There are no solutions. There are only trade-offs.
– Thomas Sowell
A few weeks ago, I was talking with another investor about the pros and cons of investing in different types of assets. Our conversation ranged from single stocks, index funds, and REITs to bonds, debt, and direct real estate ownership.
During this discussion, I remembered a funny image that was shared around on Facebook when I was in college, a time before everyone knew the word meme and Facebook was the cool social media platform.
As is so often the case, it’s funny because it’s true. It was more or less impossible to balance all three areas as a college student. Most people traded strength in two areas for weakness in the third.
And what I realized talking to this investor is that the same is true in investing.
Often, investors try to balance three attributes:
Strong returns
Good liquidity
Low volatility
So the investor “choose two” triangle looks something like this:
And just like achieving balance as a college student, it’s difficult to find an investment or asset that balances all three. Strength in two attributes is usually traded for weakness in the third.
A few examples:
Single stocks: (possible) strong returns, high liquidity, high volatility
Bonds & US Treasurys: high liquidity, low volatility, weak returns
Real estate: strong returns, low volatility, low liquidity
Obviously I’m generalizing here. But at a high level, these are usually the trade offs made by investors.
This in itself isn’t a problem. The problem comes when your tradeoffs don’t match your personality or investing goals.
For example, I always hated investing in stocks, even though I couldn’t explain why. The constant ups and downs of my very modest 401(k) balance made my stomach churn. And I’m the type of person who can’t not check the balance frequently.
For several years, I just sucked it up and dealt with my frustrations. After all, investing in the stock market through a 401(k) is what you’re supposed to do, right? That’s the path preached by all the “experts.”
What I realize now is that this strategy was optimizing on the wrong attributes for me. I wanted high returns, but hated the volatility. And liquidity was mostly irrelevant to me. I was 100% OK with trading off high volatility for low liquidity.
But at the time, I didn’t know other options existed, nor did I have this mental model to help me think through what matters most to me.
So if you’re unhappy with your current investing strategy but can’t fully explain why, try running your strategy through this model. It’s possible that you’re unknowingly optimizing for the wrong attributes.
Some self introspection is important to help determine what attributes matter most to you. And if you’d like some help thinking through this, along with the investment strategies that can optimize for the right attributes, let’s chat.