The Price of Compounding #152
Reflecting on a few interesting reads and listens over the past week
It's easy to talk about holding investments for the long term. Very few people recognize how hard it is to actually do nothing but hold.
The fear of missing out on greater returns or suffering through greater losses often prevents us from holding during the extreme highs and lows of any market cycle.
When it comes to investing, we have a few options:
Pay today's price and accept volatility and upheaval
Find an asset with less uncertainty and a lower payoff
Try to get the return while avoiding the volatility that comes along with it
Most of us end up taking the last option. The irony is that by trying to avoid options 1 or 2, many investors end up with a significantly higher cost base/lower return.
So why do people, who pay up for food, housing, clothes, don't want to pay the price of compounding returns?
It's largely because the price of compounding is generally unknown and hard to comprehend. It's important to think about volatility as a fee vs. a fine.
For investors who are entering today's market with expectations of making 20%+ returns, it's important to accept the possibility of 20%+ declines.
Once you start to accept that market volatility is the price of compounding, the next question you should ask yourself is which assets are worth paying the price of volatility.
The coming 6-18 months are going to test the ability of investors to withstand these drawdowns/lower returns. While the past few years were defined by one’s ability to deploy capital, the coming period (I believe) will be more defined by the ability to conserve capital and deploy in high ROIC projects.
This is probably one of the best compilations I've seen on a wide variety of investing frameworks and business models. Here are a couple of sections that caught my attention:
The Seven Deadly Sins Are Actually The Seven Core Motivators
All successful consumer-facing companies appeal to one or more of the seven deadly sins. They are time-tested core motivators that incentivize people to do things (the fact that they have survived for all of time without any edits is proof of their power). There are no successful consumer companies that do not appeal to any of the seven deadly sins.
Different motivators can apply to different constituents within each company, even different behaviors from the same constituent.
Examples:
Sloth: Uber, Amazon
Pride: Instagram, Tik Tok
Gluttony: DoorDash, Netflix
Lust: Tinder, OnlyFans
Envy: Pinterest
Wrath: Twitter
Greed: Bitcoin, Robinhood
A Specialized Tool Will Always Beat A Generalized Tool Over Time
A Swiss Army knife is very useful when you are space constrained. It is less useful when you need a dedicated screwdriver to assemble a room full of furniture. Similarly, products with a generalized value proposition will inevitably be cannibalized by more specialized competitors. Convenience is the only defense generalized tools have against erosion by specialized tools.
First Order Irrational, Second Order Rational
A very effective strategy to unlock potential energy in what may seem to be a calcified ecosystem is to do something that the existing, entrenched players deem to be completely irrational. The conceit in this strategy is that while the behavior may seem irrational at the first-order level, it is rational at the second-order level and often leads to a market-leading position if not a monopoly.
Distribution vs. Monetization
Platforms focus on offering the supply side of their ecosystem either distribution or monetization. Those that focus on a combination of both will be challenged by the specialized vs. generalized dynamic over time.