How to Invest with Finite Capital
Let’s say you were gifted $100,000 and instead of just plugging it into a boring index fund (SPY or QQQ) that will most likely turn that account into $1 million plus over 20 years. But, let's say you want to try to achieve better returns. Why? What’s the difference?
The QQQ’s is a tech driven ETF that has produced 14% a year since 2004. This means $100k invested in 2004 would now be worth $1.37 million. The SPY is mimics the S&P 500, and has produced 8.5% a year plus dividends since 2004, putting the $100k invested in 2004 just under $637k.
Now, let’s say your money was with a top fund manager (e.g. Arlington Value Management) who produced nearly 30% a year for 20 years, 2x as good as the QQQ’s and over 3x as good as the SPY. What happens to your money? It becomes geometrically bigger — growing from $100k to more than $19 million.
To sum up…
SPY — 8.5% ($100k — $637k)
QQQ — 14% ($100k — $1.3m)
AVM — 30% ($100k — $19m)
So…. the goal is to find the next great fund manager. 🤣 That’s all.
Just kidding.
For most people they’re going to have to go it alone. And, if you’re committed to investing for bigger gains, it will mean taking bigger risks and buying fewer issues, those that are either beaten up on the short term and, in many cases, much smaller than the names you see on CNBC.
This isn’t a stock picking post. This is about portfolio management . If you are not regularly putting new money into the market, the best way to manage is probably harvesting losses annually to limit taxes and taking original investments out of winning positions when new better opportunities arise — because they always will.
How it works? A simple approach.
5 stocks. $20k each. (or) 10 stocks. $10k each. This is up to personal preference, but again no risk, no reward. Joel Greenblatt demonstrated in his Little Blue Book and Magic Formula Investing website that a basket of 20–30 stocks is nearly as diversified (statistically) as an index or mutual fund. And, taking on a little more risk with the right opportunities could mean you hit one out of the park like Carvana (CVNA) in December of 2022.
At the time CVNA was $5 a share. Today it’s $175. Here’s how it could have been traded. $10,000 would have bought 2,000 shares. When it hit $10, you could have sold 1,000 shares and put your principal (aka original money) back into other opportunities while still owning the stock. If you waited until $20, you could have sold 500 shares, and so on…
Sure, the performance would have been lower, but 1,000 shares is still $175,000 today. For perspective, most people don’t make that in 5 even 10 years. Let’s say at the same time you bought Foot Locker (FL) for $40 a share. $10,000 would have bought 250 shares. Nearly a year later the stock was down $12, a $3,000 loss. This is when you make sure you have a good accounting professional. You can use any loss to offset any capital gains you have in the same year. If you don’t have any, you can use it to offset $3,000 of ordinary income in the year and carry forward any remaining to offset future gains or income.
At some point you will want to sell an entire position, unless it produces more in dividends than originally invested — think Warren Buffett’s Berkshire Hathaway’s Coca-cola position. In these rare cases, you can continue to borrow against the position for short term trades and reuse the dividends for future investments.
TL;DR
- Starting with $100,000
- Buy 5 to 10 stocks, investing equal amounts in each
- Cut losers before a tax year is over (if better opps available)
- Sell shares of original investment to recoup starting amount (if better opps available) to put into new issues.
- Buy seriously beaten up issues (CVNA was one) with good to great rebound potential (or) buy smaller companies that can grow into bigger ones.
- Disregard 2 or 3 if you have strong conviction and can sit on your hands. This is something most investors cannot do — even professionals.
