Monthly Archives: July 2023

Always worry about your edge

I was reading “Stop worrying about your edge” on the excellent Turtles all the way down! blog, and couldn’t resist writing the oppositely titled post. Not because I disagree with the post. Maybe on some details, but I think he makes some good points. But the truth is that every intelligent sounding investment quote breaks down at some level. People for example love to quote Buffett – and you could certainly catch me doing it from time to time – but it is important to realize that nothing is universally true. Or some types of advice sound good, but simply don’t work in real-life.

Consider the famous poker quote, “If you can’t spot the sucker in your first half hour at the table, then you are the sucker.” Hard to disagree with, right? But the thing is, that usually, the sucker is also convinced that he has spotted some players that he can beat. Perhaps he has seen some excellent pro’s involved in a big bluf, and thinks that they are spewing money away. He is wrong of course, but without the knowledge to recognize what is going on, he doesn’t have the tools to evaluate his own position at the table. And it is not like you need to be a total fool to not recognize your own place at the table. Many mediocre poker professionals – that objectively are miles ahead of the total amateur – can’t recognize better playing professionals. Their perspective is limited to what they know, and from their vantage point, the better players seem to be making errors. So, in reality, usually only the best poker players at the table can accurately estimate the skill level of everyone else. However, merely advising people to be one of the best players at the table is not a practical tip.

But to circle back to worrying about having an edge in investing. I agree that it is incredible hard to know if you have an edge in a specific investment or in investing in general. And because it is hard to know, you should always be worried that you don’t have an edge. I think this idea should be constantly on the back of your mind, shaping your investment strategy. Everything you do should be with the assumption that you could have no edge.

So, how can you invest while holding that belief? I personally think that the following three guidelines can keep you out of trouble.

  1. Diversify: Never bet big on a single name. If you invest in a sufficiently big basket of random names your expected return should be close to the expected return of the market. If you lack an edge, this approach minimizes potential harm from an expected value perspective.
  2. Minimize costs: When your investments have a neutral expected value compared to the market, the main source of underperformance comes from frictional costs associated with your strategy. Therefore, make sure you avoid incurring excessive trading fees or unnecessarily high taxes.
  3. Stay away from risky corners: Acquiring an edge is difficult, but losing money is easy. Avoid stocks with high short interest and/or no borrow, as they are almost certain to decline. Also, be cautious with recent IPOs, SPACs, or any other investment fads.

There will be times to break the guidelines above, but I think this should be a healthy starting point for most investors. I will not claim this would have saved every investor who blew up in recent times, but it would probably have come close. The downside is, of course, that you are also not getting lucky by betting it all on one stock and making it big. To actually make money like this, you absolutely need a  consistent edge. Bet after bet. Stock after stock. You will not know in advance if you have an edge, but after enough years, you should get an idea.

So you heard it. Stop worrying about your edge, but also, always worry about your edge!