Andrew Hallam
09.03.2021

Why I don’t Include “Play Money” In My Portfolio
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A couple of years ago, my wife and I spent 17 months living in a camper van while traveling through Mexico and Central America. That doesn’t mean you should. To you, might sound like hell–especially if you (like we did) had to share that space. After all, our bed is only four feet from the toilet. And the toilet is about three feet from the fridge. We brag that we almost killed each other only once. I loved that experience, but not everybody would.

We’re all different.

For example, plenty of people include a smidge of “fun money” in their portfolios. It might be a hot actively managed fund, a hot stock, a hedge fund or a crypto-currency. Let me explain why I don’t.

I have a diversified, seven-figure portfolio of low-cost ETFs. None of my money is designated, “play.” That might sound out-of-character for an adventurous vagabond. Besides the camper van journey, over the past six years we rented places in Mexico, Bali, Thailand and Malaysia. We explored more than 30 countries, often backpacking or pedaling around on our tandem bike.

I first started to invest money when I was nineteen. I worked part-time at a bus depot while attending university. A self-made millionaire mechanic convinced me that I didn’t have to earn a high salary if I wanted to build wealth. I just had to learn how to effectively manage money. By the time I was in my mid 30s, I had read more than 400 personal finance and investment books. I poured over investment research studies and fine-tuned my strategy to provide the best odds of success.

Eventually, I built a diversified portfolio of low-cost index funds. I didn’t do it because I was lazy, or because I didn’t want to research stocks on my own. In fact, I loved reading corporate annual reports (I never said I was normal). I practically slept with Benjamin Graham’s book, The Intelligent Investor and Philip Fisher’s book, Common Stocks and Uncommon Profits. Graham’s book focuses on picking underappreciated value stocks. Fisher’s book focuses on finding high-flying growth stocks.

As a stock picker, I did well for 12 years before moving everything into a portfolio of index funds. I didn’t abandon individual stocks as a result of poor performance. Overall, my stocks performed well. But I learned that 12 years of strong performance is a blip, and over my lifetime, a diversified portfolio of stock picks would likely beat my handpicked stocks.

So, I said good-bye to “play money” because I wanted to maximize my long-term profits. If you’re knocking the lights out with a hot active ETF, hot stock, Bitcoin or a hedge fund, you might shake your head. But investment durations are long.

And odds are high that your play money will eventually lose to a diversified portfolio of low-cost index funds. That isn’t my opinion. It’s a research-based fact. Most hedge funds try to speculate with brilliant managers at the helm. Some perform well for several years. But as this article explains, they eventually lose to a portfolio of low-cost index funds.

Portfolios of index funds are much like Terminators in the Schwarzenegger films. You might beat the market for a while. But the market typically comes back to dole out beatings. Ivy League college endowments sometimes get the upper hand until they, too, get humbled.

Ray Dalio’s famous hedge fund beat a diversified portfolio of index funds for several years. Many people held it as proof that, “Yes, you could find someone smart to beat the market.” But as Dalio’s investors now know, big leads can be erased as fast as someone can say, “Hasta la vista baby.”

After I wrote my story about Dalio’s fall from grace, hopeful market-beaters said, “What about Renaissance?” Hedge fund manager Jim Simons started the legendary Renaissance Medallion fund in 1988. It uses a lot of leverage (meaning investors essentially borrow money to boost returns). That outsized risk combined with fabulous trading produced eye-popping profits. Amy Whyte, writing for Institutional Investor says, “Despite the fact that Medallion reported annual net returns above 29 percent every year between 2010 and 2018, the fund’s assets under management stayed at about $10 billion throughout that period.” That’s because Simons likes to keep the fund small. So, he returns profits to investors every year. That makes his trading strategies easier. It also prevents investors from compounding growth within the fund.

It soon closed to everyone who wasn’t affiliated with the firm. But by 2005, Simons wet new appetites by launching the Institutional Equities Fund, known as RIEF. Its stated goal was to beat the market by 4 to 6 percent per year. It also used leverage. And that leverage, combined with a team of outstanding traders earned scorching returns. It didn’t perform as well as the Medallion fund, but it trounced the returns of the S&P 500.

But, as one of my friends says, “No matter how big the number, when you multiply by zero, you still get zero.” Fortunes reverse. That’s why, even funds that beat the market, have sky-high odds of getting caught by The Terminator.

And for RIEF investors, The Terminator fought back.

RIEF’s investors lost 19 percent in 2020 while the S&P 500 gained more than 18 percent. As a result, the earliest investors in RIEF gained a compound annual return of 9.1 percent from 2005-2020. But the S&P 500 (The Terminator) gained 9.7 percent per year.

Unfortunately, investors who seek market-beating funds and stocks often buy them after they have started performing well. They also often sell after they have dropped. As a result, immediate gratification really kicks them in the butt.

This is why my portfolio doesn’t include “play money.” Behavioral researchers say we dislike losses twice as much as we like gains. And because investment durations are long, (if I live to 90, I’ll be investing for 71 years) it’s best to put the odds of investing in your favor. If you want to play with money, spend it. Take a vacation. Buy something for a friend. Enjoy an activity you’ll never forget. That’s where “play money” should go. But I understand if you don’t want to listen to a guy who loves living in a van.

Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas

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