -$50k per year). The total opportunity cost runs well into the six figures: (two-year tuition: $50–100k) + (two years of salary: $100k-200k, or more).
Risk: $150k-$300k (cost/opportunity cost for a degree with questionable future relevance)
Reward: ROR unknown (and unguaranteed in an evolving digital economy)
Takeaway: investing during market drawdowns entails less long-term risk than grad school, but surprisingly few investors see it as such.
43. There are no bad investments — just bad prices: small-cap stocks have not necessarily transformed from bad to good investments over the past 12 months. Yet many have resulted in 2x-10x, or better, returns for investors that bought them in Q2 of 2020 at “good” (i.e., oversold) prices. Patient investors willing to sit on cash and wait for fire sale stock purchase opportunities should take notice.
44. Buying the dip is easier in theory than in practice: many investors were bullish as late as February 28, 2020, but turned bearish in March. Clickbait headlines exacerbated bad news and strengthened their bearish sentiment. Unless a rules-based strategy to buy the dip had been established, most investors missed a significant portion of the record-breaking recovery.
45. Resting limit orders can be triggered at bargain prices: stocks are generally priced efficiently. But large block trades in the small-cap space, particularly during light trading volumes, can cause prices to fall precipitously. The lower clearing prices that result can trigger stop-loss orders and margin calls, putting further downward pressure on the stock price (sometimes lasting a split second). Resting buy orders that are placed well below the stock’s current price can be triggered at bargain prices during these occurrences.
46. Most investors risk 100% of their portfolios in search of 10% returns: moonshot investments via a barbell portfolio strategy flip the script, enabling investors to risk 10% of their portfolio in search of 10x returns. Whereas most investors seek to avoid volatility, moonshot investments enable investors to benefit from it. Taking on fewer units of risk also frees up capital that could be opportunistically deployed during drawdowns. Investors can reap the same, or superior, returns relative to a fully vested portfolio by investing in moonshots via a barbell portfolio construct.
47. The economy and the market are not the same things: the economy does not drive the stock market. The stock market is a precursor to the economy. Many investors stayed on the sidelines from March to well past the middle of 2020 because they erroneously believed the “real” economy needed to recovery before the stock market could recover. They were wrong.
48. The inflation rate is not uniform: retirees, middle-aged head-of-households, and millennials consume very different baskets of goods. Yet, government inflation metrics are based on the weighted average cost of commonly purchased goods and services. Take the official inflation rate with a grain of salt — hedge price inflation based on the unique basket of goods and services you consume.
49. Developing patience is a virtue for long-term investors: patiently and selectively deploying one’s capital during normal market conditions enables investors to put in the decision-reps necessary to improve their ability to size up and seize opportunities during over-sold markets. Developing patience allows investors not to yield to short-term pessimism and improves their chances of benefiting from compound returns. If implementing a barbell portfolio strategy, patience will help investors confidently sit on cash during normal (and even rising) markets that they can deploy more effectively during drawdowns.
50. Putting pen to paper slows down the mind and helps falsify irrational thoughts: being a contrarian investor can be lonely, even when one’s actions are based on sound investment principles. A journaling practice that enables investors to offset fear/uncertainty with context/perspective can serve the role of an unwavering confidant or quasi-performance coach — and provide helpful reminders that sound investment decisions can take time to bear fruit.
Author also wrote: Blockchain Stocks | Flywheel Effect | Bitcoin: Mental Framework | Crypto Moonshots | 4 Crypto Stocks | Bitcoin: Insurance | Brief History: Money | Spontaneous Order | Ackman’s $2.6B Moonshot | Fragility Inducing Events | Antifragile: Definition | 1% Bitcoin: 99% Cash | COVID-19: Market
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Disclaimer: Topics covered herein are for informational purposes. Before acting on investment information, consult with a financial professional. This article is intended for people who understand the pro/con impacts of tail-risk, convexity, and asymmetric risk-reward in the context of an investment portfolio.
