Friday, November 02, 2018
The Investment Book of 5 Rings
One of the my favourite RPGs of the moment is Legend of the 5 Rings and one of the really cool design elements of the game is that it deviates from Western themed RPGs by not using the typical character attributes like Strength, Intelligence.
Instead your attributes are based on the 5 Rings of Air, Earth, Fire, Water and Void.
The elements are used to resolve dice rolls when you adopt a stance in combat or an approach to solve a problem. As it turns out, this is a pretty useful system to think about investing.
We all have some kind of emphasis and weaknesses when it comes to investing. Sometimes this can come in the form of being particularly strong in an element.
People with the gift of Fire are passionate and inventive but folks endowed with Earth are emotional stable and calm.
Let's run through this 5 element system and adapt this to field of investing.
Air is the element of subtlety and precision. We tap into Ring of Air to refine something.
When it comes to investing, Air determines your analytical skill and how deeply you can go into investment research. A person strong in Air can read the footnotes of a balance sheet and determine whether his investment thesis is likely to achieve fruition. Those strong in the Ring of Air know the key attributes of management and how each company department will generate revenue in the next quarter.
Too little Air and your understanding of your investments would be shallow. Too much Air and you will be paralysed by your analysis and would not be able to build a diversified portfolio to meet your needs.
Fire is the element of passion and invention. We tap into the Ring of Fire when we want to form an investment hypothesis.
When it comes to investing, Fire determines how inventive you are. Perhaps cryptocurrencies are correlated with Gold. Fire allows you to make a clear guess on something that is not obvious to others.
Fire is also the element for leverage. Use leverage properly and it can speed up your journey towards financial independence. Use it wrongly and it will spell your financial demise.
Earth is the element of stability and restoration. We tap into the Ring of Earth when we want to defend from bad consequences.
When it comes to hedging, Earth is the element of the historical understanding of financial events. It covers the use of bonds, dividends, insurance and various hedging tools to reduce the volatility of the portfolio.
Too little Earth and you will not have a great sleep at night as your portfolio is rocked by volatility. Too much Earth and inflation will sap your investment returns.
Water is the element of adaptation and change. We tap into the Ring of Water to understand present trends and transform our portfolio to meet them.
Water governs the importance of asset allocation and thematic investing. Understanding and reacting to market cycles is governed by the Ring of Water.
To little Water and your portfolio becomes resistant to change, locking you into too much equities in a recession. Too much Water and you lose out to brokerage expenses.
The Ring of the Void is about nothing and everything. It is the Ring of meditation.
The Ring of Void governs financial mathematics and the raw theories of economics and finance. At the personal level, the Rung of Void determines how much you can link up your personal happiness with your material wealth. What personal sacrifices you will need to make to attain your target wealth is governed by the Ring of the Void.
Too little Void and your money becomes meaningless to you as you are unable to appreciate your financial achievements. Too much Void and you find yourself motivated by the importance of money but did not put any emphasis on how to actually achieve it.
One useful way of employing this framework is to think about approach to investing based on these five elements.
My approach is has a stronger Ring of Earth, Fire and Void. Earth comes from my emphasis of keeping a portfolio volatility as low as possible and my love for dividends. Fire comes from my new found confidence in my leveraged portfolio. Void covers my willingness to embrace financial theory and tie it my existential needs.
I am weak in Air and Water. I eschew financial statements and have no time for deeper analysis, preferring to read the research reports from others. I am also not very good at assessing the skill and integrity of managers. As for Water, I tend to stick to an equity portfolio even in bad times an experience a decent amount of pain during a recession.
Therefore, my investment journey would be greatly improved if I can improve my Rings of Air and Water.
Try this exercise to figure out your own approach towards investing.