Volatility Harvesting: A Guide to Non-retarded Degeneracy

When YOLO makes rational sense and when it doesn't

Value investors often view communities like r/wallstreetbets as a group of "degenerate smooth-brained retards”, an idea that the community actually embraces rather than denies.

However, these communities are surprisingly following very rational and very non-regarded ideas. They understand that they need to achieve an “escape velocity” to break into a new tier of wealth and a new life.

This is actually a fairly common strategic concept. When you are ahead, play conservatively, and when you are behind, play with more volatility. The hail-mary pass and the half court buzzer beater are examples of plays that have negative expected outcome so they are never played unless the game is at stake.

Other similar moves include:

1. Chess gambits that sacrifice strong pieces in the hopes that the opponent will mess up in the resulting chaos

2. Putting it all on black for a roulette spin to pay off gangsters or kidnappers.

3. Going all-in in a game of Poker as your pot size dwindles.

These strategies are all related because they revolve around short-term time pressures. If there were no time pressures, then these strategies would never be played. It’s only because games end with a clear winner and loser that people need to squeeze in some extra points in the hopes of winning.

These communities are actually doing the smart thing!

Well… sorta…

Finite vs Infinite Games

With investing it gets a bit more complicated since money is a game that never ends.

But people need money because they want to make big purchases like cars, houses, weddings, private schools, etc… These purchases have to happen within specific time-windows. Young men across many cultures for example are expected to be able to afford a house and car before they even have a chance at dating or marriage. While there is a lot of overlap with expensive toys, many are viewed as critical gateways into desired futures.

Those who play the “safe” moves lose out to those who gamble with more volatility and leverage. Entire regions fill up with individuals and families with leveraged mortgages and assets driving up the cost of living for everyone.

There is no choice but to join in the bubble.

This is compounded because every region contains people who have been investing for different periods of time. In a previous article on the “Inescapable Inequality of Exponential Growth”, we show how exponential growth mathematically creates inequality. This wealth bids up any asset that is subject to auction-based market pricing like real estate so that newcomers cannot compete unless they have high-paying jobs (e.g. finance or tech).

Newcomers are forced to constantly rent and work and cannot build long term wealth just by saving cash.

They are forced to use and understand volatility… or go broke trying.

Harvesting Volatility

The key to harvesting volatility is to know just how much you are exposed to. Many new investors do the equivalent of only throwing half-court shots throughout the whole game because that is the most “heroic” play to make.

Any coach who suggests this however would most likely be fired. It’s not a strategy you want to use with your family’s hard earned money because you always eventually lose.

The way to harvest volatility is actually quite simple, probably something you’ve heard before:

It’s rebalancing.

Rebalancing is about maintaining your total portfolio’s exposure to assets that are sufficiently diversified that they are not correlated with each other.

Many new investors don’t care for re-balancing because they are chasing volatility. They are partially on the right track. However they often chase volatility by trying to time the top and the bottom resulting in the all-too-common “buy high sell low” driven by crowd-chasing and FOMO.

While rebalancing is often associated with conservative investing, it’s is actually neutral. It’s a way of adjusting your exposure to volatility without having to predict the future.

Let’s take Bitcoin as an example. Instead of following Bitcoin guru’s and staying on top of Twitter and Reddit and doing astrology-technical-analysis to try and time entries and exits you can just choose between a high or low exposure to the volatile asset. e.g.

1. A 95% cash 5% bitcoin portfolio

2. A 50% cash 50% bitcoin portfolio

3. A 5% cash 95% bitcoin portfolio.

The first portfolio is very conservative but can still take advantage of volatility. If someone starts with $9500 in cash and $500 in Bitcoin and BTC goes up by x5 then the portfolio becomes worth $9500 + $2500 or $12000. After rebalancing, this 12K is distributed as $11400 cash and $600 in BTC.

This is still a very respectable 20% gain on the total portfolio with very minimal risk.

If BTC crashes to one fifth of its value then the portfolio is worth $11400 + 600/5 = 11520 or around a 15% gain.

So while 15-20% is far from the 500% gains if you held pure BTC, it secures the gains against volatile drops. This becomes more important as the portfolio get larger and larger and includes life savings and retirement plans.

Summary

In summary, volatility-driven strategies have their place. They are critical and necessary parts of the games. They are not always degenerate.

But understanding how and when to use volatility and how to use rebalancing as part of a long-term strategy is the key to harvesting volatility and making it work for you.

After all… it’s good to have a game plan that is more sophisticated than “throw half court shots all game”.