Thursday, June 27, 2019

Balancing the Present

We all have at least as much as we need of each resource we need to be alive, and most of us have some extra of each one. "Successful" people generally have a lot of extra of those resources associated with success, like money and property. Sometimes we feel the threat implied by being close to the minimum necessary, dying of thirst (water), suffocating (oxygen), destitute (money), or desperate (hope).  Everyone feels that sometimes.  Give yourself a moment if you'd like to ponder it.  I could cry if I think about it long enough.

For a bigger picture than I intended to cover in this post, check out Maslow's Hierarchy of Needs, and feel free to disagree with parts of it. I'm going to address the balance of assets in what you think of as your savings, which is a very narrow application of the general and very useful idea of balance.

First, let's get the numeraire out of the way. If you think of the value of something in terms of price then you will think of a number and a unit. Most people reading this blog use the dollar as the unit because that is their numeraire. While it's healthy and smart to imagine using other numeraires, I'll use the dollar here.

To be in balance with your investments, you decide what portion of your investments should be in investment classes, like stocks, bonds, cryptocurrency, real estate, business ventures, cash, cars, toys, precious metals, etc.  Let's take a simple example for someone who agrees with me that keeping all of your savings in dollars is not a great idea. I know someone like that, me!  Let's say bitcoin will also be part of my savings and that I choose to do 50% bitcoin and 50% cash, and that my savings is $2000 (all dollars!  Oh no! What do I do?).  My next move is to implement balance.  To keep it simple, let's say it costs $10 to do a trade, so I can buy $995 worth of bitcoin for $1005 and have $995 left in my USD savings.

A lot of people love to speculate, and they will point out that if bitcoin is going up, I'm going to miss out on half the gain they will get. I'll most likely point out that if it goes down, I will miss out on half the loss.  "But bitcoin will go to the moon!"  Okay, you win, friend, go all in.  I'll be happy with my peace of mind and half as much gain as you.  However, most of the time bitcoin does go to the moon, it also comes down.  I prefer to be balanced and I want to describe the benefit of that other than my peace of mind.  However, at some point, hyperinflation will make "the price of bitcoin" meaningless.  No one will care.  No one will use the dollar as their numeraire any more.  I expect cash won't be in my list of assets any more at that point.

Let's say Bitcoin doubles (it just did, from 4000 to 8000 between March 27th and May 12th). I will have $995 in cash and $1990 in BTC.  Friend will have $3980 in BTC.  Friend will sit on the gains and hope it's not yet time to sell.  I will regain my balance by selling about $495 worth of bitcoin.  Then I'll have $1490 in cash and about $1490 in BTC. On May 16th, the price drops back down under 7000, and I regain my balance again, spending some of my profits to add to my position. Friend bites his nails and curses, perhaps even figuring that he waited too long already and he better just bite the bullet and sell.  Now he has $3500 in cash.  He's still ahead of me. We both bought at the right time, I sold a little away from the $6200 bottom, and he sold... too early.  Selling bitcoin will probably always be selling it too early.  Friend is kind of unmoored, floating along not really knowing what to do or even if what he already did was for the best.  In fact, we both bought and sold at the same times.  I have peace of mind, and we can say it cost me $500 or so.  Is it worth it?  This was an idealized example. So let's make it a little more real.

Oh!, more real, and more exciting - say I had $20,000 instead of $2000. Let's say the two of us decide that we'll trade whenever the price has changed by $1000.  At $4000, we both bought.  Because friend's strategy is "Bitcoin will moon!," he's not going to sell unless he needs cash.  That doesn't happen to me because I always have cash.  That's a perk of being in balance (when one of your assets is cash). When it hits $5000, My gain is $2500 (I bought 2.5 BTC at $4k), so I sell $1250 of it for cash. At $6k, 7k, and 8k, I do it again but each time my gain is a little less than $2500 because I keep pulling out bits of cash. When Bitcoin falls back to 7k, I spend some of that cash, buying back a bit more bitcoin than I had sold. Then it goes back to 8k and I sell a little less than I bought. On each cycle, I end up with a little more cash and a little more BTC than I had last time we were at that price.  It's fun, it's profitable, and it gives me peace of mind.

If you trade on smaller moves, you'll be trading more often so watch out for what you spend in transaction fees.  I don't actually use $1000 moves.  I consider whether or not I'd be happy if I buy and then it falls, or if I sell and then it goes up. If it's not a big move, it's not going to be a big trade, so if it does keep going up after I sell, the gain I will miss will be the gain on the small amount I sold, so no big deal.  Likewise if I buy a little and then it drops, no big deal.  If it drops enough, I can buy some more.  If the price goes back and forth* I gain a little bit of profit each time.  Friend just gets to sweat, or, perhaps, read the charts and make a ton more money than I can, but sweating more, or maybe losing money and sweating.  The sweating is what I like to avoid.

There is another benefit to balancing, which is the same effect that all trading profit has.  Trading profit reduces volatility.  Making a profit means that you sold when the price was higher than when you bought.  Selling pushes the price down and buying pushes it up, so since the sell is at a higher price than the buy, they are both pushing toward a price between the two.  Balancing has this effect and that is very good for whatever asset you're doing it with.  Price stability leads to healthy economies by enhancing the ability to plan.

I use a spreadsheet to tell me when the precious metals and cryptocurrencies I hold have values that are not in balance (more than 2% away from the target percentage of my savings).  I have target percentages for gold, silver, cash, bitcoin, dash, ethereum, litecoin, bitcoin cash, eos, and monero.  I get to trade a lot, but I don't have to if I don't want to.  I might miss a move here or there. I might buy or sell when the price move is just starting, but it doesn't bother me.  It feels good to be pushing the prices back toward some average, especially while I don't even know what that average is.

Here's a step-by-step guide to follow if you want to use a spreadsheet to have a balanced savings strategy:
  1. Identify the assets you want to have in your savings, and include cash if you dip into savings often.
  2. Assign percentages to each asset so they add up to 100%.
  3. Make a spreadsheet with a table with the headings Asset, Units, Price, Value, Actual, Target, and Trade!.
  4. Add each asset to the list (for example ["Gold",# ounces you have, PriceOfGold, (Units * Price) = same formula for every asset, (blank1), Target % from step 2], (blank2)).
  5. Add a row at the bottom for the totals. The total of the Value Column in the spreadsheet is what your savings is worth.
  6. In the Actual column ("blank1" in my example), put a formula that divides the value of that asset by the total of that column (In Excel, F4 toggles the $ on the row/column references so that copying a formula into a different row or column won't affect the row/column selection for that item in the formula) and format it as a percentage and copy it down the column for all the assets.  It's the "actual percentage" of each asset in your savings.
  7. In the Trade! column, use the formula (Target - Actual)*Value.  You'll get negative values for assets that are over-represented in your savings, meaning you should sell some of it to raise that much money.  The positive values tell you to spend money.  You can reverse the polarity if you want, but be careful.  I can see it both ways, but it gets confusing when I actually do see it both ways.
  8. A good sanity check is that the totals for each of the Trade!, Target, and Actual columns should always be zero.
  9. Examine the values in the Trade! column to see if there is some trading to do.  If the numbers on two assets are large but one is negative and the other positive, consider trading one for the other to get closer to balance.
* BTC's price on Bitstamp went back and forth between 7700 and 8125 between 5/12 and 6/12 five times, a 5% gain each time, but that would be five 5% gains on 5% of your BTC holdings, so, from my example, on 5% of $1000, or $50. A 5% gain on $50 is $2.50, so $12.50 total. $12.50 in a month on $1000 is an annualized return of 16%.  The last move from 7700 to 8125 has still not been erased, so if we ignore the increase in bitcoin's price, we can say it's only an 11% annualized return.  Still pretty good.

No comments: