The Role of Margin of Safety for Cost Disadvantage of Extremely Small Sums of Money

There’s a follow up article called “The Role of Concentration for Cost Disadvantage of Extremely Small Sums of Money

Managing small sums of money is a bliss in terms of investment options, but extremely small sums of money when starting out on the other hand is frustrating in terms of not only investment options but also cost disadvantage.

Not only does many investment options that require simultaneous multiple investments become off limits as you don’t have enough money to minimize risk to a minimum with Kelly criterion, you also face huge commissions percentage wise due to purchases that warrant the minimum commission fee (eg. $100 commission for $1000 purchase is much more expensive percentage wise than $100 commission for $10000 purchase).

Not only are there frustrations on the investment front, there are also frustrations with capital allocation. When you are starting out with extremely small sums of money, it can be an emotional struggle between allocating more money to your emergency reserves or to deploy large chunks of your emergency reserves into investing to save on commission fees. I’ve definitely been tempted to start investing again even though I’ve yet to hit 1 year worth of expenses in cash (very close though).

I think this is why margin of safety is that much more important for those with extremely small sums of money starting out.

During Money Accumulation Phase, 1 year worth of expenses in cash is absolutely uncompromisable until you really run out of money, which provides a margin of safety in terms of career (you can afford the time needed to find another job if need be), investment (you’re not completely screwed if all your investments go to zero), and life (you can pay for the unexpected emergencies of life).

Another aspect of margin of safety that comes to play is to always buy index funds during Money Accumulation Phase that is undervalued EVEN AFTER taking commissions into consideration. This allows me to stick to the 1 year worth of expenses in cash and bear the pain of expensive commissions percentage wise when making small sum stock purchases since as long as the index fund is undervalued even after taking commissions into consideration, meaning I have a realistic chance at making a profit.

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

Advertisements

One comment

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s