00511 Risk and Cash Are the Real Starting Points for Investing

I. Current Theme

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The core viewpoint of this episode emphasizes that investment decisions should be independent of market volatility, with sufficient cash reserves serving as the first step and cornerstone of investment planning. After determining the cash level based on individual risk tolerance and living needs, then proceed with long-term (15+ years) investment in index funds (especially the Nasdaq 100). Beta is a result of asset allocation, not the starting point. At the same time, be wary of various risks in investment, especially cognitive risks and behavioral biases, and remain vigilant about conflicts of interest in financial services.

II. Briefing Content

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Market Volatility and Long-Term Perspective

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• Market fluctuations are normal. Having experienced multiple major crashes (2000, 2008, 2020, 2022), the current volatility is relatively mild.
• In the long run, most of the current concerns will “leave no trace.” Don’t panic over short-term events. Time is the best medicine, but people are prone to repeating mistakes (old habits die hard).
• Investing is a long-term matter (15+ years), and dips are buying opportunities. James has been investing for 40 years and has never “seen” a market crash, only buying opportunities.

Core Investment Principles

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• Focus on Doing the Right Things: The core is “Han Xin Counts Soldiers” (i.e., using affordable and safe borrowing, such as mortgages and credit lines, for investment), putting borrowed money into the market, but with sufficient cash reserves.
• Investment Targets: Only invest in the Nasdaq 100 index fund (such as QQQ, 00662, 513100, etc.), as it represents human growth and innovation and has a self-evolving mechanism of survival of the fittest. Related materials are linked on page 10 of the handout. It is mentioned that HXQ and other Nasdaq 100-based funds may outperform QQQ in certain periods.
• Long-Term Holding: Holding for 15+ years after purchase is key, “never selling.” Only inaction can lead to wealth, not frequent trading.
• Stay Optimistic: Investment is based on confidence in the long-term development of humanity.
• Independent Learning: Investment requires self-study, understanding the reasons behind the strategy and the then-current market environment, and not blindly following.

Asset Allocation: Cash First

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• Primary Question: The first step in investing is not what to buy, but how much cash needs to be retained to live securely and cope with emergencies. This is the most important thing.
• Cash Needs Determine Allocation:
  • Young People: First, prepare an emergency fund (e.g., NT$400,000/CNY100,000), and only invest surplus funds.
  • Asset Allocation Model Examples:
    • 433 (Beta 1.0): 40% Index + 30% Leverage + 30% Cash. Requires 30% Cash > Emergency Fund (e.g., NT$400,000), requiring total assets of NT$1.33 million to implement.
    • 424 (Beta 0.8): 40% Index + 20% Leverage + 40% Cash. Requires 40% Cash > Emergency Fund (e.g., NT$400,000), requiring total assets of NT$1 million to implement. Illustrates that reducing Beta can lower the funding threshold.
  • High-Net-Worth Individuals: The principle is the same, determine the cash ratio according to personal comfort (potentially millions of RMB or hundreds of thousands of USD).
• Beta is the Result, Not the Goal: First determine cash needs and risk tolerance, naturally forming the allocation ratio, and finally calculate the Beta value as a measurement tool. Don’t set a target Beta from the beginning.
• Allocation Irrelevant Factors: Asset allocation is unrelated to age, fund size, or market level, only related to how to prevent accidents and how much accident can be tolerated.

Risk Management and Cognition

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• Risk Tolerance:
  • Young people have less experience, so risk tolerance may not be high, and should not blindly pursue high Beta (e.g., 442).
  • Wealthy people are usually more conservative, pursuing stability rather than extreme returns (Beta 0.5 may be sufficient).
  • Conclusion: Taking risks beyond your tolerance is foolish. Investment is like eating spicy food, do what you can handle.
  • Recommendation: Start conservatively. If you believe you can tolerate Beta 1.2, start with 1.0; if you believe you can tolerate 1.0, start with 0.8.
• Leveraged Fund Usage Principles: The ratio of leveraged funds should not exceed the ratio of cash or the ratio of the original fund. This suggests that a 442 allocation (40% Index + 40% Leverage + 20% Cash) is not suitable for most people.
• Behavioral Biases: Retail investors often feel sad when the market falls (regret buying early) and also sad when the market rises (regret not going all-in). The correct allocation should achieve “happy when it rises, comfortable when it falls,” maintaining “immovability.”
• Individual Stock Risk: No company lasts forever (examples: Intel, Kodak, Blackberry), individual stock risk is high. Index funds mitigate individual stock risk through a mechanism of survival of the fittest.
• Borrowing Risk:
  • Safe Borrowing: Mortgages, credit lines (Han Xin Counts Soldiers), assuming income can cover monthly payments, unrelated to market fluctuations.
  • Dangerous Borrowing: Margin trading, stock-pledged reinvestment. Market declines can lead to forced liquidation or even bankruptcy. These operations are strictly prohibited.
  • James’s pledge loan: Based on holding cash far exceeding debt, ensuring absolute security.
• Specific Funds Use Risk: Money earmarked for short-term use (e.g., down payment on a house) within a short period (e.g., 3 years) absolutely cannot be invested in the stock market. Someone recently defaulted because of this.
• Tax Risk: Tax planning is very important and can affect significant wealth. Rules need to be carefully studied (e.g., the application of the U.S. Wash Sale Rule across accounts).
• Spending Ability Mindset: True “affordability” means being able to easily repurchase an item if it breaks down, as in James’s example of replacing a juicer. Large expenditures (e.g., buying a house) should also have this mindset, otherwise the risk is too high.

Be Wary of Paid Services and Conflicts of Interest

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• Firmly Do Not Charge: James emphasizes that his services are free because charging easily creates conflicts of interest. His YouTube channel also does not have monetization enabled.
• Warning Signals: Be highly vigilant about any paid groups, paid recommendations, or financial services that charge commissions or kickbacks (e.g., account opening, buying funds). Mentions feedback that some groups may be transferring benefits through financial service referrals.
• Harm of Conflicts of Interest: Those who charge may recommend unsuitable or even harmful products/strategies for commissions.
• Self-Protection: Learn independently, compare multiple sources, understand financial products yourself, and do not easily trust introductions. Be especially wary of “pits” introduced by acquaintances.
• U.S. Regulations: The U.S. prohibits paying commissions to referrers for financial product recommendations (account opening rewards are usually given to the account opener themselves) to prevent conflicts of interest. Regulations may vary in other regions.

Other Suggestions

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• Emergency Fund: Do not use the emergency fund to buy the dip. Survival is the most important thing.
• Regular Investment: Buy index funds immediately with new income (e.g., salary).
• Financial Literacy: Financial intelligence requires learning, there are no shortcuts. Be wary of the “get rich quick” mentality. Discuss with his daughter the mindset of speculators: it may be “greed,” it may be “poverty,” or it may be “not wanting to get rich slowly.”
• Video Viewing: New friends are advised to watch video #451, then start from #398 (January 2023) and watch in order.

III. Q&A Session

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CAD

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• Sharing:
  1. Observed that regardless of wealth, some people are keen on short-term trading, possibly due to addictive pleasure or a sense of accomplishment. Poor people may say they need quick returns, while rich people may enjoy the process.
  2. Emphasized the strict prohibition of margin trading or stock-pledged reinvestment. Recently, with the market decline, someone was forced to liquidate and even became indebted because of it. Compared this to his own use of credit lines/mortgages for investment, stating that as long as he can afford the monthly payments, the market decline does not affect his survival.
  3. Mentioned a senior who was forced to liquidate due to margin calls during the Kuo Wan-Jung incident (Taiwan stock market historical event) and has been in debt ever since, warning future generations.
  4. Important Reminder: When observing an investment portfolio, you should pay attention to the fluctuation range of the overall assets rather than just staring at the leveraged portion with the biggest decline, which helps manage emotions.
  • James’s Comment: Agreed. Explained the risk of illiquidity under the Taiwan stock market’s limit-down mechanism, compared to the U.S. market. Re-emphasized the danger of margin/pledge reinvestment. Explained that while he uses pledge loans, he holds cash far exceeding his debt to ensure security. Criticized putting house-buying money into the stock market as ignoring risk.

BG

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• Sharing:
  1. Agreed that money management (cash ratio, position control) takes precedence over buying and selling signals.
  2. Money management should start from oneself (capital amount, risk tolerance willingness).
  3. Backtesting is not just to verify signals, but also to understand the money drawdown of the strategy under historical market conditions, to adjust positions to suit one’s own tolerance.
  4. Under the buy-and-hold strategy, investment funds must be strictly separated from living funds to avoid affecting long-term investment plans and mentality due to living needs.
  • James’s Comment: Distinguished between strategy (long-term goals, cash planning, asset class allocation) and tactics (specific buying and selling points, short-term adjustments). Emphasized that tactics should not interfere with strategy, for example, one should not liquidate due to market panic or use the emergency fund to buy the dip.

Rui

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• Sharing:
  1. Thanked James for solving many investment confusions (cash first, the use of leverage, asset allocation, etc.) through learning videos.
  2. Adopted the teacher’s advice and used 2% of his assets (through pledging) to pay for the Tesla purchase.
  3. After adopting the 433 allocation, he felt excited when the market fell, in contrast to the panic of his colleagues.
  4. Used a brokerage account (transfer from Yuantai Securities) that does not show the cost price, which helped reduce anxiety.
• Questions:
  1. Has reached the retirement goal (50x annual expenses), but his current salary is equivalent to 6% of total assets. He hopes for a higher retirement replacement rate in the future (assets need to increase by another 2-3 times). Between 433 (30% cash + 2% withdrawal) and 442 (20% cash + no withdrawal), how to further think about the choice from the perspective of safety and applicability?
  2. (Implicit question) Should he continue working for a sense of accomplishment, or retire early?
  • James’s Response:
  1. Regarding Purchasing the Car: Praised his use of “non-own funds” for consumption, pointing out that being able to borrow money is itself a manifestation of wealth, the key is controllable risk (sufficient cash).
  2. Regarding Retirement Choices: This is a classic question. Cited another case to illustrate that early retirement may bring huge benefits due to tax planning (such as Roth conversions). Suggested that Rui reflect: if work had no salary or recognition, would he still want to go? The value of work may change with stage, and there may be new pursuits in the future. Looking back from age 90, would he regret working several more decades? With financial freedom, the work mentality can be more relaxed.
  3. Regarding 433 vs 442 Safety: Assuming the market goes to zero, which is safer? The answer is the one with a higher cash ratio (433 has 30% cash, 442 has only 20%).

Kai Xin

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• Question: Regarding whether the interest on the U.S. Pledged Asset Line (PAL, pledge loan) can be tax-deductible, and how to operate? Feels that the rules are complex and there are many restrictions.
  • James’s Response: The money borrowed from PAL is mainly used for consumption, not reinvestment. The issue of interest tax deduction is complicated and may require adjusting the type of capital gains (e.g., converting long-term to short-term), relying on accountant operations. James himself does not pay attention to this operation because his strategy is to hold a lot of cash, making interest income far exceed PAL interest expenses, and PAL interest is close to zero. The more fundamental strategy is to achieve “zero income, zero capital gains,” so there is no need to consider tax deduction.

Derek

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• Sharing: Thanks to James and the community (Chen Feng, Sister K, etc.). Recently joined, the teacher’s reply and teaching made him have the courage to operate according to the plan when the market fell, and deeply realized the importance of risk control. Listening to the teacher’s videos can bring a sense of stability.
  • James’s Comment: This is precisely the reason why he insists on teaching, knowing that it is difficult to succeed in investing alone, and guidance and companionship are needed.

Nai Xi

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• Sharing: As the founding moderator of the Taiwan 00662 community, thanks to James’s inspiration three years ago for changing his life. Thanks to all 19 administrators of the community (mentioning the rotation system, member contributions such as Chen Feng bringing it to a new height, Chris developing tools, etc.) for their hard work. Reiterated that he was inspired by the teacher’s “eliminate poverty” mission and hopes to help more people through the community.
  • James’s Comment: Recalled the meeting with Nai Xi and the community backbone (eighteen arhats), praised their quality and Nai Xi’s persistence and humility. Affirmed the value and operation of the 00662 community and regretted that it was limited by the LINE platform and could not cover the world.

Ming Yu

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• Sharing: No questions or sharing.

Yao

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• Sharing: Mentioned recent rumors about Trump’s friends profiting from trade war news, and extended thoughts about the relationship between the morality of politicians and social progress. Lamented that moral constraints are limited, but human technology is still developing.
  • James’s Comment: Agreed that the world is full of unknowns (quoting Buffett), and the market always has surprises (epidemic circuit breakers, drastic trade war fluctuations). Need to remain humble and prepare for extreme risks (such as market closure/continuous decline for 10-15 years). Re-distinguished between safe borrowing (fixed repayment) and dangerous borrowing (linked to the market).

Julia

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• Sharing: Revealed an American tax trap: the Wash Sale Rule may apply to all accounts (including 401k/IRA and other retirement accounts). If you sell a loss-making asset (such as QQQ) in a taxable account for Tax Loss Harvesting (TLH) and automatically buy a similar asset (such as an SP500 index fund) in a retirement account at the same time, the loss in the taxable account may be permanently disallowed (because retirement accounts are taxed at ordinary income rates when withdrawn, with no capital gains concept). This is especially important for high-tech employees, as they often hold a large number of RSUs and perform TLH.
  • James’s Comment: Tax issues are extremely important. Pointed out that TLH itself also has risks, such as the market rebounding after selling, making it impossible to buy back the original asset (QQQ) at an ideal price, or generating new capital gains when buying back. If James himself has no need (such as no capital gains without selling stocks), he tends to let the loss carry forward and deduct $3,000 of ordinary income each year, rather than use it to offset capital gains. However, for Julia, who needs to offset a large amount of RSU capital gains, TLH is a reasonable strategy and needs to be operated carefully. Discussed the problem of high tax rates in California. Re-emphasized the ultimate goal of pursuing a zero-tax state, and the value of tax planning far exceeds the salary itself.

DDF

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• Question: Asked about the risk of the Pacific War two years ago, at that time the teacher suggested reducing 50% of QQQ. Now that he has adopted the strategy of holding a large amount of cash (such as 433/424), can he withstand this type of risk, insist on holding it and rebalancing at the end of the year, without selling in the middle?
  • James’s Response: The evolution of the strategy is because the introduction of leveraged instruments allows holding a large amount of cash more effectively. The core risk management issue is not specific events (wars, disasters, etc.), but whether it is possible to survive in extreme market conditions (such as closure/deep decline for 10-15 years). If cash reserves are sufficient to support such a long time, there is no need to make predictive operations for specific events. Comparing risks: for young people, the risk of carrying a mortgage and facing unemployment + market decline may be more realistic and fatal than the risk of war. Buying a house should be as easy and stress-free as buying slippers to be considered affordable.

Jason

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• Sharing: Summarized two major investment risks:
  1. Choosing the wrong asset: The market is full of various temptations, choosing a high-quality asset for the long term (such as QQQ) is the foundation. Thanks to the teacher for continuing to emphasize this.
  2. Missing the upside: Statistics show that missing the 10 days with the biggest market gains (in the past 20 years) will cut total returns in half. These big rally days often occur during periods of extreme panic (such as 2008, 2020). This confirms the importance of the “never sell” strategy to avoid timing the market.
  • James’s Comment: Highly Agreed. Defined the real, permanent loss as the returns that should have been earned but were not (such as missing a 12% rally). Book losses caused by market declines are temporary and will recover. Compared buying QQQ at a high point (540) with buying at a low point (440), the difference in annualized returns after holding for 40 years is extremely small (11.98% vs 12.5%), indicating that the timing of the purchase is not important, but long-term holding is key. Use a long-term perspective (40 years later) to review current decisions.

Jing

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• Question: Approaching retirement, but savings have not reached the 30-50x target. There is a stable high income in the next 5 years, and Pension/Social Security will cover most expenses after retirement. Does not use pledging due to concerns about risk. Can I not retain 20% cash and take a 100% stock holding strategy, relying on future income, emergency fund, and future pledgeable options to accelerate asset growth?
  • James’s Response: No. Risk tolerance decreases as retirement approaches, the time window is short, and you should be more conservative. Since the Pension already covers most of the expenses, the urgency for asset growth should be reduced. The most aggressive allocation for retirement or near retirement, without using pledges and without holding leveraged funds, is 80% QQQ + 20% cash. Pension should be regarded as a stable source of income, and when calculating the total amount of retirement funds required, the Pension portion should be deducted from annual expenses first, and then the remaining net expenditure needs should be multiplied by a multiple (such as 30 or 50 times). If you hold leveraged funds, you must sell them and deal with tax issues before retirement.

Frank (from the comments section)

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• Question: Should global diversification be carried out?
  • James’s Response: Not recommended. The U.S. market is optimal in terms of innovation, transparency, and long-term risk-reward ratio. Other markets have higher risks and relatively low return potential. Investing in U.S. index funds is sufficient.

IV. Wonderful Views

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The first step in investing is not to say, ah, I come in and start, what should the teacher buy, how much leveraged funds should I buy… No… The first thing to invest in is how much cash you need, how much cash you need to keep, this is more important than anything. – James

Background: Emphasizes the primacy of cash reserves in investment planning.

Our strategy has nothing to do with market volatility… What are investment plans or investments supposed to do? It is to be based on your own risk tolerance… How much cash is appropriate to keep, this is the first step in investing. – James

Background: Explains the core concept of his investment strategy, which is not affected by short-term market sentiment.

Beta is naturally formed in the end, not set at the beginning… So you have to ask the first few questions, how much cash do you keep to feel comfortable… An accident may come in the next second. – James

Background: Explains the role of Beta in asset allocation, which is a result, not a goal, emphasizing safety first.

Young people should not take risks, because they lack experience, and rich people do not take risks much… Coming back to the point, taking risks is not very worthwhile, taking risks beyond what you can afford is just very stupid. – James

Background: Refutes traditional concepts, pointing out that excessive risk-taking is not advisable, regardless of whether you are young or wealthy.

Don’t turn your tactics into a strategy… It seems that the emergency fund should have been so much, but you, ah, it’s dropped so much, quickly buy it all in. That turns tactics into a strategy, you can’t do that. – James

Background: When commenting on student sharing, distinguishes the boundaries between strategic determination and tactical flexibility.

What you should look at is not your single stock (referring to leveraged ETFs)… Drops a lot, you should look at the range of fluctuations in your entire asset… Don’t pay too much attention to the part that is dropping the most. – CAD (Student)

Background: Reminds that when holding leveraged ETFs, you should pay attention to the volatility of the overall investment portfolio rather than a single product, to stabilize your mentality.

What is the real risk of the market? The real risk of the market is your investment return, the real risk is the returns that you should have earned but didn’t, that you will never earn… A drop in losses is not a loss. – James

Background: Redefines investment risk, emphasizing that opportunity cost (missing the upside) is the real permanent loss.

The risk of buying a house is higher than the risk of war… If you treat buying a house like buying slippers, then you can buy a house. – James

Background: Responding to questions about geopolitical risks, compared and pointed out that for ordinary people, financial leverage (such as mortgages) may bring more direct and serious risks.

If you don’t manage your finances and taxes well, you may pay 85% of your assets in taxes in this life, and you actually only get 15%… Saving taxes can save tens of billions. – James

Background: When discussing tax planning, emphasizes its huge impact on long-term wealth accumulation.

Because being poor is also right to do speculation… So it’s also right that most people who speculate are poor… Many people who speculate don’t even know it, they don’t know what they don’t know, which is very strange. – James

Background: When discussing speculative psychology with his daughter, reflected on the relationship between poverty and greed, and that speculators often lack self-awareness.

V. Summary

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This lecture once again consolidates James’s core investment philosophy: taking sufficient cash reserves as a prerequisite for ultra-long-term (15+ years) holding of the Nasdaq 100 index fund. It emphasizes the priority of risk management, especially determining the cash ratio based on individual circumstances and building asset allocation based on this, rather than pursuing a specific Beta value or being driven by market sentiment. The differences in risk perception at different life stages and wealth levels were discussed, and the use of high-risk leverage (such as margin trading) for investment was strongly opposed. In addition, practical advice and warnings were shared on tax planning, retirement preparation, financial service selection, and consumption mentality. The Q&A session delved into the specific problems encountered by students in practice, further clarifying strategy details and risk considerations, such as retirement fund calculation, the view on global diversification, and psychological management techniques (focus on overall portfolio rather than local volatility). Overall, this content revolves around the two words “determination” and “safety,” that is, maintaining strategic determination and financial security in a volatile market, and adhering to the correct principles.