Diversification [does NOT equal] Bankroll Management!

Even though guys like Tom Dwan (a.k.a. Durrrr) can run up a $200 starting bankroll to over $10 million in 3 or 4 years playing poker online, I don’t recommend this as a serious ‘investment’ strategy!

Nor, do I recommend simply dumping your entire portfolio (401k included) into just one stock pick, as Josh has done ….

… even though both Tom and Josh are both ‘big winners’ … so far 😉

That’s why I recommended – for those amongst my readers who insist on traversing the high-wire of their financial life (there ARE rich prizes at the other side, IF they make it, so who am I to say “don’t!”???) – a simple three-part strategy to protecting their finances, by taking:

1/3 of any ‘windfall gains’ for spending (presuming that the speculation activity is their primary source of income);

1/3 of any ‘windfall gains’ to fuel a parallel ‘passive income’ investment strategy; and,

1/3 of any ‘windfall gains’ for their trading activity (this could be trading stocks/options; developing or flipping real-estate with little money down; etc.; etc).

If the person has another (reliable) source of income, then any ‘windfall gains’ can simply be split 50/50 between ‘speculation’ and ‘passive investments’.

Of course, this will slow down growth, which is why Josh still wants to:

Go 100% 401k and 200% brokerage … [because] sometimes the opportunity is so obvious and risk so low

Spoken like a true Most Probably Will Go Broke Someday Trader!

This strategy is just there to protect the Josh’s of this world in the unlikely event that they should miscalculate ever so slightly 😉

Look, I’m not going to attempt to teach anybody anything about trading, but it’s always good to remember: it takes just ONE bad piece of news on a ‘volatile stock’ (bad ceo, drug that doesn’t get FDA approval or shows unexpected adverse side-effects, law suit) to override the fundamentals.

It’s the equivalent to a ‘bad beat‘ in poker (a.k.a. ‘variance’) … they are inevitable in poker – and, I would argue, also in trading – and you survive them by good bankroll management …

… after all, there are still Enrons out there that people are trading up every day 🙂

On the other hand, Jeff throws a curve ball:

Looks like you have changed your stance a little on diversification. [http://7million7years.com/2008/12/19/the-allure-of-diversification/, where you don’t recommend diversification due loss specialized knowledge and consigning yourself to average returns]

I’m interested why you made the shift…

As I said to Jeff, this may appear to be a shift, but it’s not …

Diversification ≠Bankroll Management!

… for example:

– if Josh said that he was going to invest 100% in buy/hold cashflow-positive real-estate, I would say “go for it”

– if Josh said that he was going to invest 100% in an existing profitable business, I would say “go for it”

– if Josh said he was going to invest 100% in 4 or 5 stocks that he felt were undervalued and was prepared to hold for the long-term, I would say “go for it”

… but, I would say that if the future income stream is in any doubt (e.g. if it is a royalty, or speculation, or short-term investment) to divert some of the cashflow produced from profits (capital gains and/or operating profits i.e. one of the ‘thirds’ that I mention above) and use those to start creating your own Perpetual Money Machine: that’s VERY different from the standard type of diversification that most financial advisers talk about.

Be Sociable, Share!

6 thoughts on “Diversification [does NOT equal] Bankroll Management!

  1. Interesting post. Never thought I would be compared to Tom Dwan, that guy is amazing.

    I’m actually looking forward to getting into some REIT’s and MLP’s in the future when I think the general market has bottomed. The dividend alone will be in the double digit yield arena. Now thats what I call a Perpetual Money Machine.

  2. @ Josh – LOL. Sure MIGHT be 🙂

    I reread my post, and want to make sure that it’s clear to everybody that I’m NOT criticizing your trading strategy (or Tom Dwan’s poker playing prowess!) … YOU have to decide how you want to make your money.

    All I’m trying to do here is outline an accompanying strategy to PROTECT what you make if you manage to continue being successful in your trading endeavors.

    BTW: Just make sure that the REIT is investing in high quality RE assets; some are being set up to buy the mortgage/debts … although the return may be decent, you’re buying debt not income-producing assets.

  3. Adrian,

    Great post. I have been trying to grow my NW faster by agressive trading in stocks- have about 20% of my NW available to play aggressively. Trouble is I don’t want to get flushed out so I am being very cautious! Really need to strike a balance…


  4. @ Mike – The key with this strategy is not what % of your Net Worth you allocate to trading (after all, you might be going ‘all out’ to reach your Number) … but, to ensure that you put at least 50% – 67% of all ‘winnings’ aside.

    Limiting what you trade to a set % of your Net Worth (a la the 20% Rule for Housing) is a simple-yet-interesting concept worth pursuing … please keep us posted.

  5. Adrian,

    Will do. Basically I put aside $230k in trading last year, about 20% of my net worth at the time. Was researching some individual small cap stocks where I got a job offer but didn’t take, know the products and mgmt team real well… but no inside info of course!

    Put most of this into 2-3 stocks in May 2008, watched them go down and became trapped long for much of 2008. In May 2009 I sold for a small profit and made a bit of money in exchange traded funds like SKF and the like. Today that $230k is $270k, all in cash. Waiting for a good quick swing trading opportunity.

    Not a great growth rate but this ‘mad money’ for trading now represents about 17% of my net worth, the rest is going up by good old fashioned savings from my ‘day’ job (actually 14 hours a day!)


  6. Adrian, thank for the advice on REIT’s will make sure it’s not structured for that before I buy.

    Mike, just remember, “price is what you pay, value is what you get” rule.

Leave a Reply