Capping Investment Value

Diversification is an abstract concept, it can be easy to understand why to diversify, but not how. True diversification requires each set to be completely unrelated (no correlation). In other words, if one effort fails, the negative effects do not harm others. This ideal is generally impossible, as all things are linked to some degree, but it is certainly possible to keep the effects of any one catastrophe to one or two groups.

To start, create a simple cap for each investment group, a number small enough that it wouldn’t ruin your life to lose the entire value. Many will argue based on percentages, but that number fluctuates constantly, and doesn’t account for your psychology. For example, you could put no more than $25k into any set. This is the minimum buy-in for many investments, and plenty high for most of us.

Assuming you have $100k saved, you would want it in at least four separate opportunities:

  1. Principal in a Mortgage
    1. Applying the concept here, you would get to 25 as soon as possible, making minimum payments beyond.
    2. There are examples of people contributing to an income property, so you could contribute 25k to the downpayment, for a portion of the rental income.
  2. Microlending (P2B)
  3. Index Investing
    1. If the indices are significantly unrelated, they can be counted separately
      1. US-only
      2. Anything but US
  4. Venture Capital
    1. Unrelated ventures can be considered different pools.
  5. Cryptocurrencies
    1. Arguably the riskiest mentioned, which I like to think of as buying shares in a specific company. As with any emerging industry, many coins will go bankrupt, while others will become global forces.

It is also important to keep in mind how quickly you can access the capital from each investment. If your regular income suddenly disappeared, can you access enough cash to last 6 months? a year? Debt can be part of an emergency plan, but is best reserved for unexpected expenses.

To integrate with the stairway of spending, you could cap each investment based on yearly expenses. For example, if you spend $30,000 annually, it would serve as both a good target and cap of principal. This method would simplify considerations for liquidity, you can simply count the fractions to determine how many years you have, and could group to determine the timing of such withdrawals. Considering stocks and crypto are volatile, but liquid, you may want more than 2 units accessible per year of spending required from such assets.

Fixed assets generally have a “best after” date, which should help you determine the progression of sales. If you’re looking to buy into a seed round, or make a down-payment on a house, you should be able to last at least 5 years without needing to divest for cash flow. Don’t depend on business plans or market forecasts to accelerate your expectations. Follow the logic long enough, and you’ll find glaring assumptions, if not outright wishful thinking.

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