A multidisciplinary lens on investing!

Today’s post will draw insights from complexity, psychology & mathematics and apply it to the field of investing*. This post is not intended for wall street investors or day traders. It is more for employees who are likely investing for their retirement.

My interest in investing began long before I got my first job - from trivia and quizzes! Here is one of many such questions that reveal interesting insights - ones that I felt were compelling enough to adopt and take action in real life.

Most people get the answer right (Yes, it is X 🙂) as they begin with the assumption that this is a “trick question” even though the intuitive answer seems to be Y, as he contributes WAY more (24 more years) than X.

Only when we do the math it becomes fully evident to us that we don’t grasp the concept of compounding intuitively. Let’s start right there - with the concept of compounding…

[*] I'm not a financial advisor. This is not financial advice.

Table of Contents

• Compound Interest

• Margin of Safety

• Animal Spirits

• Ignore the News 

• Redundancy 

• My Funds

• Hedging

• My Best Investment

• Wrapping Up & Book Recommendations

Compound Interest

Here is my favorite quote about compounding:

Most of us learn about compound interest in school. Many students memorize the formula and use it to get right answers and good grades. But, they don’t truly understand it. They don’t know where or how to use it in real life.

The exponent in the formula for compound interest is time - not the rate of return. Therefore, the first rule of compounding is to never interrupt it.

But, what does that mean? Don’t obsess about squeezing the highest rate of interest in any specific year. If you can stay invested for a long time (like when you invest for retirement), it is completely OK to settle for the average market returns - with this approach you may very well end up in the top 10% of all investors.

The only people who lose money in the market are the people who trade frequently - who dance in and out of the market. As the saying goes, “Time IN the market is more important than timing the market”.

A good real-life example is Warren Buffett. He is worth over $130 billion today - but, not many are aware of his secret ingredient…

Buying and holding means that you never get into a situation where you are forced to sell when the market is down. Before we talk about what to buy, let’s first talk about what enables us to hold during rough waters - the margin of safety.

Margin of Safety

Note that last several years before the pandemic was the era of low interest rates and high stock market growth. Many financial advisers recommend to keep aside only six months worth of expenses as “emergency cash”.

But, maintain enough liquid cash to weather through bad times. Bonds are also typically seen as a ballast. 100% efficient allocation of funds may not be effective in real life.

Will the stock market go up or down in 2024? Those who understand the purpose of the margin of safety typically need not worry about the forecast.

You might not find it surprising that Buffett recently sold a significant portion of its Apple shares in Q2 2024, boosting its already high cash reserves to a record $277 billion. Cash also helps you to be greedy when the market is fearful.

Animal Spirits

Many macro “experts” talk about how interest rate hikes/cuts or wars will affect the stock market returns. End of the day, what really moves the markets is our animal spirits - Fear, Greed, Envy, etc. We can’t ignore what lies between any news event and the market movement - our perception/interpretation.

Understanding human psychology as it plays out in the overall market and also learning to manage our own emotions is key.

You might think that you can withstand a 35% market drop in a month. But, when it happens in the middle of a global pandemic when everything is getting shutdown with no light at the end of the tunnel and a job loss, you might not be so sure. There are so many stories from different countries/cultures about soldiers from training camps completely freezing up during a real battle.

Make sure that your margin of safety allows you to sleep well when the world around you burns and is going crazy.

Also, don’t become envious when your colleague or neighbor makes a million dollars in trading or lottery. Play the long game!

Jeff Bezos once asked Warren Buffett: ‘You are the second richest man in the world and yet you have the simplest investment thesis. How come others didn’t follow this?’ Buffett responded:

Ignore the News 

Every “market analyst” or “macro expert” who makes a prediction about the future market is either a charlatan or is someone who is vastly underestimating the complexity of the global market. The stock market is best perceived as a complex adaptive system where you can’t reliably predict any short-term outcomes. There are billions of actors and algorithms (with their own incentives and emotions) interacting in complex ways with geo-political events and more.

If you read the newspaper from last year instead of today, you’ll understand the folly of following the news for your investments. Most news is just noise.

Don’t worry about the new hotness (like AI) or what changed recently. Instead, focus on what doesn’t change in the long-term. Don’t bet against the ingenuity of humanity and our ability to problem solve and make progress despite setbacks.

For the premium subscribers, I’ll

1. Talk about the importance of redundancy with a real-life example

2. Discuss a couple of hedging options along with a specific hedge fund recommendation (no affiliation)

3. Provide the specific funds in which I invest (no affiliation) and also talk about my best investment so far!

4. Provide book recommendations on investing.

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