Excellent work! I loved how quantitative this was! This is exactly why I think rebalancing can be a poor investing decision: rebalancing is all about selling what's doing well which, as you show so elegantly, is one of the worst things you can do.
“Rebalancing can be a poor investing decision.” Honestly, I didn’t have your level of wisdom before running this simulation. Like many investors, I tended to justify every sale and purchase based on what I believed were sound fundamentals.
But the results are clear: on average and over time, the reasons I came up with were often poor ones that led to poor decisions. That is why I need to adapt my system.
I’m speaking in the past tense, but this realization is actually very recent. I have no doubt I will still struggle not to systematically sell a position I believe is overvalued, or not to reallocate capital toward what I see as a major opportunity.
As always, simple, but not easy.
If you’ve already managed to get past that stage, then honestly, well done!
I think I've honestly just lucked into my current mentality. One of the earlier books on investing I read almost a decade ago was Michael Covel's "Trend Following." And trend following is all about buying and holding what's going up and avoiding/selling what's going down
A brokerage statement serves as a ledger for transactions but possesses no capacity to record the profound costs of inaction or interrupted compounding. Long-term wealth is a function of Ergodicity, necessitating a psychological framework that prioritizes staying in the game over the illusory comfort of frequent activity.
The most significant drawdowns are often the invisible ones where time was traded for the false promise of market timing.
The drawdown approach to opportunity cost is interesting. It might actually have been a more intuitive way to frame it.
That said, I disagree on brokers. I do the calculation myself using my statements and an API, so I have little doubt they could do it as well. They could even show clients an annual opportunity cost estimate by comparing actual results to a simple buy-and-hold of the portfolio from the start of the previous year (essentially a “do-nothing” benchmark).
But from a business standpoint, that would probably be close to economic suicide.
That’s true. But I don’t see it as a pure counterexample.
First, that -90% drawdown happened during the dot-com bubble. Many tech companies (and even some non-tech ones) fell well beyond -90%, and that does not imply Amazon would automatically have been sold.
And even if it was sold, other compounders from the eventual winner bucket could still have been held while Amazon was not. That kind of scenario is inherently captured in the simulation and partly contributes to the results (I actually mention that specific case.)
That said, the simulation only looks at the numbers in hindsight. It completely ignores the psychological skill required to apply such a rule over time, which is precisely what makes investing so difficult. In my view, that is the main limitation of the result.
It quantifies a simple and intuitive idea, but beyond giving one more reason to apply it, it does nothing to reduce how hard it is to execute consistently over time.
I want to be a critic on the post, what you will do in a war like scenario and you just find out a gem from micro cap universe, yet the stock corrected more than 50%, however there are no change in fundamentals and the going is intact, what changes is liquidity, liquidity matters a lot in such case , but saying that compounding happens when a stock moves higher and higher, this is just the partial truth.
I gladly accept the criticism, and it actually points to a limitation I explicitly acknowledged in the methodology: this is only a simulation of broad statistical tendencies. It is too far removed from specific real-life situations to be applied directly or mechanically. That limitation is intrinsic to the exercise, if only because of the computing power and modeling scope available to me.
Your example of a war-like scenario and a 50% drawdown in a micro-cap highlights the psychological dimension of investing, which is probably its most central one. And that is precisely what this simulation does not capture. But I think criticizing it on those grounds approaches the problem from the wrong direction. The point of having data, and of understanding what the data implies, is precisely to reduce the influence of our biases and emotions, so as to avoid value-destructive actions such as panic selling.
That was the initial purpose of this simulation: to give me concrete data points I can bring back to mind at the right moments, in order to reduce the probability of making mistakes such as selling a winner too early.
Put differently, the goal of the simulation is to provide data that can help improve decision-making, not to prescribe the right decision in every specific situation.
And on the last point, I think reducing the post to “saying that compounding happens when a stock moves higher and higher” misses several of its core arguments: the impact of portfolio size, the role of turnover, the relevance of buy-and-hold, and the quantification of these effects and how they evolve over time.
Love this! I posted a Substack on this topic using Keynes’ art collection as a heuristic: “To Build Wealth, Don’t Sell Your Cezanne Stocks”. Your data is invaluable.
Great methodology and a well-written post as usual.
Identifying losers early and consistently is a challenge especially when there are weeds that looked like flowers at one point. That said, difficult doesn't mean impossible. I believe over time, one gets better at making these decisions.
Ideally, running a concentrated portfolio should be an advantage to the investor here. The opportunity cost of preventing capital from searching from a true winner is greater here and that should motivate the investor to act decisively.
Holding onto winners for long enough is a whole other level of difficulty. In most cases, this means holding overvalued stocks where market value far exceeds intrinsic value. Still, that's not an excuse. Many 20-, 50-, 100-baggers would have been overvalued at different periods of the holding period. The upside of one of these great investments far exceeds the downside.
As always, thank you for sharing posts that provide an "intellectual itch" for lack of a better term!
Thanks for the feedback, Seyi, really appreciate it.
As always, you’re dead right, especially this part: “this means holding overvalued stocks where market value far exceeds intrinsic value.”
From my perspective, not selling when you know it’s overvalued is probably the hardest things in investing. And yet, in the median case, not doing it is value-destructive.
All I/we can do now is hope, and make sure, this becomes true: “over time, one gets better at making these decisions.”
The data on psychological winners will be a gut punch to many. We’re wired to lock in gains to feel successful, but your simulation suggests that playing it safe by selling winners is actually the most aggressive way to destroy future wealth.
Given that the biggest winners often have the scariest valuations, it's likely many readers have difficulty distinguishing between letting a winner run and being blind to a genuine bubble. Are you considering a future post on specific frameworks or 'red flags' you use to hold onto winners even when the valuation feels stretched?
I’m still digesting the data and coming to terms with the fact that the “fundamental” reasons that, in theory, and sometimes in practice, seem to justify my approach are very likely destroying value over time.
Honestly, I don’t have a framework or red flags that survive these results + a precautionary principle yet. But I’m working on it right now!
Here a contrary thought: In Benjamin Graham's universe, where I practice, one can identify a fair value for a company and can buy its stock when the undervaluation is significant. You don't sell something just because it is a "loser", but you do sell it if the investing thesis breaks. You also sell it when it reaches fair value, perhaps letting it run some to take advantage of the momentum investors who are acting like the stock market is a casino. You do need to understand and pay attention to the company. This has proven successful for many investors including myself. But the kind of analysis discussed here can never hope to identify such success.
That Buffett line is a perfect bridge into his own evolution: he went from classic Graham-style deep value to something much closer to GARP (the implicit style of my analysis), largely under Charlie Munger’s guidance and pressure.
You framed your answer as a “contrary thought” to my point. But it isn’t, at least not to me.
I put numbers on the table and interpreted them. The only real rebuttals are: my numbers are wrong, there are better numbers that contradict them, or the interpretation is flawed.
Saying “other strategies work without holding onto winners” doesn’t contradict any of that. Those numbers may still hold inside those strategies. The opportunity cost isn’t “winning vs. losing.” It’s how much you fail to win, sometimes to the point of turning a win into a loss.
So it’s hard for me to validate or contest your “counterargument,” because I don’t see it as one. Deep value can work, I’m not arguing otherwise, but it’s not the path I’ve chosen. If it works for you, I’m genuinely glad.
Likewise if your approach works for you and your subscribers, I am glad for you and them. And certainly doing deep value requires having the necessary temperament. I do think there is a fourth response to your list, though I don’t see it as a rebuttal. In my view, your methodology will be unable to detect winning value investments as distinct from other investments that happen to win. But value investing does take investors to distinct places.
Excellent work! I loved how quantitative this was! This is exactly why I think rebalancing can be a poor investing decision: rebalancing is all about selling what's doing well which, as you show so elegantly, is one of the worst things you can do.
Thanks for the feedback, I really appreciate it.
“Rebalancing can be a poor investing decision.” Honestly, I didn’t have your level of wisdom before running this simulation. Like many investors, I tended to justify every sale and purchase based on what I believed were sound fundamentals.
But the results are clear: on average and over time, the reasons I came up with were often poor ones that led to poor decisions. That is why I need to adapt my system.
I’m speaking in the past tense, but this realization is actually very recent. I have no doubt I will still struggle not to systematically sell a position I believe is overvalued, or not to reallocate capital toward what I see as a major opportunity.
As always, simple, but not easy.
If you’ve already managed to get past that stage, then honestly, well done!
I think I've honestly just lucked into my current mentality. One of the earlier books on investing I read almost a decade ago was Michael Covel's "Trend Following." And trend following is all about buying and holding what's going up and avoiding/selling what's going down
A brokerage statement serves as a ledger for transactions but possesses no capacity to record the profound costs of inaction or interrupted compounding. Long-term wealth is a function of Ergodicity, necessitating a psychological framework that prioritizes staying in the game over the illusory comfort of frequent activity.
The most significant drawdowns are often the invisible ones where time was traded for the false promise of market timing.
The drawdown approach to opportunity cost is interesting. It might actually have been a more intuitive way to frame it.
That said, I disagree on brokers. I do the calculation myself using my statements and an API, so I have little doubt they could do it as well. They could even show clients an annual opportunity cost estimate by comparing actual results to a simple buy-and-hold of the portfolio from the start of the previous year (essentially a “do-nothing” benchmark).
But from a business standpoint, that would probably be close to economic suicide.
Still the absolute best compounders usually have also brutal drawdowns, for example Amazon -90%. Pretty easy to become the worst loser on some point
That’s true. But I don’t see it as a pure counterexample.
First, that -90% drawdown happened during the dot-com bubble. Many tech companies (and even some non-tech ones) fell well beyond -90%, and that does not imply Amazon would automatically have been sold.
And even if it was sold, other compounders from the eventual winner bucket could still have been held while Amazon was not. That kind of scenario is inherently captured in the simulation and partly contributes to the results (I actually mention that specific case.)
That said, the simulation only looks at the numbers in hindsight. It completely ignores the psychological skill required to apply such a rule over time, which is precisely what makes investing so difficult. In my view, that is the main limitation of the result.
It quantifies a simple and intuitive idea, but beyond giving one more reason to apply it, it does nothing to reduce how hard it is to execute consistently over time.
I want to be a critic on the post, what you will do in a war like scenario and you just find out a gem from micro cap universe, yet the stock corrected more than 50%, however there are no change in fundamentals and the going is intact, what changes is liquidity, liquidity matters a lot in such case , but saying that compounding happens when a stock moves higher and higher, this is just the partial truth.
I gladly accept the criticism, and it actually points to a limitation I explicitly acknowledged in the methodology: this is only a simulation of broad statistical tendencies. It is too far removed from specific real-life situations to be applied directly or mechanically. That limitation is intrinsic to the exercise, if only because of the computing power and modeling scope available to me.
Your example of a war-like scenario and a 50% drawdown in a micro-cap highlights the psychological dimension of investing, which is probably its most central one. And that is precisely what this simulation does not capture. But I think criticizing it on those grounds approaches the problem from the wrong direction. The point of having data, and of understanding what the data implies, is precisely to reduce the influence of our biases and emotions, so as to avoid value-destructive actions such as panic selling.
That was the initial purpose of this simulation: to give me concrete data points I can bring back to mind at the right moments, in order to reduce the probability of making mistakes such as selling a winner too early.
Put differently, the goal of the simulation is to provide data that can help improve decision-making, not to prescribe the right decision in every specific situation.
And on the last point, I think reducing the post to “saying that compounding happens when a stock moves higher and higher” misses several of its core arguments: the impact of portfolio size, the role of turnover, the relevance of buy-and-hold, and the quantification of these effects and how they evolve over time.
I acknowledge it and understand your point.
Love this! I posted a Substack on this topic using Keynes’ art collection as a heuristic: “To Build Wealth, Don’t Sell Your Cezanne Stocks”. Your data is invaluable.
Great methodology and a well-written post as usual.
Identifying losers early and consistently is a challenge especially when there are weeds that looked like flowers at one point. That said, difficult doesn't mean impossible. I believe over time, one gets better at making these decisions.
Ideally, running a concentrated portfolio should be an advantage to the investor here. The opportunity cost of preventing capital from searching from a true winner is greater here and that should motivate the investor to act decisively.
Holding onto winners for long enough is a whole other level of difficulty. In most cases, this means holding overvalued stocks where market value far exceeds intrinsic value. Still, that's not an excuse. Many 20-, 50-, 100-baggers would have been overvalued at different periods of the holding period. The upside of one of these great investments far exceeds the downside.
As always, thank you for sharing posts that provide an "intellectual itch" for lack of a better term!
Thanks for the feedback, Seyi, really appreciate it.
As always, you’re dead right, especially this part: “this means holding overvalued stocks where market value far exceeds intrinsic value.”
From my perspective, not selling when you know it’s overvalued is probably the hardest things in investing. And yet, in the median case, not doing it is value-destructive.
All I/we can do now is hope, and make sure, this becomes true: “over time, one gets better at making these decisions.”
The data on psychological winners will be a gut punch to many. We’re wired to lock in gains to feel successful, but your simulation suggests that playing it safe by selling winners is actually the most aggressive way to destroy future wealth.
Given that the biggest winners often have the scariest valuations, it's likely many readers have difficulty distinguishing between letting a winner run and being blind to a genuine bubble. Are you considering a future post on specific frameworks or 'red flags' you use to hold onto winners even when the valuation feels stretched?
Your diagnosis is spot on in my case.
I’m still digesting the data and coming to terms with the fact that the “fundamental” reasons that, in theory, and sometimes in practice, seem to justify my approach are very likely destroying value over time.
Honestly, I don’t have a framework or red flags that survive these results + a precautionary principle yet. But I’m working on it right now!
Here a contrary thought: In Benjamin Graham's universe, where I practice, one can identify a fair value for a company and can buy its stock when the undervaluation is significant. You don't sell something just because it is a "loser", but you do sell it if the investing thesis breaks. You also sell it when it reaches fair value, perhaps letting it run some to take advantage of the momentum investors who are acting like the stock market is a casino. You do need to understand and pay attention to the company. This has proven successful for many investors including myself. But the kind of analysis discussed here can never hope to identify such success.
"There are many roads to the investment heaven"
That Buffett line is a perfect bridge into his own evolution: he went from classic Graham-style deep value to something much closer to GARP (the implicit style of my analysis), largely under Charlie Munger’s guidance and pressure.
You framed your answer as a “contrary thought” to my point. But it isn’t, at least not to me.
I put numbers on the table and interpreted them. The only real rebuttals are: my numbers are wrong, there are better numbers that contradict them, or the interpretation is flawed.
Saying “other strategies work without holding onto winners” doesn’t contradict any of that. Those numbers may still hold inside those strategies. The opportunity cost isn’t “winning vs. losing.” It’s how much you fail to win, sometimes to the point of turning a win into a loss.
So it’s hard for me to validate or contest your “counterargument,” because I don’t see it as one. Deep value can work, I’m not arguing otherwise, but it’s not the path I’ve chosen. If it works for you, I’m genuinely glad.
Likewise if your approach works for you and your subscribers, I am glad for you and them. And certainly doing deep value requires having the necessary temperament. I do think there is a fourth response to your list, though I don’t see it as a rebuttal. In my view, your methodology will be unable to detect winning value investments as distinct from other investments that happen to win. But value investing does take investors to distinct places.
Opportunity cost are two folds.
.
When Inflation is low, and the company takes huge loan to expand, Opportunity overwhelms Cost leading to victory.
.
When Inflation is high, and the company takes huge loan to expand, Cost overwhelms Opportunity, leading to doomageddon.