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Welcome to The Long Term Investor, a proud member of the Retirement Podcast Network.
A few weeks ago, you may have noticed that Nvidia (NVDA), a chipmaker that has become synonymous with the AI revolution, became just the third company to reach a $2 trillion market capitalization. (The first two companies were Apple and Microsoft.)
Just 12 months ago, Nvidia shares traded at just under $239. As of this recording, it sits at $853 per share.
But here’s the question that’s probably gnawing at the minds of many investors out there:
If the AI boom was so clearly on the horizon, why didn’t more of us see Nvidia’s potential sooner? Why did so many overlook the signs that Nvidia was a key player in the future of AI?
In this episode, I’ll delve into the heart of Nvidia’s recent surge and why it’s not the missed opportunity it might seem.
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NVIDIA Corporation (NVDA): A Leader in the AI and GPU Revolution
Nvidia is a chipmaker, but not the type of chipmaker most people think about.
When most of us think about computer chips, we’re usually thinking about the Central Processing Unit (CPU), which acts as the brain of a computer.
The CPU performs a variety of tasks needed to operate the computer, from running your operating system to browsing the internet. CPUs are incredibly versatile, capable of handling a wide range of computing tasks, but they work mostly in a sequential manner, executing one instruction at a time.
NVIDIA specializes in a different type of chip known as the Graphics Processing Unit (GPU).
Originally, GPUs were designed to render images and graphics for video games, which requires processing a huge volume of simple, repetitive tasks simultaneously.
Unlike the CPU, a GPU is made up of thousands of smaller, efficient cores designed for multitasking at a lower level, making it exceptionally good at processing many parallel tasks at the same time.
So the GPU cores are like having thousands of workers who each do a small, specific task quickly whereas CPU cores are like having a few highly skilled workers who can do a wide range of tasks one at a time.
What’s powered Nvidia’s meteoric rise is their ability to harness the parallel processing power of GPUs not just for gaming but for a broad array of complex tasks, allowing it to become a pivotal player across several high-growth markets such as artificial intelligence (AI), data centers, autonomous vehicles, and professional visualization.
Hearing this description, you’re probably thinking, “Of course, Nvidia will be a prime beneficiary of these secular trends.”
The Obvious Meteoric Rise of NVDA
When I was a stock analyst at the beginning of my career, one of the things that I quickly learned was that massive success stories seem incredibly obvious after the fact.
Anyone that’s invested in individual stocks has almost certainly uttered the words:
“I said it would happen.”
“It had to happen.”
“I knew it would happen.”
Investor or not, probably everyone has made statements like these at one point or another.
That’s because once an event occurs, our brains immediately connect the new information from what happened to related knowledge stored in our memory. By making those connections, the facts we store in our brain strengthen one another.
The more we see things fitting together into a cohesive narrative, the more we feel as though we knew it all along.
And the more time that passes, the more difficult it is to accurately recall the way an uncertain situation seemed to us at the time actually happened. We forget what information was available at the time of the event, as well as our own initial reasoning in support of or against a particular decision.
These tendencies make up what’s known as hindsight bias, which is the tendency to exaggerate what could have been known in advance. As you can imagine, hindsight bias can cause problems and mistakes when we need to evaluate investment decisions.
You won’t ever be able to stop your brain from working the way it does (remember, there’s good evolutionary purpose to things like hindsight bias), but there are some practical ways to prevent it from hindering your decision-making ability in the modern world.
1. Keep Track of Past Decisions and Reasoning
Writing out your predictions, forecasts, and investment ideas creates a valuable source of objective feedback. Reviewing past decisions (both good and bad) improves the quality of your decision-making feedback and reduces the chances of repeating past mistakes.
2. Think Probabilistically
Thinking probabilistically allows us to make rational decisions in the face of uncertainty.
The future is unknowable, but assigning probabilities to potential outcomes allows us to make the best decisions we can given what we know and what we don’t know. Looking back at probabilities you’ve assigned to a range of potential outcomes at the time of the decision may reveal that you acted appropriately based on what you knew at the time.
3. Discuss What Could Have Happened or Consider the Opposite
After knowing an outcome, it’s easy to forget the infinite possibilities that did not occur.
Talking about outcomes that didn’t happen, but easily could have, prevents your natural tendency to throw out information that doesn’t fit with your narrative. As a result, you can gain a more nuanced perspective of any particular chain of events.
4. Inoculate Yourself from Regret
There is a close relationship between hindsight and regret.
Beating yourself up for not buying a winning investment or for not knowing you should have cashed in before an investment turns into a loser are two of the most common ways I see this play out for investors.
Minimizing the Regret of Not Owning More Nvidia
We often feel regret when we can clearly envision the alternative paths we didn’t take and decide those paths would have been better than the one we ultimately chose.
It’s particularly easy to see the alternatives after the fact when you are an investor.
Winning investments, like Nvidia, always find their way to the center of attention. They’re the subject of financial news segments, social media posts, and even conversations with friends or coworkers.
Investing is also highly quantifiable, which can lead us to believe there’s always an objectively optimal decision out there.
If we spend enough time thinking or researching or looking, we could find it. And if there’s an optimal choice, there’s also a wrong one. Knowing that things can go wrong leads many investors to put a lot of pressure on themselves to get it right.
This is largely an illusion, of course; there is no perfect portfolio because we can’t know in advance what investments will win over any given time period.
If we kick ourselves for missing an obvious opportunity, it’s probably because we conveniently forgot it was only “obvious” after the fact.
Good News: You Owned Nvidia All Along
Now here’s the good news…
If you’re broadly diversified and own something like a total US stock market index, you did own and benefit from Nvidia’s gravity-defying rise.
Proponents of diversification, including myself, often highlight benefits of diversification such as preventing a catastrophic loss in one investment that materially impacts your overall portfolio. But the other benefit of broad diversification, particularly when you own the entire market, is that you effectively guarantee that you won’t miss out on the winners.
If you’re holding a total U.S. stock market index fund right now, you have a 3% weight in Nvidia.
And if you’re globally diversified—as I think you should be—then a market-cap weighted index approach still leaves you with about a 2% weighting in the company.
In both circumstances, that’s not an insignificant weight and leaves you well positioned to benefit should Nvidia’s outsized gains continue.
Most people would agree that 2-3% in any one stock would represent a pretty decent sized bet. I realize that not every listener has the same portfolio, but the average investor owns the market portfolio, so the average portfolio has a 2-3% weighting in Nvidia going forward.
Sure, the average investor’s position wasn’t that size 12 months ago when Nvidia’s share price was 3.5 times lower, but to go out and add to such a large position would be very aggressive. And owning individual stocks, regardless of the company, is a lot riskier than most people realize.
Individual Stocks Are Riskier Than You Think
I’ll close out with a message that I find myself repeating fairly regularly: individual stocks are much riskier than you think.
Not only that, picking winners is so difficult that even professional investors whose explicit objective is to do that consistently fail to meet their objective.
See: Should You Invest in Individual Stocks
When you boil it down to the simplest, first-principle level: the purpose of investing is to grow your wealth at a rate that is greater than inflation without taking undue risk.
When you learn enough about how markets work and the implications the stock market being of complex adaptive systems, it’s all but impossible to see buying individual stocks as something that doesn’t fall into the bucket of undue risk.
And when it comes to growing your wealth at a rate greater than inflation, remember that inflation in the U.S. has historically averaged three percent. Meanwhile, the owning the entire stock market has averaged a return that is roughly 7% above the rate of inflation—isn’t that enough?!?!
No portfolio should exist without a financial plan at its foundation. And no financial plan should require you to find investments that earn a rate of return materially higher than the long-term real return (which is the nominal return minus inflation) of 7%.
It’s really boring advice. So boring, that it’s easy to understand why newspapers don’t plaster that on the front page every day.
Good investing is boring. Good investing is mostly about minimizing mistakes.
You might feel like you missed out on Nvidia’s huge gains, but if you were a diversified investor:
(1) you probably didn’t miss out because you had some exposure and
(2) you did so by minimizing the chances of making an unnecessary mistake.
Resources:
- How Hindsight Bias Can Impact Your Investment Decisions
- EP 7: Minimizing Regret
- EP 63: Should You Invest in Individual Stocks?
- EP 14: How Markets Work
- EP 70: Thinking of Markets Like Piles of Sand
The Long Term Investor is edited by the team at The Podcast Consultant
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