I often write on Quora.com, where I am the most viewed writer on financial matters, with over 376.5 million views in recent years.
In the answers below I focused on the following topics and issues:
- Are cryptocurrencies really anonymous?
- Is it better to be diversified, or concentrated, when investing?
- Is it wise to use leverage, or debt, when investing?
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Source for all answers – Adam Fayed’s Quora page.
Are cryptocurrencies really anonymous?
Have you seen the news in the last few days?
Coinbase has restricted about 25,000 accounts in Russia. This isn’t the first time.
In the past, the FBI has mangled to detect illegal transactions using Bitcoin.
This is one of the big lies about cryptocurrencies. In the beginning, it was promised as something which would be anonymous and therefore a hedge against authoritarian government control.
Not a bad thing, provided that the amount of fraud on display is no bigger than fiat currencies, which after all attract drug dealers and others who use physical cash for illegal purposes.
Yet as per Nassim Taleb’s critique of Bitcoin and other coins, it, in reality, isn’t secret, so offers no practical hedge against authoritarian governments.
Bitcoin also isn’t
- A hedge against inflation.
- A hedge against falling markets. In 2020, it went down further than stock markets, and only recovered once markets also recovered.
- A hedge against anything
- Digital gold. Gold and silver, as per Taleb’s paper, do not require a sustained interest in them. They have existed for thousands of years, even during times of little media interest, and don’t require a ledger to be kept from interested parties. That doesn’t mean they are the best investments in the world, but they will exist in another 1,000 years.
- A dividend-paying asset, or for that matter a revenue-producing asset. Unlike the tech firms of the 1990s, it also isn’t promising any future dividends or earnings.
It is merely a speculative asset.
I haven’t yet heard any convincing critique of Taleb’s work. The naive are merely reassured by the fact that prices have risen, which is merely his point.
As the asset doesn’t produce a dividend, yield, or coupon, the price is only dependent on supply and demand.
So, the major reason for price going up (or down) is merely that, and not any intrinsic value.
If people put a small percentage of their net worth in the asset it doesn’t do any harm though.
What are the pros and cons of diversification versus concentration in an investment portfolio?
We have all heard of the old adage don’t put all your eggs in one basket, right?
One with diversification, you are lowering your risk a lot. This is because there are two kinds of diversification:
- Asset diversification. Stocks, gold, commodities, cash, real estate, etc.
- Time diversification. Being in the assets for a long period of time. For example, being 100% in MSCI World or the S&P500 sounds risky right? It is, if you only plan to invest for 5 years, but not if you intend to invest for 35 years:
The vast majority of investors should be diversified, as it is very unlikely that they will beat the market long-term.
Your chance, as an ammeter, non-professional investor, to beat a diversified investment of 500 large firms (the S&P500) is small over 5 years.
Over 40–50 years, your chances are exceedingly small. Having knowledge in the sector won’t help.
Being a doctor won’t allow you to better pick pharmaceutical stocks, or having a tech job won’t help you beat the Nasdaq long-term.
For a very small number of people, however, being concentrated is best. There are only two kinds of people I have seen this work for:
- A small number of truly professional investors in stocks or real estate
- In private businesses. In terms of public businesses (the stock market), you are competing against institutions. If, on the other hand, you have your own business, you aren’t to the same extent. The information is also not as publicly available. What is more, a business owner can often be more focused on having just one company, rather than ten.
The biggest money is made in concentration, but it is only for a small number of people, and it increases your chances of losing it all.
Even if you do make incredible amounts of money in concentrated business (or investment) areas, it eventually makes sense to diversify.
Almost everybody who has made huge amounts of money in one business has eventually diversified as they age.
Is it wise to use leverage when investing?
It is risky for a number of reasons:
1. Firstly, you often need to put assets up as collateral to get decent returns. Take Lombard loans as an example.
The interest rates on these are very reasonable. Typically they cost 3%-3.6% per year.
Let’s say you have $800,000 in your account, you might be able to get another $500,000 from a Lombard loan.
The issue is, you would need to repay $530,450 if you get a two year loan at 3% per year.
Statistically speaking, you are likely to be up in that two year period, if you invest in the entire market.
The S&P500 has historically been up on 75%-80% of two year periods, and usually does better than 3% per year.
The issue is, there are no guarantees and you also need to repay the loan even if things are going wrong.
There are other ways to leverage, like using leverage ETFs, but these come with their own risks.
In certain situations, leverage might make sense. Imagine this scenario for a second.
You have $800,000 in your account but markets are down by 30%, or even 50% like they were in 2008 and after Covid.
If you take out a $100,000 loan at 3% interest, your chances of making great returns are high.
If somebody would have done that in 2008 and 2020, they could have doubled their returns over a two-year period.
If things go wrong, then the person has only taken out a loan which is 1/8 of the total.
The problem is, if you do well with leverage once, the inclination is to keep getting more leveraged.
We saw this with the real estate market crash:
The advantage of leverage, in both real estate and investing, is that you can use other people’s money to make more money.
Yet if something goes wrong, you are often left needing to sell other assets to cover the loss.
The reality, then, is leverage isn’t bad per see. Many professional investors use leverage, but it needs to be used with care.
This is especially the case for the everyday investor, considering there are other strategies that can work which are much less risky.
Those strategies can include leveraging time, by being long-term and compounding returns.
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Adam is an internationally recognised author on financial matters, with over 735.2 million answer views on Quora.com, a widely sold book on Amazon, and a contributor on Forbes.