Cheat Days in Investing
And The Speculation Sandbox
I am a big fan of the Coffee Can Portfolio, an “Active Passive” approach to investing. The idea is simple: You try to buy a basket of the best stocks you can and let them sit for years. You incur no costs with such a portfolio, and it is simple to manage.
My stock baskets can be found here on my Scorecard. Coffee Can 6 remains under construction. I added Bitcoin to it last week.
Big money was never made in the buying or the selling.
The big money was made in the waiting.
— Jessie Livermore
The above quote really embodies what investing is all about. One of the hardest parts about investing is having patience. Unlike other parts of life, where more effort usually bears more fruit, when it comes to the stock market, too much activity can be the enemy of investing success.
Human nature tends to make us want to act, usually at the wrong time, because it makes us feel like we’re making progress. This can often lead to ill-timed or uninformed investment decisions. This can be very dangerous.
Since this urge to act is a behavioral bias, counteracting it also requires a behavioral counterbalance.
For me, this counterbalance is the Permission to Speculate.
To be clear, when it comes to the stock market, I spend the majority of my time, energy, and capital on investing, not speculation. But I have come to believe that there is in fact room for some speculation in one’s investment toolkit.
I believe that speculation is to investing, what “cheat days” are to a diet regimen. When it comes to food, most of us get the urge to let loose every now and then. Whether that’s an In-N-Out Burger (Animal Style anyone?) on a Tuesday night or a Mocha Frappe on a hot day, sometimes the craving is just too much to deny. However, whether giving-in to these cravings helps or hurts you in the long run is largely a matter of how you approach it. In my experience, having a bad meal every now and then makes you much more likely to follow your diet the rest of the time.
Similarly, when it comes to investing, by not stopping ourselves from making a speculative investment every now and then, we stand a much better chance of remaining disciplined when making “real” investments.
So how can we do this without getting ourselves into trouble?
Enter: The Speculation Sandbox
My approach: Build my very own Speculation Sandbox.
In software development, a Sandbox is a testing environment that isolates untested code from the production environment. It protects "live" servers and their data from changes that could be damaging to the system.
My Speculation Sandbox serves a similar purpose. It represents a behavioral hack designed specifically to improve my patience. When I have the urge to speculate, rather than stopping myself, I simply limit such behavior to the sandbox. This simple hack has worked wonders. Just like a cheat meal, this allows me to “indulge”, and it keeps me from taking unnecessary risk.
Speculation Principles
To stop myself from making unnecessary investment mistakes, I follow the below speculation principles.
Don’t Let a “Cheat Meal” Turn into a Cheat Week, Month, or Year
Cheat days only work if you limit their size and frequency. So moderation is key.
Similarly, when it comes to speculation, I do it only with very very very small amounts of capital (relative to the size of my total portfolio). I use a separate account. And I assume a high chance of losing money. In fact, worst case, any money I speculate with, I expect to lose.
Don’t Do It Blindly...Keep Score.
I am the type of person who learns best by doing. When I was in University, I was unsure about the profession I wanted to get into. To help me with my decision, I completed 6 different internships by the time I graduated. That was a wonderful way for me to actually experience what it would be like to have a certain job. I use the same mentality when it comes to investing.
I often use my sandbox to test or experiment with several of my theories and ideas. For example, I speculate when
I have less conviction about an investment idea
I haven’t yet had the time to build as thorough an investment case as I would like
I am experimenting with a new investment approach, or instrument
This notion of making “small bets” to test, experiment, and learn is used by pretty much all companies here in Silicon Valley, but is seldom talked about in the world of investing.
Jeff Bezos, one of the greatest business minds of our generation said this about experiments:
“If they’re experiments, you don’t know ahead of time if they’re going to work.
But a few big successes compensate for dozens and dozens of things that didn’t work.”
-- Jeff Bezos
Keeping track of my speculative experiments creates a “Heads I win, Tails I don’t lose much” situation:
On the Downside,
I may lose some money, but this is an insignificant amount to begin with. So, not a big deal if it happens.
On the Upside, many good things can happen:
I may make a profit
If I make a mistake, I limit diluting the results of my primary investments
The best part: I learn something new. Keeping track of results, and learning from them, often leads to improvements in my primary investments.
Which leads me to the third principle.
Go Ahead, Indulge, and Don’t Feel Guilty About It
I speculate with the explicit understanding that I am in fact speculating, not investing. The objective isn’t not to lose money. In fact, that is expected and that risk is taken care of by limiting speculative transactions to the sandbox. The objective instead is to successfully counteract the human behavioral bias to “do something”.
Giving myself the Permission to Speculate works wonders. It is a behavioral hack designed specifically to improve my patience. It protects my mindset, and it is an effective way to protect my portfolio from myself. Just like a cheat meal improves one’s chances of sticking to a healthy diet, the Sandbox allows me to “indulge safely”, and keeps me from taking unnecessary risks.
Ok that’s a wrap!
Question For You: How do you improve your patience?
If you enjoyed this article, share it with a friend. They may like it too!
Thank you.