January 1, 2007

Fortune’s formulae – II

I just finished reading the book. In addition to my previous post on the topic (see here), I found the following important points and learnings

- Size your bet/ stock position based on the edge or odds. Although I don’t have a scientific formulae behind it, my typical approach is to put 2-5 % of my portfolio in a stock where the odds are 3:1 or less. For cases where the risk is low and I have a very high level of confidence, my typical wieghtage is around 10%. I however rarely exceed 10% in a single stock. I however do not resort to portfolio rebalancing and allow my winners to run.
- Geometric return is more important than arithmetic return. Geometric returns are the compound returns from an investment whereas arithmetic returns are the average of the annual returns.
- Fat tails in the distribution of returns can cause large fluctuations in the portfolio value. As a result managing risk through optimal portfolio sizing and diversification is important (personal thought: buying real estate in 5 different cities is not diversification. More important diverisification criteria is to spread money across asset classes)

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