Nassim Taleb, a derivatives trader turned writer, coined the term “anti-fragile”. Fragile objects break easily. Durable or sturdy objects don’t break so easily or last longer. Anti-fragile denotes things that gain from disorder (entropy). If you’ve watched Dragonball Z as a kid (or adult – no judgement), yes, that applies to Goku and the Saiyan race.
A portfolio shouldn’t be fragile, although fragile portfolios tend to have the best short-term returns. Think all-in Trump coin or Fartcoin with 5x leverage and you get the picture.
A portfolio can be durable. Think Warren Buffet, the Ford Foundation, or Alfred Nobel’s endowment.
The trade-off when moving from fragile to durable is that you diminish returns by lowering risk. Durable portfolios work great if the starting point is a big pile of money.
The Kashyap Sriram Research (KARE) portfolio is neither fragile nor durable. It is sturdy. Cut off one support, and the structure remains intact. Cut off a second support, and there’s a wobble. By the time the market gets to mount its next offensive, the portfolio is healed. That’s the magic of diversification.
Diversification is a trade-off between high returns and stability.
Lehman Brothers traders thought they were smarter than everybody. They had their net worth tied up in deferred stock compensation. They used their cash bonus to buy more of the company stock, took bank loans to pay the IRS, and HELOCs to pay for extravagant spending. Why stop the compounding by selling an appreciating asset?
Come 2008, they are out of a job. The value of their deferred stock goes to zero. The cash bonuses invested in company stock? Turned to ashes. The loans? Those remain. The bank gets its money even if the home is now in negative equity.
What looked like smart decision making in good times – put all your eggs in one basket and watch that basket closely – ended in personal bankruptcy and ruin.
That’s fragility. But imagine that’s your neighbor, and you watch him get rich every day. Thanks to social media, the guy doesn’t even have to be your neighbor.
One of the best finance books I’ve ever read is Jim Paul’s What I Learned Losing A Million Dollars. The title is self-explanatory.
I’m diversified because I never want to be in Jim’s position. Give me a sturdy portfolio over a fragile one.
As for the anti-fragile portfolio, it exists. They’re marketed as tail risk funds, and they perform admirably when the stock market tanks.
Hold them long enough, they’re just as terrible as fragile portfolios.
In the markets, there is no way to get paid without taking a risk. I try to think through the risks and be sensible about the ones I take.
I have funds for 6 months of expenses in a savings account. I own physical gold and silver. I have zero debt. That puts me in a comfortable position to take risk. Comfortable, not complacent. If you have read my two articles…
…you know I think this will be a tough year. I’m not a doomsayer or a permabear.
But I think this is a good time to think through the risks. Not just at the portfolio level, but at the personal finance level.
Preparing for a hurricane that doesn’t arrive is either a waste of time, or a practice run that cuts response time when it is most needed.
The KARE portfolio is having an explosive start to the year. I could be bragging, but instead I’m preparing.
It always pays to think through the risks. The upside takes care of itself.
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Good Trading!
Kashyap