Invest where you have an Edge

INVEST WHERE YOU HAVE AN EDGE

Along your path to financial freedom, you must optimize your resources, sweat your assets, and grow your wealth.

You can do it through your job, investments, and business. I covered these aspects when commenting on Kiyosaki’s Cash Flow Quadrant and Dan Lock’s Wealth Triangle.

A growth mindset and personal development are additional pillars for your financial growth. While it is true we should never stop learning and embracing new challenges, it is essential to recognize an underlying dichotomy between:

1) focusing on the journey, or

2) focusing on the destination (the desired outcome)

In today’s article I will point out why – when you work for your financial security and livelihood – it is strategic to focus on the destination by hustling and investing where you have an edge.

For instance, when you study music, practice a sport, artistically express yourself, and ultimately, with your life, it is great to focus on the journey. You value every moment.  Success is part of the equation but is not the only expected result. As Viktor Frankl stated, success will be a by-product.

Conversely, in business and investment situations, your livelihood is at stake. Here, you must focus on something other than the journey. Here, you need to nail it! You need to focus on the destination, embracing a more pragmatic approach.

HOW TO GET BETTER – TRAIN HARD FOR PERSONAL DEVELOPMENT

Because “every battle is won or lost before it is fought” (sun Tzu), let’s focus on how you prepare and train for it!

I bet you know what it takes to learn and improve yourself. You have better chances of succeeding if you are the best version of yourself. Right? You push yourself to the limits and beyond. You go outside your comfort zone. That’s the spirit.

Training and playing with stronger opponents is also great, even if you lose. It is widely reported that “success is a bad teacher.” So, embrace the training, embrace the challenge, and even embrace the failure: it is part of your personal growth.

There is also an intrinsic beauty and ethics in training for it is own sake. It is a path of self-improvement without any interest in the outcome. You can embrace the romantic/amatorial approach of competing for the pleasure of competing, to test yourself. It is fine.

However, there is a caveat: when you “play” with high stakes, you have risks and rewards to gauge to ensure you break even and make a living.

In this second scenario, you must switch from the rabbit-hole mentality of “getting better” to the result-oriented mentality of “winning better.” But How?

 HOW TO WIN BETTER – CHOOSE YOUR BATTLES

Let me quote Michael Mauboussin’s story told in the Long View podcast:

I was preceded as chairman of the board at the Santa Fe Institute by a guy named Jim Rutt. And Jim, in his younger days, was a poker player…he’d spend his days learning about mathematics and poker tells and so forth. And by night, he would play, and as he got better, he played in more difficult and difficult games and typically higher stakes games. And he was doing OK on balance. But, of course, it got harder as he got to more advanced levels.

And then, one day, his uncle pulled him aside, and he said, “Jim, I would stop focusing at getting better at poker and start focusing on finding easy games.” So, actually, playing where you’re the most skillful player at the table is the best way to ultimately make money.

Here is how Personal Finance author Nick Maggiulli has commented on Maubussin’s story:

In the world of poker, this idea is known as table selection and demonstrates how, sometimes, the optimal strategy isn’t to improve your skill, but to find weaker opponents. In life it’s important to realize this as well. You don’t need to constantly try to be the best. Sometimes, the smarter move is to find a table—or field, or job, or project—where you have an edge, and then play that easier game instead.

Now, this practical wisdom no longer focuses on your personal growth, blindly “competing” for the game’s beauty. It is not about the satisfaction of playing at the highest levels and eventually losing against the best. It is not about focusing on the journey!

Competing for your financial security and livelihood is not enough to train yourself and do your best. You must “choose your battles” and focus on the destination (success)! You need to keep the odds at your side, maximize the chances of winning, and minimize the chances of losing.

There is a humble realization to be made. You need to know yourself, and keep your ego in check. You need to know there is always someone better than you. Therefore, you need to identify your circle of competence, where your edge lies, and the right market niche. Here are a few quotes that nail the point:

Warren Buffett; 1988 Shareholder letter: 

As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.”

Warren Buffett; 1996 Shareholder letter:

What an investor needs is the ability to correctly evaluate selected businesses. Note that word “selected”: You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital. 

Tom Watson Sr., Founder of IBM:

I’m no genius. I’m smart in spots—but I stay around those spots.

Warren Buffett:

The first rule of investing is don’t lose [money]. The second rule of investing, is don’t forget the first rule. And that’s all the rules there are.

Charlie Munger:

You have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make. You have to figure out where you’ve got an edge. And you’ve got to play within your own circle of competence.

 

Reading the Book of 5 Rings (1643), by the undefeated samurai Miyamoto Musashi, I recall the concept of (training) with a wooden sword or with a real sword. When stakes are low, and your livelihood is not at risk, you are ultimately in training mode with a wooden sword.  You can embrace trial and error for personal development and growth. You can enjoy the journey, and keep the destination as an inspirational goal.

However, you must focus on the destination when you are “game-on,” training or fighting with a real sword! Here, losses hurt. Plus, in some “games,” losses are hardly recovered. Remember:

– losing $1000 of savings, you need to earn up to $1400, not $1000, because you need to consider taxes from your income/revenues without even considering “opportunity costs” (what you could have done with that money), and “the time value of money” ($1000 now value more than $1000 in a month). 

– losing 50% of $1000 invested means you have lost $500. Your balance of $500 should double to recover the initial loss and restore your balance of $1000; that would imply an increase of 100% (+$500) to reach $1000 (200% of the ultimate balance). It is a challenging task! 

It is, therefore, essential to (i) measure and (ii) minimize risk. As Monish Pabrai famously stated:

People are under the misconception that entrepreneurs take risks and get rewarded for them. In reality, entrepreneurs do everything they can to minimize risk. They are not interested in taking a risk. They want free lunches and they go after free lunches. They focus on low-risk bets that have high-return possibilities. Not high risk-high return. But low risk-high return.

BOTTOM LINE

When you play high stakes, and your livelihood is on the line, protect your hard-earned/hard-saved money. As reported by Charlie Munger, Warren Buffett, and Tom Watson, understand your circle of competence and invest where you have an edge.

For instance, if you want to try active investing to feel the excitement or test your skills, trade only a small amount of your portfolio. For the rest, Invest in the market; be the market, buying low-cost / highly diversified index funds. In fact, unless you have a particular investment edge, a retail investor does not need to try the odds of beating the market because the odds would be against him.

Ultimately, choose your game wisely. When you play with a real sword, play to win.  

If you like article #141 on Invest Where You Have an Edge, check out other Financial Wisdom in my Archive, YouTube videos, and Audio Podcasts.