In exploring various ways to think about building a portfolio, inverting the default may help with ignoring subpar ideas. My default when thinking about how big an investment should be in my portfolio is to go bottom-up. Thinking about whether something should be 2.5% or 5% or 10%, etc…

I imagine this to be the case for most given how small most positions are in portfolios. It almost seems natural as making a position small means less capital at risk. I’ve justified buying complete speculations with the rationale that the capital allocated was small. Lack of information available is another data point here too (i.e. early-stage VC money). It truly makes sense when one is investing in some pre-revenue product with six people in an apartment. 

I’m not saying early-stage investors don’t think as much because they are making dozens of bets. I’m saying I don’t think as much when I make small weightings in my portfolio. Less thinking is balances by minimal capital and less need for conviction during volatile times. I fear this lazy mindset is at the root of why I explored a ’tail strategy’ of having a number of 2.5-5% positions in my portfolio in the past. I could say I’m going for the ‘coffee can’ portfolio merged with the idea of capturing the few businesses that will provide extraordinary returns. But I’d be a fool to ignore that small bet sizes work when the payoffs are 100-1000x returns. Not saying it’s impossible but it’s extraordinarily difficult to achieve such returns in one business in the public market. 

Buffett once remarked that if he was managing ~$1m he’d be able to achieve 50% returns. I know his partnership years were filled with controlling cigar-butts but I imagine he’d still be able to achieve that with a ~2-4 stock portfolio like Munger advocates for. 

A 50% position that doubles delivers a 50% increase to the overall value of the portfolio. A 5% position needs to 11x while a 2.5% position would need to 21x to match a similar level of impact to the overall portfolio. I think it’s exponentially harder to find businesses that will 13x.

With position size mattering a great deal (i.e. it’s how much you make when right and how little you lose when wrong), approaching position size top-down may be a reasonable approach. Asking the simple question of whether I would want a particular business to be 100%, 80%, or 50% of the fund. It starts with asking different questions. What makes me hesitate from putting it all into one business (i.e. like most entrepreneurs/owners do)? 

As I start with the view of putting a greater part of my capital at risk, I find I get stricter on the quality of the people (by extension, the business) I’m investing in. I start with a requirement of needing a higher level of conviction… dare I say mental comfort…before pulling the trigger. It doesn’t kick the behaviour of being lazy. Being lazy ends up playing the other side where I end up ignoring most businesses. 

Theoretically, making a bigger bet would require more thought. Practically, I think it makes one give fewer exceptions and requires things to be more obvious. Not obvious to others, but at least obvious to me. I imagine this is a small part encapsulated in Buffett’s 20-punch-card idea. At the very least, it’ll stop me from being careless and trigger happy if each subsequent idea into the portfolio needs to be a big allocation. It’ll also push me away from looking at nascent businesses that need a lot of attention. Which is fine because I prefer not to do that. 

Now, some investors talk about the value of averaging up into a position after starting small (i.e. 5-10%). If the opportunity presents itself, I don’t see it too different to average up from a 50% position to a 60% position either. It’s not mutually exclusive. But given the tiny sum of money I manage, comparing between a 5% versus 10% weight seems immaterial compared to 2.5% versus 50%. In a game of no called strikes, having higher constraints might be preferable for someone like me. Not that I won’t have small positions in my portfolio. I imagine having existing holdings stay in my portfolio and be left alone and some might naturally get smaller compared to others.