Money For the Rest of Us

How Much Should You Invest in Stocks? The Art of Position Sizing in a Volatile Market

Oct 11, 2023

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

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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.

Introduction

3min

Bailout, Losses, and Investing Reflections

3min

The Dissipation of Wealth and the Value of Diversification

5min

Position Sizing in Investing and Managing Risk

6min

Managing Volatility and Risk in Investment Decisions

4min

Position Sizing in Stock Investing

7min

Allocation to Risk and Expected Return

4min

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

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Show Notes

How to avoid a common investment mistake - Buttonwood - The Economist

The Missing Billionaires: A Guide to Better Financial Decisions by Victor Haghani and James White

Money For the Rest of Us List of Most Influential Books

Charles Feeney, Who Made a Fortune and Then Gave It Away, Dies at 92 - New York Times

Elm Partners Coin Flip Exercise

Evaluating gambles using dynamics - O. Peters and M. Gell-Mann

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