Investing: Embracing The Uncertainty

The other day I read ‘the best investors are those with the patience and the perspective to do the opposite of what the masses are doing’. I’ve invested nearly all my invest-able money in one particular stock (my company’s). The masses would never do that. The masses diversify.

Now, it didn’t only say ‘those who do the opposite’. It also said ‘…those with the patience and the perspective…’.

It is not the first time I talk about diversification. It’s a hot topic and I’m constantly reminded of its relevance by other personal finance bloggers, either directly or indirectly. Everyone diversifies. Everyone seems to be waiting for ‘when Marc from Finance Your Fire finally sees the light’ (okay I am sure no one does, but perhaps there is a slight bemusement among some of my followers).

This is a ‘thinking out loud’, reflective, exploratory post. I try to structure my thoughts rather than trying to convince readers about the superiority of one particular strategy. You’re welcome to follow my train of thought and if you have some feedback to share I’d be really grateful.

Conventional wisdom dictates that diversification is essential to long-term investing success. You’re often told to spread your money across a variety of stocks or asset classes to protect yourself from risk, to weather any potential stock market storms.

“Don’t put all your eggs in one basket” is what you hear.

Warren Buffet said: “Diversification is protection against ignorance.”

That’s interesting. What did he mean with that?

You diversify and spread yourself really thin if you are not sufficiently confident to bet on what asset (or asset class) will do well and which ones will do poorly. I figure this lack of confidence applies to most people who invest, including myself.

So why aren’t you diversifying Marc?

“Behold, the fool saith, “Put not all thine eggs in the one basket” – which is but a matter of saying, “Scatter your money and your attention”; but the wise man saith, “Put all your eggs in the one basket and – WATCH THAT BASKET .” ― Mark Twain, Pudd’nhead Wilson

You’d be a ‘fool’ scattering your money and attention. The more stocks you own, the slower you may be able to react when the next serious bear market begins. You simply lack the insights of what is going on with each and every stock. If you’re smart however, you focus on a few stocks only. While a concentrated portfolio strategy will require a fair amount of analysis and attention, as you only have a limited number of assets to follow you will be able to react much quicker in case action is required.

I think there is some truth in that. But only if you’re in it to ‘beat the market’. And the big catch is that you need to have really good insights. Only then a concentrated portfolio – many eggs in one basket – may be your best strategy.

Beating the market is not what aiming for FIRE is about. I want to beat full pension age, gather sufficient wealth to become financially independent so I no longer have to trade my time and labor for a paycheck.

The question remains unanswered. Why my ‘non diversified’ strategy?

My portfolio is very concentrated. See the pie-chart below. ‘Stocks’ means ‘my company’s (employer’s) stock’.

Here are a few reasons for why I keep so many eggs in this particular basket:

• I believe in the future growth of the company. This is not just wishful thinking. I know the values and philosophy behind the decisions of management. I understand its road map for the future (next 4-5 years at least).
• The company is a global market leader within its field(s), rated very highly by Gartner.
• Strong fundamentals. Solid growth rates and a lot of growth potential ahead.
• Last but not least, it is a golden investment opportunity. Because I am an employee of the company I am in the position to obtain shares for a discounted price. Cheap shares of a company with a lot of growth potential. Who can say no to that?

I cannot control external factors and it is certain there are more stock market storms ahead. My company stock will suffer as well. But its fundamentals are so strong and the shares so cheap (for me), that I am willing to embrace the uncertainty for at least a few more years.

About the uncertainty… can I qualify and quantify that?

I want to achieve FIRE before I turn sixty. Not necessarily a fat fire, but not too lean either. Something in between, but without any need for still having to trade time and labor for a paycheck (which rules out barista FIRE).

This is what is at stake. And to me it only makes sense to talk about total risk in relation to this goal. The risk of losing my company stock investment is only one of the factors.

Now, you can finance FIRE in various ways. What I am aiming for is ‘bridging the years between early retirement and full pension age’. Once I reach full pension age (68 in Denmark), my pension will be my income.

While I bridge those years I have no problem with depleting my savings. Retiring at 58 for example would require my savings to ‘keep me floating’ for ten years. After that my pension will kick in. See below simplification.

Even though my portfolio is concentrated, I do not put all my eggs in exactly one basket. More specifically, when I reach FIRE I will turn my equity into more liquid assets (selling or reverse mortgage).

This means that risk/uncertainty can be qualified like this:

Risk => Risk that equity + stocks isn’t sufficient to bridge 8 years until full pension age.

What about quantifying it?

I’ve made projections in other posts using the 4% rule and making lots of other assumptions. I won’t go into that kind of detail here, but my conservative estimate was that the equity I hold in my home makes up around 50% of the required money for a pretty comfortable FIRE at the youngish age of 59, with plenty of money to spare to complement my somewhat modest pension.

You want a number? A total of $600K (wisely invested, adopting a more defensive, diversified strategy) to bridge 8-10 years until full pension age. That’s more than enough.

But a leaner version of FIRE would be possible where the equity in my home makes up 75% of the required FIRE fund. This would equal $400K (let’s say to bridge 8 years).

To make it more tangible, it implies that I can afford to lose 50% of my total (projected) investment in company stock and still reach FIRE before I turn 60 (if real estate market doesn’t collapse).

I wouldn’t be happy if my company stock investment would turn out to be that disastrous. But even then it wouldn’t be the end of the world.

It all comes down to this:

• If just prior to reaching FIRE things go horribly wrong with my company stock investment (losing 50% of my total investment) and real estate market collapses (prices dropping 50%) I have no other option than to keep working.
• If things go horribly wrong with my company stock investment (losing 50% of my total investment), but real estate is unaffected I still reach FIRE before turning 60. It would be a fairly lean FIRE, but doable.
• If the total return is 0% I will have more than enough to bridge 8 years until full pension age (my total projected investment in company stock exceeds $200K).
• If the total return is 25%-50% I will have a very comfortable FIRE with money to spare to supplement my pension once I get there.
• If the total return exceeds 50% I may reach FIRE 1-3 years earlier than projected.

For what it is worth, the current total return stands at 83%. This is a bit useless, because it’s unrealized. Only when I turn my gains into real money I can use it for something.

There’s a worse situation of course. In case my company goes bankrupt, I’d lose my job and all my shares. Granted, that would ruin things big time (although I’d still be able to reach FIRE a few years prior to full pension age). But I don’t worry too much about that (for the simple reason it is very unlikely this would happen within the next 5-10 years).

Life is full of risks. To some extent you can and should mitigate them. But others are there to be embraced.

That’s also what investing is about: Getting paid for embracing a certain level of uncertainty. I do that with my strategy. Instead on focusing on how I limit my potential losses, I choose to focus on maximizing the potential gains. Only time will tell whether this strategy works out for me. 

But having said this, I still have a wonderful secret weapon: Geo-arbitrage.

A final word

This year I will most likely sell a limited number of company shares to ‘secure’ some of the current gains (and repeat that in following years provided we experience bull market conditions). The funds will then be re-invested in other assets, most likely crowd lending.

It doesn’t fundamentally change my concentrated portfolio, but does spread some of the money in anticipation of FIRE, which is getting closer and closer.

How about you?

What are your thoughts? Given the above, do you (still) think I take too much risk?