No. of Recommendations: 2
The arguments for and against owning bond funds are well understood. The necessary conclusion is that accessing the asset-class in that manner is generally a waste of time. For sure, there are some truly superior, active managers who serve their shareholders well, and there are niches within the bond world for which holding a basket of derivatives (said equivalently, shares of an investment company that traffics in that niche) isn’t a bad bet to be making, or even the only practical bet that can be made. But by and large, even if you’ve got tiny money (conventionally considered to be less than $50k), there’s no theoretical reason why your results couldn’t rank within the top 5% to 10% of fund managers with your same investing objective. In other words, if you can’t identify in advance who the superior fund managers are, then just become one by owning the underlying directly.

For sure, you’ll need to bring to the table the same analytic skills they do. But you’ve generally got equal access to the same info they are using, and you’re not disadvantaged that much by the prices and commissions imposed on you, as opposed to them. What you generally won’t have, though, is the stones to do what they do, because they’re betting with OPM, and you’re betting with your own. Out of not unreasonable caution, you’re going to back away from putting on some positions that need to be put on in order to be competitive with them. Small money by itself won’t be your barrier to success, but the small courage that comes from thinking about that money as small money.

So here’s one way to change your thinking. If you’ve got $25K to work with, it’s easy to scale out how much could be allocated to each risk tranche. If your self-imposed limit is no more than 2% of AUM per speculative bet, and no more than 10% for a basket of them, then you know how much capital you’ve got to work with. When your account has grown to $100k, you’ll now be able to bet $2k per spec position. But you’re not going to get to $100k from $25k unless you bet as if you’re working with $100k already, but manage your risks as if you’re working with the $25k you really have.

ARRGH! Shades of Yossarian, right? If you’re sane enough to know that flying the missions is crazy, you’re not crazy enough to be excused from flying them. Accepting investment-risk is no different. To get from where you are to where you want to go to, you’ve gotta already be there in terms of how you bet, but you can’t bet that big or else you put yourself at risk of not getting there. How you fix that problem is for you to decide. My solution, years ago, was to substitute ‘diachronic diversification’ for the more conventional concept of ‘synchronic diversification’. In other words, I had to determine how many bets I could lose, while learning the game, without getting myself thrown out of the game before I learned it.

There’s going to be no single, magic number that works under all market conditions for all investors and their widely varying circumstances. But this rule of thumb is generally offered. Bet as much as you can afford to lose, but no more, and believe that, on average and over the long haul, if you’re betting from a plan with a proven positive-expectancy, you will survive any likely string of reversals. You might lose that bet and grind your account into nothingness. But it can be rebuilt the same way it was created in the first place, through savings, and you can take another run at learning the game. Many of the top traders interviewed by Schwager in his books on 'market wizards' report having to have restart multiple times before things finally clicked into place for them.

"Winners never quit; quitters never win."

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