278: Thoughts on Risk, Selling, and Your Base Case

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Happy Monday! I couldn't think of a specific theme this week so here is a collection of semi-connected thoughts from this week related to personal finance and crypto.

When To Sell

A few people asked me this in the DeFi Orientation Discord and here's a better organized version of my answer.

If you were buying crypto from May till now, you've probably made a good chunk of money. Most assets have more than doubled since then, quite a bit more for NFTs and Solana.

The question that helps me the most with figuring out when to sell anything that's run up in value is "would you buy back in at this price?" I'm not sure who I got it from, but it's extremely helpful.

For NFTs, there's really no way I'd buy into the big ones right now at their current prices. Not necessarily because I think they're overvalued, but because the amount they cost would just be too high a percentage of my net worth for me to be comfortable. And I feel like the market has gotten too hot, where buying anything besides the blue chips (Punks, Apes, Art Blocks, maybe a few others) is a much riskier speculation than it was a couple months ago. Unless you know how to play the minting game.

When something has run up 2, 5, 10x, it's hard to not keep thinking "this will keep going up!" And it might! But if it's now at a price where I wouldn't buy it, then it's time to sell, even if I think it'll likely keep going up.

It basically helps you get around the sunk cost fallacy. Instead of thinking "should I sell" you're asking "would I buy?" and if the answer is "no" then you sell.

I wrote about this in "The Money Pile" back in May and ended up being ahead of the Bitcoin/Ethereum crash by a couple weeks, so we'll see if I'm calling the NFT top or not!

But there's one big thing I've changed my mind on since then: what my base case is.

What's Your Base Case

In "The Money Pile" I talked about selling some Bitcoin because it had gotten to be an uncomfortably high percentage of my portfolio.

That choice was based on my base case being index funds in USD. That's a pretty typical base case since that's the standard investment advice and it's worked out really well since we created index funds ~40 years ago.

I've re-oriented my financial mindset a little bit though where now my base case is just holding Ethereum. This will sound insane to some people, and I'm not necessarily recommending it, but that's how I think of things now.

From getting very deep into the technical side of the crypto world, it does feel like something special is happening on the Ethereum platform (Ethereum, Polygon, Arbitrum, Optimism) and to some extent now, Solana. Not because of any price action, but simply because of the number of smart people "moving there" to work.

It kind of feels like the new Silicon Valley isn't a place, it's the whole creative ecosystem developing around Web3 and Ethereum. The number of smart people leaving their jobs in Web2, finance, and elsewhere, to try to start a business or join a DAO or just find a job in this new ecosystem is staggering. And most of the gains from that ecosystem are going to be reflected in the value of tokens and protocols, which suggests holding Ethereum and relevant tokens for protocols you believe in is actually a better exposure to emerging tech than holding stocks.

So back to the base case question, my way of evaluating these things now is more centered around "how will this perform relative to ETH" and "would I rather have more ETH, or this other investment?"

Given how highly correlated most assets are in crypto, it's easy to trick yourself into thinking you made a really good investment when really the thing you invested in just followed the price of ETH. Especially since most liquidity pools are denominated in ETH, if the price of ETH moves, the value of different tokens automatically moves as well.

So I don't hold any index funds outside of my retirement accounts anymore. They felt like they would underperform relative to crypto over a 10 year time horizon. And for non-crypto hedges, I prefer real estate anyway.

But that brings me to the third topic:

Planning for the Worst, Aiming for the Best

I think "what's your risk tolerance" is the wrong question. It doesn't matter that much how you feel about risk, it more matters how risky you can afford to be.

For example, if you're 60 and you've saved up a decent retirement account over your entire career and you need that to retire on, and you don't have a way to make it all back quickly, it doesn't matter how risky you want to be. You really shouldn't risk a meaningful amount of that account, because if you make the wrong bet, you're screwed.

But if you're 22 and you have to decide how to invest a few extra hundred bucks a month, I think putting it into index funds or even a retirement account is kind of silly. Any compound interest on a few hundred bucks is going to likely get turned into a rounding error by the growth in your future earnings, so you may as well put some of that money earlier on in your career into higher risk, higher reward moves.

The first one would probably be saving up enough in cash that you can not work for 6+ months on a meager cost of living. Spending all your savings at 24 to have 6-12 months to try to figure out what kind of work makes you happiest is a way better use of funds than putting it into an IRA. The increased earnings you'll get from answering that question will probably make the amount lost meaningless, and you'll never have a better opportunity to run that experiment.

For me, most of my money has come from entrepreneurship and I've earned most of it in the last two years, so if crypto exploded tomorrow and I had to start over it wouldn't be that big a deal. Losing two years of progress sucks, but it's not life ruining. Whatever amount of money you play with in potentially riskier moves, like some crypto stuff, you want to have a good idea of what your absolute dire worst case scenario possible looks like.

If you can recover pretty quickly and easily from the worst case scenario, you may as well push the envelope a little bit. It's not that likely you'll end up in the worst case anyway, and if you do, you'll probably at least learn a lot on the way there.

So for me, I'm comfortable being more aggressive and allocating heavier to crypto, but that might not make sense for you. Assessing what would happen in the absolute worst case scenario of whatever you're considering, how bad that situation would be, and how you would handle it, can be a lot more informative than just asking "how risk tolerant am I?"

Try going through that exercise from time to time. Ask yourself "If everything I'm doing right now blows up, and I suddenly have no job or income, what happens next?" to figure out how well covered your downside is, and if it's happily covered... well don't go crazy but maybe be a little more adventurous.

Especially if you're young.

Thanks for reading this weeks newsletter, forward it to a friend if you liked it! Nat

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