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Speculation is the new luxury

Recently, I came across a few interesting reads (Psychology of Money by Morgan Housel ; Adventure Capitalism- an article in The Economist, 27th Nov and Seth’s Blog – Speculation is the new luxury good) which provide a good perspective on what’s happening in the world of investment and wealth creation. In this blog, I intend to share some of my key takeaways which might help in demystifying what works for some people in creating outsized returns. It’s not necessary that they are successful because they are right all the time, but it’s because of the 2% “outlier” bets that they have taken which have delivered exponential returns. They understand that it’s the “outliers” who move the needle.  While choosing those bets you need to have made peace with the price that you might have to pay for the risk either in the form of volatility or losses or it may not even have a financial tag on it. These people have reconciled to taking risks because they know it pays off over time but at the same time have also learnt not to push themselves to take ruinous risks. They treat this price as a fee and not as a fine.

Since everyone is primarily in the pursuit of happiness, it all starts with defining what happiness is all about?  Happiness means different things to different people. However, once you dig deep, you realise one common thread that runs across is about being able to do what you want to do, when you want to do, for as long as you want. 

To be able to do this, almost everyone tries to build mathematical models and algorithms to stay ahead of the crowd. As is seen that almost all models depend heavily upon patterns which happened in the past but the reality is that “Things that have never happened before happen all the time”. Which means  investments cannot rely solely on algorithms and mathematical models to win every time. Also events are impossible to predict – black swan events do repeat, may not be the same but do repeat. As a result, investing is more behavioral, it’s an art and a science as investors have feelings. Number of times the negative outcome can be attributed to the failure of imagination and not analysis as the world is full of surprises. So planning, for your plan not going according to the plan, holds the key. Most people fail in this, due to their linear thinking like in the case of risk averse bankers who end up playing the gatekeepers with zero imagination. This is unlike venture capitalists who focus on exponential thinking to scope what all is possible. The venture capitalists believe in the 2% as against the 20% rule, as they believe there is little correlation between investment effort and investment results – a few variables impact the majority of the results as it is the tail events that hold the key. Hence, they believe in taking a portfolio vis-a-vis an individual stock view.

Another important factor that matters in investing is time. It’s your own time horizon which you define to weigh against the success of your investment. Invariably, bubbles occur when long term investors take cues from short term traders. Similarly, another dimension of time brought to the notice of everyone by none other than Albert Einstein is the rule of compounding, which he referred to as the eighth wonder. People who never interrupt it unnecessarily benefit the most from it. They are aware that being steady and continuing to be in business patiently is what matters. This is just like what Malcom Baldwin brings out when he refers to the 10,000 hours rule in his book The Tipping point. Wherein he quotes umpteen number of instances wherein 10,000 hours of practice has been the key to master anything from artists to sports persons.

Successful people have learnt to use money to gain control over their time, thereby getting the best return on any investment. They also have learnt to choose between being happy and being “right”.

As I started looking around for evidence to correlate the above, I realised the easing of monetary policy by central banks across the world has given the luxury of excess liquidity to the well off. The HNWs  are happily putting this excess liquidity into speculation via investments into asset classes such as the cryptos or startup ventures . This quote from one of Seth Godin’s blogs – “Speculation is the new luxury” sums this up well. The article in Nov 27th Issue of The Economist Adventure Capitalism- start up finance goes global also  provides a good pointer towards why everyone is flocking towards investing via venture capital funds. The venture capital funds are able to deliver better returns v/s mutual fund managers who prefer following the classical investing school is a good case in point. For the VCs the 2% rule out sizes the wrong bets, as can be seen from the fact that 7 /10 world largest firms today are VC backed. 

Another pointer is the Golden decade wherein today an index of VC funds has made compounded annual returns of over 17%.  As a result of the outsized returns, seed funding is likely to hit an all time high of $570bn this year, as per PitchBook i.e 50% higher than 2020 and 20 times higher than in 2002. Seed investments are done even before startups earn any revenue. Sand Hill Road is home to a host of VC firms. Although VC- backed companies represent less than 0.5% of American companies created every year, they make up nearly 76% of the total public- market capitalization of companies started since 1995. VC was the highest performing asset class globally over the past three years. Seed stage valuations are close to where series A valuations were a decade ago. Average seed valuation for an American startup in 2021 is $3.3 m, more than five times what it was in 2010. Similarly investments in the Crypto asset class, which even as it struggles to find acceptance from regulators, is primarily driven by speculation, were up to $ 8.7 Mio in the first half of 2021 itself, more than twice the entire 2020’s figure.

Looking at this scenario, I’m sure the quote from Seth Godin’s blogs – “Speculation is the new luxury” resonates as much with you as it does with me. I do hope some of the take aways encourage you to recalibrate your investments against your own time horizons. This in turn could help you weigh diversifying your investments into newer asset classes, as you welcome 2022, Cheers !

Ref: Psychology of money – Morgan Housel ; The Economist, 27th Nov 2021- Adventure Capitalism; Speculation is the new luxury – Seth Godin

Acknowledgements- My Friend Ashish Parulekar and Sheetal Nagle for being a solid member of my blog support team.
P.S To read my other blogs on Cricketing / Corporate Tales, Start up stories, Covid Times, Friends, Family and Marriages go to the Home Page

Published by Salil Datar

Eager beaver , enthusiastic but amateur blogger !!

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