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Two weeks ago, I shared the two qualities that separate great investments from mediocre ones: Resilience and Optionality.

Last week, I showed you what 16 Coffee Can portfolios taught me about the path to 100% portfolio returns.

Today, I’m going to show you how to design such portfolios.

If you’re an individual investor serious about building wealth through concentrated, long-term investing, I believe this is a winning playbook.

If you’re new here, I share “buy-and-hold portfolios” designed to double in 3-5 years. 

My investment approach is simple: find the best stocks I can and let them sit for years. We incur no costs with such a portfolio, and it’s simple to manage.

On Designing Portfolios That Double

Recall, to win at investing, you either have to do something that other investors aren’t smart enough to do, or do something other investors aren’t willing to do.

That means designing a strategy that fits your personality. This is important because it will help you persevere through the inevitable periods of underperformance.

My strategy is heavily influenced by my background in Tech and Venture Capital. That has led me to Approach Stocks Like Venture Capital.

Most importantly, I focus where I have a competitive advantage: exploiting my ability to invest for longer than the average market participant.

Here are 6 principles I keep in mind when building portfolios designed to outperform the market.

1: Hunt For Resilience + Optionality

I covered this in depth 2 weeks ago.

Here’s a quick summary:

• Resilience means the business is durable. It adapts. It survives shocks. It can weather storms.

• Optionality means massive upside potential. New S-curves to climb. Markets to expand into. The ability to become something much bigger than it is today.

The magic happens when you find both in one company.

When it comes to Investing in Mavericks

• Stage 1: Disruptors represent mostly optionality.

• Stage 2: Contenders represent emerging resilience.

• Stage 3: Leaders represent Resilience + Optionality.

As companies graduate from one stage to the next, they de-risk. The best ones retain their optionality, and keep finding new ways to grow.

2: Focus on Risk Sizing, not Position Sizing

Position sizing isn’t about how many dollars you put in.

It’s about how much risk you’re taking.

A 15% bet on a Stage 3 Leader might equal the risk on a 2% bet in a Stage 1 Disruptor.

Why?

Because the Leader is de-risked.

The business is proven.

The range of outcomes is narrower.

You can size it up.

On the other hand, the Disruptor could go to zero… or it could 20x.

So you size it small enough that failure doesn’t hurt, but large enough that success matters.

This is why a well-constructed portfolio has a barbell shape.

The dollars look uneven.

But the risk is more balanced.

You’re not over-risking on your big positions.

And you’re also not over-risking on your small ones.

Here’s a position sizing framework I keep in mind when sizing my bets.

3: Beware Overconfidence and Loss Aversion

We are all filled with cognitive biases. Our brains constantly try to protect us by creating stories and narratives that are simply wrong.

Cognitive biases therefore can easily lead us astray.

Investment guardrails can help us overcome, or at least minimize our biases.

Overcoming Overconfidence:

Almost everyone is overconfident.

If you don’t think you are, that’s probably because you’re overconfident about it :)

Two things that work for me when overcoming overconfidence.

1. Max Bet Size (At Cost)

With our Investing In Mavericks approach, we’re aiming for outsized returns from a small fraction of our bets.

So if we’re right, a little is all we really need to outperform.

And if we’re wrong, we don’t want a very large bet anyway.

Diversification is also a natural side effect of capping starting position sizes.

2. Low use of Leverage

I have learned to avoid margin. Although not necessary, I do use options. But I cap their bet sizes per position and also limit their total portfolio exposure.

Overcoming Loss Aversion:

Everyone dislikes losses.

But that’s not surprising.

What’s surprising is… how much we dislike them.

Loss aversion means we take extreme steps to avoid a definite loss, even when it would be better for us to accept those losses.

A few examples:

• Bill Clinton. He lied about his affair. Rather than coming clean, he hoped instead that the world wouldn’t find out.

• Bernie Maddoff. I doubt he started off as a ponzi scheme.

• If you’ve ever blown up your investing account, you likely fell victim to loss aversion. I know I did.

To overcome loss aversion, here are a few things that work for me.

1. Track your portfolio without dollar values

Look at my Scorecard: no dollar amounts, just percentages.

“Stock X is down 25%” hits differently than “I just lost $50,000!”

As a result, to track my portfolio, I prefer reviewing my scorecard instead of logging into my brokerage account.

2. Make investment decisions outside trading hours

I try to make my buy-sell decisions outside trading hours.

No flashing red numbers.

Just me and the thesis.

3. Don’t use stop losses

Investing In Mavericks is a low hit-rate, high expected value strategy.

We’re betting on Power Law outcomes.

So we know up front, we’ll be wrong often.

Stops are incompatible with this reality.

4: Beware Commitment Fallacy

Here’s a dangerous cognitive bias I wanted to call out separately, particularly because we are building multi-year buy and hold portfolios.

Don’t Mistake Commitment For Conviction:

• Conviction is believing in a thesis because the evidence supports it.

• Commitment is refusing to let go of an idea because we’ve invested ego, time, or money into it.

They feel identical. They’re not.

I’ve fallen into this trap.

You buy a stock.

It drops.

You tell yourself the thesis is intact.

You buy more.

It drops again.

You dig in harder.

You start avoiding information that contradicts your view.

You seek out people who agree with you.

Etc etc.

How to protect yourself:

1. Avoid narrow predictions.

   • “This company has multiple ways to win over the next decade” is better than “This company will win because X will happen by Y date”.

2. Watch for conviction turning into commitment.

   • If you’re holding mainly because you don’t want to admit you were wrong, that’s commitment, not conviction.

   • My simple hack for this is having a minimum 3 year holding time frame. By then, I typically know whether my investment thesis was right or wrong, and enough time has passed from my original decision that I can look at things more objectively.

Speaking of which…

5: Time Is Our Secret Weapon

Our edge isn’t information.

Leave that to the hedge funds.

Our edge is patience.

Most investors can’t sit still for three months, let alone 3 years.

Their impatience is our opportunity.

What I’ve come to realize is that the market tends to be very forgiving, when pricing good assets over the long term.

It makes sense: There will always be demand for a good asset. Just not always when we’d prefer.

6: What to Avoid

Looking back at my losers, the patterns are embarrassingly clear.

Anchoring mostly on cheap valuation:

• Anchoring on valuation while the business crumbles.

Fragile resilience:

• Companies that looked resilient but depended on external factors they couldn’t control.

Narrow predictions:

• Too much riding on being right about one thing, especially in the near term.

Hubris:

• Coffee Can 11 in particular was a result of Hubris.

  • Betting 20% on CWEB, a leveraged ETF, was particularly dumb.

  • It was also pretty clear many stocks were expensively-valued at that time. I was reducing positions in other portfolios. So I should not have been building such a concentrated portfolio like this one, at that time. Instead, I should either have waited or had better asset allocation across other sectors.

But, you live, and you learn.

Three Portfolio Design Templates

There are an infinite number of ways to build a coffee can.

Here are 3 approaches I find compelling:

1. The Classic Can

2. The Barbell Can (With Options)

3. The Barbell Can (Without Options)

Template 1: The Classic Can

This is the simplest approach:

• Only include stocks, no options.

• There are no hard or fast rules, but I prefer 6-8 equal sized bets.

• I find building such a concentrated portfolio during/after a bear market tends to work best. We saw this with Coffee Can 3, 4, and 11.

Template 2: The Barbell Can (With Options)

This is my favorite approach to building coffee cans.

Here’s what it looks like:

• At least 75% of portfolio in stocks that offer both resilience + optionality

  • Individual bet size: 7-15%

• Up to 25% of Portfolio in bets that offer mostly optionality

  • Equity Bets: Individual bet size: 3-5%

  • Option Bets: Individual bet size: 1-2%. I typically prefer longer dated options. Limit Options portfolio exposure to 10%.

The smaller options bets are a great way to help overcome overconfidence and loss aversion.

Plus options provide a flexible way to amplify returns, require low-capital and can generate exponential returns in relatively short order.

In fact, just two days ago, this past Monday, in Coffee Can 16, we sold ALB Calls, which generated a whopping 6.5x (+550%) return in only ~4 months.

If you’re new to options, you can read my Intro to Options series here.

Template 3: The Barbell Can (Without Options):

If you’re unfamiliar with options or prefer not to use them, the good news is options aren’t necessary to beat the market.

Here’s a similar approach to building coffee cans without options:

• At least 75% of portfolio in stocks that offer both resilience + optionality.

  • Individual bet size: 7-15%

• Up to 25% of Portfolio in stocks that offer mostly optionality

  • Individual bet size: 3-5%

Note:

• All the above percentages mentioned are guardrails, not black and white rules.

• As I’ve also said before, investing has no rules… so sometimes I deviate from these guardrails.

The Hardest Part Isn’t Stock Picking

After almost 7 years and 16 Coffee Cans, I find that stock selection is maybe 30% of the game.

The other 70%? Temperament.

• Sitting on your hands when a stock drops 40%.

• Ignoring the urge to “lock in gains” when something doubles.

• Trusting the process when your portfolio lags for months at a time.

Ralph Wanger, who returned 16.3% annually for 33 years (that’s 145x!) at the Acorn Fund, put it perfectly:

Most investments are laundry.

It’s the home runs that change everything.

But to experience them, we have to learn to force ourselves to wait.

The Coffee Can approach enforces this discipline by design.

You make decisions upfront.

Then you wait.

No tinkering.

No optimizing.

No reacting.

Most people can’t do it.

That’s precisely why it works.

In Conclusion:

Over the past three weeks, I’ve given you:

1. The proof: Almost 7 years of market beating results.

2. The framework: Resilience + Optionality, the two qualities that matter most.

3. The lessons: From 100% Portfolio Returns.

And today:

4. The structure.

This is largely what you need, to build your own Coffee Cans.

If you decide to build one, let me know how it goes :)

Thanks, and Happy Investing!

Questions about building your first Coffee Can? Feel free to reply to this email.

And if you liked this article, do please share with a friend. Thank you!