Portfolio Performance
In the last few years I have become interested in how portfolios perform. This is a different mindset than thinking about how asset perform — it’s a more holistic and mathematical exercise.
When you come from crypto and see the top hedge fund managers posting 30% CAGR (compounding annual growth rate), you may not think that is impressive.
It is. I have learned to appreciate how incredible this is and hopefully this post will influence your thinking too.
They key lesson in (my) portfolio theory is understanding the following equation:
CAGR = (Hit Rate x Position Size)
Yes I know it’s technically more complicated than that, but like most things, simplicity is more effective. Kelly Criterion is mostly just a justification exercise — real alpha comes from conviction.
If I had to sum up what drives long term portfolio outperformance, it would be:
- Executing a proven, high quality edge
- Using outsized position sizing when the edge is largely in your favor
- Minimizing drawdowns (including taxes + fees)
It is not about picking winners and having one of your “bets” do a 10x return. While that can work for one or maybe two years, over time you will fail to beat the beta benchmarks (S&P500 or BTC) unless you hit some once in a lifetime unicorn.
Private markets have been a good example of this — since 2010 most VC and PE returns can’t beat simple public index funds like SPY or QQQ.
Put another way — if you make 100% returns in one year, but fail to make any positive returns for the next 4 years, you actually only made ~20% for each of those 5 years. For most people in crypto, it’s more like 300% one year then -40% the next, +20% the next, etc.
All together it ends up being worse than if you just held BTC.
All that hard work, all those 18 hour days stressing in Telegram groups…for what? Trading is hard. If you think this doesn’t apply to you, stick around a few more years. Markets humble every one of us, just give it time.
The easiest way to see this in a practical way is to benchmark your crypto performance in BTC terms (instead of USD) and see how well you’ve done. The longer you’ve been in the space, the less likely you beat holding BTC, especially after paying taxes.
This is not intended to dishearten you. I am writing this to hopefully save you from wasting even more of your precious time and energy. There are ways to dramatically beat the market and build generational wealth that you keep.
The sad truth of crypto investors is that many have made money but few have kept it. I believe a lot of that is because they don’t understand how this game really works.
Let’s do an example to illustrate what’s going on.
Say you have $1,000,000 in total assets. This is everything that you are trading, investing or saving. The benchmark for this would be the SPY, which spits out around 7% a year in real returns (nominal returns minus inflation). Your entire goal is to make and keep $70,000 a year. Seems easy right?
Some simple math would show us that, in the USA, you would need to find about $100,000 in profits to net the $70k you’re looking for (after taxes and fees) So you would take that entire $1,000,000 and trade it fully on the asset that would get the 10% gain ($100K).
Pretty straightforward, yeah?
But anyone who knows how this game works knows how hard it is to put the entire $1M stack on one single trade. Because if you’re wrong, you need to make about 12-15% on your next trade to make up for the loss you just had. Instead of looking for your original “easy” 10% trade, you now need to make a little more with your entire trading stack.
All of a sudden, this starts looking like work. Finding a 15% move feels a bit harder than finding a 10% move especially with the emotional baggage of a recent loss.
So what happens is you break your portfolio into smaller buckets and move out on the risk curve. You take $200k and put it on a higher risk trade or investment and $300k on a medium risk. Then you’ll just let the other $500k collect 4% in a money market until a big dip that may come.
Your trading capital is now half the size, so you actually need to clear 20% on these trades to make the $100k.
The spiral continues — you take 5% of the portfolio and put it on a trade that can go 10x, like a memecoin, and you take another 25% and use it to trade TQQQ (3x Long Nasdaq ETF). You take all these smaller trades but ramp up the risk. If one of them hits, you think, it will pay for everything + then some.
Or maybe, like a true crypto degen, you actually take the entire $1,000,000 and put it into a very speculative trade. You crushed it in 2020 and 2021 and know what can happen when you are heavy enough into alt season. How can you pass up an opportunity like that now?
You now have a “diversified” portfolio which is supposed to spread your downside risk but realistically is just spread out to maximize your upside gains. There is almost no way all these trade ideas have a real edge, otherwise you would have piled entirely into one or two of them.
Read that last sentence again. Burn it into your brain. This single idea is why you can’t seem to build wealth.
Now we have your current trade portfolio —
- 20% on higher risk trade
- 30% on medium risk trade
- 5% on memecoin (highest risk)
- 25% TQQQ (medium risk)
- 20% cash/money market
All this to make 10% blended gains. Many who are reading this know the feeling of having a basket of risk and feeling oddly comfortable — there is an opiate-like safety that comes from owning stuff that “could” have enormous upside.
That’s why so many crypto and retail traders feel more comfortable in drawdowns than sitting on winners. When it’s a drawdown, you just need to wait longer (certainty). When it’s a winner, you need to decide if you should sell or wait (uncertainty). And the risk-seeking degens cannot handle uncertainty — that’s why most traders and crypto people have underlying and undiagnosed addictions. But this topic deserves another blog post so I won’t digress.
Going back to the portfolio, I won’t do the math here but I would encourage you to ask yourself what each of these trades needs to do as part of a portfolio, not as an isolated P&L.
Ask yourself how much does my higher risk trade need to go up to make the expected return assuming the other 3 trades don’t work? Or if 2 others don’t work and one is flat? If you have a quant system you just do the math on each trade’s edge and spit out an expected Sharpe Ratio but most people don’t have this setup or won’t do this analysis.
Simply put — most of your trades, especially the higher risk ones, will not work the way you want them to. That means the ones that DO work need to make up the losses, moving you further away from the “easy” 10% you needed to make.
This is a silent killer. We forget about these paper cuts or the stop losses that get hit and focus on the next big winner that will make up for it all.
But what you really want to be focusing on is your EDGE. How confident are you in this trade? 55% 75% 95%? And when you get above a threshold that you are happy with (mine is 80%), you HAMMER those trades. Full portfolio sometimes. Absolute laser eyed focus.
A 10% move with your entire portfolio is the same as a 200% move on 5% of your portfolio. But you have to be right…otherwise that needs to become 300%, 400%, 500% to match the 10%. And it is really REALLY hard to consistently be right on stuff that risky.
One of the reasons I am not as active in crypto trading anymore is because I do not have the same edge I used to have. If I wanted to get back into it, I would be spending 100% of my time networking and getting insider information. All the edge is in insider info now. Everything else is mostly luck.
Sure, there is some quant edge in trading early markets and memecoins and on-chain metrics but that’s going to be harvested every few months. You can make short term money doing this, but it won’t last. And you’ll probably keep doing it for too long, giving back a lot of the gains you made because you don’t know what your edge is. You won’t know when to stop.
Ask any market maker how often they need to change their core strategy and they will say it’s always evolving, constantly adapting to new conditions of liquidity and opportunity. Very different than Citadel market making the SPY options chain.
Similarly, you can still trade the momentum in altcoins or even BTC to beat holding. There are many funds out there than do this well. But then you get into taxes and realize, unless you are in a tax-free jurisdiction, this really isn’t worth it. You will spend all your time trying to extract an extra 5% performance, if you’re lucky.
My point is that I have no real edge in crypto. You probably don’t either, which you would realize if you start denominating your performance in BTC and subtract your taxes/fees beyond just the bull markets.
All those +3R trades you are getting from your paid trading group are NOT really making you money. In the short term they are giving you outperformance but you won’t know when to stop. And a few bad trades, usually the ones you go big on, will eliminate the gains you had during the bull market. Then you pay taxes on the remaining profits.
What are you left with? More than if you just held BTC? Probably not.
There is a reason why trading is one of the hardest ways to make and keep money. You are not special, I am not special. It is simply about executing repeatable edge and knowing how to walk away when you’re ahead.
Much of this information will fall of deaf ears. It’s a bit abstract and lacks a clear action plan.
But one exercise you can do is to imagine you are running your own hedge fund. And every time you want to buy or sell something, you need to justify the trade to your boss or investors. You need to convince someone, who is incredibly smart, what your edge is on the trade.
Is it macro research? Is it a quant signal? Is it an arbitrage on the MEV for new memecoins launching? You know the core dev or whale who is buying the supply? Your paid group leader told you the ‘chart looks good’? The this is some magic pivot date and price will most certainly move the way you think?
When you do this, you quickly realize how full of shit you really are. Sometimes I go out to lunch with fund managers or guys 20yrs older than me who are absolute GOATs in the industry and talk about markets. They ask me about BTC or NQ or whatever I’m looking at for trade ideas. Unless I have some very succinct, smart reason to buy something, they don’t give a shit. It forces me to really think through why I would make a trade and how I can prove it’s a good trade. It forces me to hone my edge.
I think to myself, “What would Bobby Axelrod think if I pitched him this trade? What would his feedback be?” Most of the time, he’d tell me I’m an idiot and to stop wasting him time lol. But once in a while, he’d agree with me. Those are the only trades I should be doing…and I should be going BIG.
This is how you should be thinking too. You must be able to articulate your edge. You need to stop “diversifying” into stupid trades because you don’t have the balls to go heavy on something you have an edge on.
As I have written before, I believe we are entering a weird phase of markets where indexes largely top out and flows begin to spread into harder to reach places. I am no longer a blind bull on anything, including crypto, and think anyone who wants to make money in the coming years should DRAMATICALLY step up their game. The easy money train is over.
The outperformance (which, by the way, can be not losing money) will come from identifying high edge trades and executing with a meaningful position size. Full stop. That’s it. That’s all it’s ever been.
If you’re serious about making trading and investing a career, especially on your own, you should consider a tax advantaged jurisdiction. You should find a mentor who will help you sharpen and articulate your edge. If you don’t have a mentor, train ChatGPT to be your coach. You should stop spreading your portfolio thin into riskier assets and learn to HIT IT HARD on the trade ideas that meet your criteria.
Consistent outperformance is reserved for the elite. Many in this game will make money on short time frames. Few will do it for years on end.
Now is the time to sharpen the axe.
