What Is A"Base Case"
Level 3: Master of Mundane
In the fast-paced and often unpredictable world of investment, mastering the ability to navigate the market's ebbs and flows with confidence and composure is a valuable skill. If you've ever wondered how to approach investment decisions without succumbing to emotional impulses, especially during a bull run, this article offers a concise overview.
We will delve into the art of crafting a resilient investment strategy, and this will be your base case, that stands strong regardless of the emotional rollercoaster that financial markets can sometimes become.
Keep in mind: this post is called “What Is A Base Case” not “What Is THE Base Case” because a base case is always subjective and depends heavily on your individual risk tolerance, beliefs and unique disposition. Examples used are never prescriptive, what is important is the logic, reasoning and evidence behind the example.
Differentiating Between Base Case and Best Case
At The Guardian Academy (TGA), we steer clear of the “Best Case” Scenario approach.
Why?
Because Best Case relies on the assumption that everything will unfold flawlessly, disregarding the realities of time and randomness. Future projects are exactly that; a best guess of future predictions with the information we have today. Inevitably, new information will come to light as time passes.
Our preferred mode of operation centers on A Base Case – A scenario grounded in probability. While serendipitous moments may occasionally align with the Best Case, relying on this outcome in your plans is not advisable. We have numerous posts breaking down why we don’t play in the arena of the rigid and dogmatic.
TGA's mission is to help you craft an approach that combines three critical concepts:
These core concepts form the foundation for achieving your objectives with the highest likelihood of success, all within a timeline tailored to your specific needs. We will touch on these briefly to give a bit of context for this article.
Navigating Time And Randomness (Engineering Luck)
We often mention that having a longer time preference is highly advantageous. However, it's essential to clarify that having a long time preference doesn't necessarily mean it will take an extended period to achieve your goals. Instead, it serves as a valuable tool in mitigating the risk of encountering unexpected challenges. Think of it as giving yourself an extra hour for your trip, as opposed to rushing and hitting every red light when you're already running late. Rushing under pressure increases the likelihood of accidents and panic.
Moreover, it's crucial to recognize that randomness is an ever-present factor. The more we build our plans on the Base Case rather than the Best Case, the better we harness the power of randomness, especially when paired with a longer time preference. This is detailed, in depth, in the adaptive dilemma posts.
Scientific Orientation Vs Dogmatic Orientation (The Adaptive Dilemma)
Within TGA we are consistently striving toward maximizing the highest probabilities while minimizing risks. We’ve covered that the adoption of a Dogmatic Orientation tends to seek and expect the absolute best outcomes, whereas the Scientific Orientation encourages a shift towards “risk-adjusted” thinking.
A scientific orientation is about improving your decision making skills through a scientific process. A dogmatic orientation is making a guess and then riding it out. It’s not difficult to discern which one is more likely to yield positive or favorable outcomes, over time.
Solvable Problem™
In the tumultuous waves of extreme market highs and lows, having a clear Solvable Problem™ is your North Star. It anchors you and prevents you from losing sight of your objectives.
The Solvable Problem is a concept we’ve borrowed from Dan Nicholson. His book and other resources from Dan are linked in the Solvable Problem posts.
“Base Case And Chill” Mentality
The idea of "Base Case and Chill" stands as a foundational principle within TGA's philosophy. We strongly advise against blindly adopting someone else's Base Case. Instead, we encourage you to construct your Base Case meticulously, drawing upon your individual logic, reasoning, and the evidence available to you. By doing so, you can confidently relax, knowing that you are firmly on track with the highest probability of achieving your Solvable Problem™.
“Base Case and Chill” means understanding a range of what is acceptable and a timeline that is appropriate so that you don’t have to stress about your investments every minute of every day. In order to base case and chill, you will need to form your own macro belief.
Again, we DO NOT recommend blindly adopting someone else’s - including ours.
How It Works- Overview
Here's a breakdown of how it all comes together:
[Macro Belief]6 X [Strategy] = Base Case.
This equation forms the foundation of your investment approach.
Using your unique [Logic, Reasoning, and Evidence] X [Frequency of Exposure] X [Time Preference] = Chill
This formula helps you maintain a calm and steady course.
When you successfully integrate both of these equations, you attain the state of "Base Case and Chill."
Why This Is Important
The vicissitudes of the market (and of life). How do you guard against the emotions the abs and flows of a market (or life) can evoke?
“It’s going up! I gotta buy in before I miss the train.”
“It’s going down! I gotta sell before I get rugged.”
Fear and Greed will override all of our logic, evidence, and reasoning. This is why we want to make decisions in moments of Sobriety for our Base Case in order to overcome Fear and Greed.
Decisions made in states of fear or in states of euphoria are likely emotional decisions, having a base case allows you to make adjustments in moments of sobriety.
Deconstructing And Reconstructing A Base Case
Here are some example scenarios for a Base Case:
You believe that if you DCA into BTC for 5 years it will get you 30% or more on average. That is a Base Case.
Further, you believe that if you day trade you will do slightly better and if you flip day trading profits into BTC for 5 years it will get you 45% or more on average. That is another Base Case.
Perhaps you believe that if you acquire 1 home that meets X criteria per quarter and they are 75% rented out, you’ll get 18% a year on average over 10 years. Base Case. That’s a base case around real estate.
You can insert any number and asset you have come to [based on your own logic, reasoning, and evidence].
This allows us to ignore the fluctuations in the market day to day, week to week and month to month as long as our base case remains the same.
By doing this, it tells you how to operate. You might be tempted to take more risks and do MORE, which is fine and entirely up to you, just note by doing so you’d lower the probability of getting what you want as defined by your Solvable Problem™.
One of the biggest causes of why people fail is because they get greedy from doing calculations of potential wins and not having a Solvable Problem™ which leads to taking more risk. If you remove all the risk of NOT getting what you want
…Well you’re going to get what you want.
How To Start
Back into Base Case strategies starting with your Macro Belief. Don’t reason forward because there is no end it’s just more and more.
Define Your Macro Belief.
Have Your Solvable Problem™.
Work Out Your Base Case.
Utilize Strategies To Achieve Your Base Case.
As an example: BTC is your Macro Belief and based off your own logic, reasoning, and evidence you believe it will get 30% a year over the next 10 years on average.
Now go back to your Solvable Problem™.
If your goal is 5 million in 10 years with an initial investment of $10,000 and recurring monthly of $7,000 you need a 32.8% annual return. With your Macro Belief of BTC you are pretty much there (30% Versus 32.8%).
You reclaim some resources and reallocate it from the 2 Oreo Principle (recapture and reallocate)7 and now you have $9,000 a month. Your Macro Belief has an overage (28.4% Versus 30%).
You can reason to the next step (your Base Case). From your Solvable Problem™ your additional monthly investment required is $9,000. This means as long as you can acquire $9,000 of BTC a month you’ll be on track to reach your Solvable Problem™.
What is the probability of you getting $9,000 a month to purchase BTC?
If you already have an overage of $9,000 a month then all you need to do is set reoccurring buys daily to DCA. If not, you may want to turn your attention to increasing your income by $9,000 a month. Obviously some people will have an obvious path forward to this, others (especially W2 employees) will not.
You’re done, this is “Base Case and Chill.”
This would be the highest probability (think back to System Reliability)8 if you start adding pieces the system probability goes down. You want as few moving pieces as possible.
On the other hand, if you only have $7000-8000 a month, maybe your route is day trading to make $9,000 of profit to buy BTC that you stash and put away. You don’t continue to trade once you’ve hit that $9,000 a month because now you’re putting your system at risk (using this methodology)
You can pick whatever strategy you think will help you to close the gap to hit the $9,000 a month. You could figure out how to work harder and more efficiently to make more money in your day job.
Can you see how this helps to inform strategy? Once you have backed into the strategy you can execute it going forward in the path.
Strategy –> Base Case –> Macro Belief.
It’s okay if this doesn’t make sense immediately. If you’re a paid member, feel free to use the comments section to get help from experienced Guardians and the team. Remember: if you feel yourself rushing or a sense of urgency, the best thing to do is to slow down - step away from the computer or phone, go for a walk an circle back when the urgency subsides.
NOTE: BTC is not the blanket macro belief of the TGA, not does it make up our base case. We used BTC and Real Estate as an example because they are more mature assets than some of their counterparts, making them good to use as examples.
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