In real investment management, it is difficult to fully realize the mathematical compounding effect.

Hello, this is Capital Cat.

The theme this time is that, in real investment management, it is difficult to fully realize the compounding effect in calculation.

Although the compounding effect itself is theoretically powerful, real investment management is subject to various constraints and does not progress as calculated. In particular, risk management and psychological aspects also have an impact. The important point among these is, "How much of the amount you would be distressed to lose can be protected" as an approach to risk management.

Reasons why compounding is difficult in actual investing

1. Market risk:

   • The market is constantly fluctuating, and unpredictable events (such as financial crises, pandemics, geopolitical risks) can occur. It is difficult to ensure a steady monthly return as calculated while dealing with such risks.

2. The importance of risk management:

   • The most important point in investing is "risk tolerance." If you pursue compounding by increasing risk, the risk of large losses also increases. The upper limit of investing lies within the range of risks you can tolerate.The amount you would be distressed to lose should be set in advance and operated based on that.

3. Psychological risk:

   • If you aim for large returns, you tend to take more risks. Especially when managing with compounding, as profits grow, the invested amount also increases, which can add mental burden. You must also consider stress from sudden market fluctuations causing large losses and the challenge of timing a withdrawal.

4. Trading costs and taxes:

   • Transaction fees and taxes are factors that erode the compounding effect in actual management. Frequent trading accumulates fees, and taxes on profits must also be considered, making pure compounding harder to achieve.

How to think about the upper limit

Investment upper limitvaries depending on each investor's risk tolerance and asset situation. The amount you can afford to lose is a factor that determines that upper limit. In general, it is good to set "the amount you would be distressed to lose" based on the following points.

1. Portfolio diversification: By balancing high-risk/high-return investments with low-risk assets, you diversify the overall investment risk. This provides a buffer to avoid large losses even in investments that expect compounding effects.

2. Investment time horizon: In long-term investing, you gain the leeway to withstand temporary market fluctuations. If you seek too large returns in the short term, the risk increases and the risk of exceeding the amount you would be distressed to lose rises.

3. Setting withdrawal rules: It is important to set rules in advance, such as a stop-loss line (for example, withdrawing at a 10% loss) or a rule to lock in profits when targets are met.

Practical approaches

To manage investment risk, you should aim for the theoretical growth of compounding while also planning step by step to minimize risk.Gradually increase assets, or if you feel the risk is high,lock in part of the profits to reduce riskis a realistic management method.

If you need specific guidance on asset allocation or risk management, we can provide deeper support!

Capital Cat