How Much Should You Invest in Stocks? The Art of Position Sizing in a Volatile Market
Oct 11, 2023
auto_awesome
Explore topics like avoiding common investment mistakes, the downfall of Long-Term Capital Management, the value of diversification, position sizing in investing, managing volatility and risk, and allocation to risk and expected return in this entertaining podcast.
27:37
AI Summary
AI Chapters
Episode notes
auto_awesome
Podcast summary created with Snipd AI
Quick takeaways
Determining the percentage of one's wealth to invest in a risky opportunity is a crucial decision, and maintaining a certain allocation in the safest asset possible is essential.
The Merton Share formula helps determine the optimal percentage of wealth to invest based on expected returns, volatility, and risk aversion.
Deep dives
The collapse of Long-Term Capital Management and the importance of position sizing
The podcast discusses the rise and fall of Long-Term Capital Management (LTCM), a hedge fund that relied on relative value arbitrage. LTCM's use of leverage resulted in significant losses during the financial turmoil caused by Russia's default on its government debt. The podcast emphasizes the importance of position sizing, highlighting the story of Victor Haggani, who lost a substantial amount of his wealth investing in LTCM. Haggani's experience led to his realization that determining the percentage of one's wealth to invest in a risky opportunity is a crucial decision, and that maintaining a certain allocation in the safest asset possible is essential. The podcast mentions the Merton Share formula, which helps determine an optimal percentage of wealth to invest based on expected returns, volatility, and risk aversion. It concludes by highlighting the concept of volatility drag and the importance of adjusting allocations based on changing expectations and risk levels.
The Missing Billionaires: Wealth dissipation over time and reevaluating investment approaches
The podcast introduces the book 'The Missing Billionaires' by Victor Haggani and James White, which explores the dissipation of wealth over decades. The authors highlight the case of Charles Feeney, a billionaire who gave away his entire fortune, and emphasize that most billionaires do not follow a similar path. They discuss the need to reevaluate investment approaches and tackle the question of how much risk individuals and families should take in their investment strategies. The podcast presents a study conducted by Haggani and a co-researcher, which reveals the tendency of individuals to make suboptimal investment decisions due to misjudgment and subjective biases. They also delve into the concept of risk aversion and discuss how the Merton Share formula can help determine appropriate allocation to risky assets based on factors like expected return, volatility, and risk aversion. The podcast concludes by emphasizing the importance of understanding one's risk aversion, aligning portfolio allocations to risk levels, and focusing on the median outcome rather than the average return.
Position sizing and the importance of dynamic allocation
The podcast explores the concept of position sizing and its role in effectively managing risk in investment portfolios. It highlights the potential catastrophe resulting from good investments coupled with poor position sizing, using the case of Long-Term Capital Management as an example. The podcast mentions a study conducted by Haggani and a co-researcher, involving a coin flipping game, to demonstrate the impact of position sizing on investment outcomes. It discusses the Merton Share formula as a tool to help determine the optimal allocation of wealth to risky assets based on expected returns, volatility, and risk aversion. The podcast emphasizes the importance of understanding the impact of volatility drag and positive skewness on investment outcomes. It also emphasizes the need for dynamic allocation, where portfolio allocations are adjusted based on changing expectations and risk levels. The podcast concludes by reiterating the significance of aligning position sizing with risk levels and focusing on the median outcome rather than the average return.
Our allocation to risky assets should vary based on the expected return, volatility, risk aversion, and how much we can earn risk-free. That means we should be taking less risk right now. Listen to learn why.
Topics covered include:
Why there are so few billionaires
Why the hedge fund Long Term Capital Management imploded
Why how much to invest is more important than where to invest
How the Merton share formula can assist with determining what percent of our wealth to invest in risky assets
Why are expected outcomes so much greater than the median outcome and why it matters to our investing
“net IRR” refers to the annualized internal rate of return net of all fees and costs, calculated from the offering closing date to the sale date. IRR may not be indicative of Masterworks paintings not yet sold, and past performance is not indicative of future results. See important Reg A disclosures: Masterworks.com/cd
