If you have an option to choose from below two portfolios which one will you choose?
a) Momentum Portfolio – CAGR 30%
b) Fundamental or Long Term Portfolio – CAGR 22%
Most of us will probably choose the one with higher CAGR. It is an instinctive selection without much thought. However, it may be worth to have a look at the real returns from both these strategies. Let’s have a look at the below table for a quick comparison.
For same net returns, the risk – adjusted portfolio returns are actually a lot higher for a fundamental or long term portfolio. The amount of risk, tension & luck involved to be successful in a momentum portfolio is not everyone’s cup of tea.
Can you remember one famous investor who made it big by momentum or short term trading? All the Buffets to Jhunjhunwalas made their money by staying in good stocks over a longer period of time. During this time period, momentum would have shifted back & forth many times in their stocks but they stayed put and by doing that they not only saved tax but also unlocked the power of compounding.
What is a multibagger? Let’s say, 100x returns. It is possible but takes times. A stock has to grow 10 times twice & you have a 100 bagger. If this happens over 15 years the CAGR for 100 bagger or 10000% returns is less than 36%. That is the power of compounding. As Einstein famously said:
Compounding is the eighth wonder of the world. One who understands, gains and one who don’t pays.Albert Einstein
To get rich, you only need to aim for 20-24% net CAGR. Graph is very steep if you aim higher than this range. The chances are very slim if not impossible. Partly because to gain a higher CAGR, you need to climb up the risk-reward ladder and after a point risk is too much to sustain over years and thus pushes down the average.
Now-a-days, momentum investing seems successful as we are in an era of rich valuations and easy money. It will not be remain like this forever.
So when you are parking you hard earned money for long term goals, think carefully about the risks involved and not just the CAGR. There is no harm in putting small amount in riskier bets but it needs to remain small. I have often seen with monetary success, risks are thrown out of the window. It has happened to me and I have learned from it.
That is where having strong mental model is the single biggest advantage in the stock market. People get rich in a bull market but go back to same level after a bear market. Only level headed investors remains rich in this zero sum game called stock market.
Have a thoughtful weekend afternoon 🙂