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Welcome to another issue of my Newsletter.
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Before diving in, I spent a ridiculous amount of time reading this newsletter- a recommendation from David Perell’s Friday findings, watching tutorial videos on Obsidian from youtube (h/t Naomi)
Let’s dive in;
Today’s newsletter is about my thoughts on diversification and going all-in on things. The last time I did, I wrote about it here.
The Shiny Object Syndrome(SOS): This when you find yourself jumping from one project to another to follow an idea or trend without first weighing its potential and, as a result, and getting distracted from your current pursuit.
In investing, this is similar to you get a hot tip and jump on it. You see a buy or sell recommendation on the news and jump on it without weighing its effect on your portfolio and abandoning your investment strategy.
In life, we should try to be flexible and not always stick to our guns. We should have some doors open for course correction and better options.
Keeping optionality is not achieved by saying yes to most things, but rather the opposite.
An empty schedule creates more optionality than a busy one.
But it’s not about saying no to everything either. Moreso, it’s saying yes to the right things.
Taking optionality to the finance world, one would argue for the creation of multiple streams of income.
So having multiple streams prevents you from relying on one. COVID did teach that lesson.
Just like a bridge would have multiple points of failure. Points of failure are things that would have to happen (usually simultaneously) for the bridge to fail. You too, should have multiple points of failure for your sources of income.
Having too many options brings paralysis and confusion. That’s the paradox of choice.
When you have 3-4 options, you are usually fine but, when you have 20, you get confused and can’t choose. Even when you do decide, you end up unsatisfied with your choice.
Optionality is good. It gives you the ability to choose what serves you best instead of choosing based on lack or scarcity. However, your odds of success improve when you are forced to direct all of your energy and attention to fewer things.
The same thing applies to investing. You don’t want to invest in too many things at a time. That’s over-diversification. Someone called it diworsification. When you do that, you are stretching yourself too thin, and your returns skew towards a lower mean.
Diversification is necessary. It prevents risks that can wipe you out completely. If you invest all your money in a single stock or industry and there is a downfall of such sector or company, you would get back to zero.
In most things, the Pareto rule works. The rule, which is also a form of the Power law, states that 20% of your input dictates 80% of your result.
So, 20% of your investments provide 80% of your returns. 20% of your actions bring in 20% of your results.
Warren Buffett’s “20-Slot” Rule
Warren says, “I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches—representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.”
He says, “Under those rules, you’d really think carefully about what you did, and you’d be forced to load up on what you’d really thought about. So you’d do so much better.”
The winner has to bet very selectively.
An example would be two portfolios with returns.
A:8,3,4,9,5,7,9,7,6,6 and
B: 8,3, 9,7,6
The mean of both portfolios would be A= 6.4 B=6.6 which means that portfolio B has a better average than A.
This is what it would look like when B takes time to research and carefully selects a few investments than A who goes too wide and without depth.
Conclusion
Rather than carefully researching and going all-in on a goal for a year or two, most people “dip their toes in the water” and chase a new trend, diet, a new college major, a new exercise routine, a new side business idea, or a new career path for a few weeks or months before jumping onto the next new thing.
Don’t be like most people. Take your time to research investments and goals, choose two to three, and go all-in on them.
Readings
The ambidextrous mindset: how to balance exploration and exploitation
6 big tips for overcoming ‘shiny object syndrome'
Commitment as a defense against the void
Tools
Apps you should check out:
If you want to discuss any of the ideas mentioned above or have any books/papers/links you think would be interesting to share in a future edition, please reach out to me by replying to this email or sending me a direct message on Twitter at @iamuhammadtahir.
Until next week, take care!
Muhammad Tahir.