February 20, 2017

Mental capital

This is a term I like to use to represent the time, and mental energy devoted to each position in my portfolio. I would also add mental stress to the equation.

I have realized that in a lot of cases the percentage of mental capital allocated to each position does not match with the allocation of financial capital. On the contrary, some of my top position have needed the least amount of mental energy on an ongoing basis and caused the least amount of stress. This has been mainly due to the quality of the business and management.
On the other hand, some of the smaller positions in my portfolio have resulted in a much higher allocation of mental capital and that could be also the reason why I never raised the size of these positions.

Not a mathematical exercise
Unlike the amount of financial capital, one cannot calculate the percentage of mental capital allocated to a position. However there are several pointers one can use to see if a particular company is taking a dis-proportionate amount of your mental energy
-           You are regularly surprised by the quarterly results
-           The management makes your stomach churn and causes you to worry about the safety of your capital
-           The industry is undergoing a substantial amount of change and you have no means of evaluating the economics of the business even for the short to medium term
-           You keep coming up with new reasons to hold on to your position, even after your original thesis has been invalidated. The word ‘hope’ keeps coming up in your thinking
-           You ‘worry’ about the position for any of the above or other reasons

The killer combination
If the financial and mental capital allocated to a position is too high, then we have a deadly combination. This is kind of an extreme situation can make you act irrationally and in the end be injurious to both your financial and mental health, if the position turns against you.

I have realized over time, unlike financial capital which can compound, mental capital is limited and does not increase much beyond a limit.  It is important to use it smartly both for your financial and mental health and finally for your quality of life.
A certain level of mental capital has to be invested when investing directly in stocks (instead of an index or mutual fund), but in some cases the level can go much beyond the amount of financial capital allocated to it. In such cases, I have usually found that selling down or completely exiting the position has freed up my mind to look for new ideas and devote more time to other stocks in the portfolio.

The tail (portfolio) should never wag the dog (your life).
Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.


Parag said...

I think Mental Capital also depend upon how much conviction one has about a stock. If the stock is going down and one is asking many people to understand why the price is plunging, it adds to existing mental capital. More often than not, mental capital is needed when the prices are falling, and you doubt your convictions again and again.


Unknown said...

Interesting point....so true!!

Yep..important to act upon it since we have limited focus/energy in life, must be used wisely :-)

Anonymous said...

Fantastic. You said something unwritten, an experience.