Investing is rarely a problem of asset selection; it is a problem of mathematical categorization. Most portfolio failures stem from a “Category Error”: treating a volatile asset that requires harvesting as a compounder, or treating a durable compounder as a trade.
This framework proposes a wealth architecture segmented into functional ‘Buckets.’ While the market as a whole is governed by the same forces, different assets express these forces differently.
Therefore, we do not group assets by sector or geography. We group them by their Dominant Mathematical Nature:
-
Bucket 1 optimizes for Skewness (capturing the winners).
-
Bucket 2 optimizes for Ergodicity (durability over time).
-
Bucket 3 optimizes for The Power Law (asymmetric upside).
By matching the strategy to the math, we avoid the fatal error of treating a Power Law asset like a Compounder, or a Compounder like a Trade.
I. THE THEORETICAL FOUNDATION
Before defining the buckets, we must clarify the forces at play.
1. Skewness (The Bessembinder Law)
Hendrik Bessembinder’s research demonstrated that stock market returns follow a Positive Skew.
-
The Reality: The median stock underperforms Treasury bills. A tiny minority (approx. 4%) generates the entirety of the market’s net wealth.
-
The Implication: In a concentrated portfolio, the statistical probability of picking a long-term loser is high.
2. Ergodicity (The Time Problem)
While Bessembinder defines the distribution of returns, Ergodicity defines the experience of the investor.
-
The Ensemble Average: If 1,000 investors play a game once, the group may show a profit.
-
The Time Average: If one investor plays that game 1,000 times, they may go bust.
-
The Conflict: High-volatility assets are Non-Ergodic. The volatility drag (variance drain) ensures that your personal compounded return will be lower than the asset’s average return.
The Solution: We must segregate assets based on their Ergodic nature.
BUCKET 1 — THE INDEX
Systemic Survival
Function
To guarantee exposure to the economic system’s average return without the risk of individual ruin.
Mathematical Nature
-
Ergodic: The index survives over time.
-
Self-Cleansing: It systematically deletes losers (Left Tail) and adds winners (Right Tail).
-
Skewness Capture: It automatically owns the “Bessembinder 4%” without requiring prediction.
Management Rule
-
Passive Buy & Hold.
-
Zero Optimization.
The Axiom: The Index is not designed to be intelligent. It is designed to be immortal.
BUCKET 2 — THE COMPOUNDERS
The Engine of Wealth Creation
Function
To generate wealth through Endogenous Growth: retained earnings reinvested at high rates of return over long durations.
Mathematical Nature
-
Effectively Ergodic: While individual stocks carry risk, high-quality compounders possess such durability that the “absorbing barrier” (bankruptcy) is statistically negligible.
-
Time-Dominant: The return is driven by the duration of holding, not the variance of price.
Structural Criteria
A valid Compounder must demonstrate:
-
High & Sustainable ROIC: Evidence of a moat.
-
Reinvestment Runway: Ability to redeploy capital internally (Organic Growth > Financial Engineering).
-
Low Volatility of Operations: Cash flows are predictable, rendering stock price volatility essentially “noise.”
Management Rule: Buy & Monitor
In this bucket, Volatility Harvesting is a mathematical error.
Selling a compounder to “lock in profits” interrupts the exponential curve. The tax paid and the friction incurred permanently lower the terminal wealth.
The “100-Bagger” Clarification
The rare 100x outcomes are not a separate category. They are the extreme, a-posteriori expression of Bucket 2 when durability and reinvestment persist long enough for both earnings growth and multiple expansion to compound.
A “100-bagger” is simply a Bucket 2 asset that was:
-
Mathematically valid (Compounder).
-
Held for a sufficient duration.
-
Not interrupted by the investor.
BUCKET 3 — THE AMPLIFIERS
Capital Acceleration
Function
To accelerate capital growth by exploiting Volatility, Convexity, and Individual Skewness.
Mathematical Nature
-
Non-Ergodic: High risk of ruin. High volatility drag.
-
Bessembinder Dominant: The majority of these assets will eventually mean-revert or fail; a few will deliver asymmetric returns.
The Role of Volatility Harvesting
Because these assets are Non-Ergodic, “Buy & Hold” is dangerous. The volatility acts as a tax on compounding.
Therefore, Harvesting is Structural.
-
We systematically trim excessive deviations (Right Tail events).
-
We recycle that “fragile paper wealth” into “anti-fragile assets” (Bucket 1, Bucket 2, or Cash).
Management Rule
-
Aggressive Rebalancing.
-
Tax as Insurance: Capital gains tax is the premium paid to insure against the asset returning to zero.
-
Zero Attachment: An amplifier is not a pet; it is a utility.
II. THE CRITERIA OF UNTOUCHABILITY
When does a Bucket 2 asset earn the right to be held forever, regardless of valuation or volatility? This occurs when the Investor becomes a greater risk to the compounding process than the Asset itself.
A stock becomes “Untouchable” when five conditions accumulate:
-
Invariant ROIC: Return on Capital remains high across multiple economic cycles.
-
Frictionless Reinvestment: The company absorbs massive capital without diluting returns.
-
The Moat Paradox: The larger it gets, the stronger it becomes (Network Effects/Scale).
-
Non-Existential Volatility: Daily price swings no longer threaten the portfolio’s survival.
-
Inverted Asymmetry: The risk of selling (tax friction + opportunity cost + error in re-entry) mathematically exceeds the risk of holding.
The Intervention Risk:
At this stage, the primary cause of compounding failure is Interruption Risk—the human urge to “do something.” Inaction becomes a strategic competence.
III. THE GOLDEN RULE OF THE SYSTEM
Functional Integrity
A portfolio fails when assets are forced into roles they cannot perform.
-
An asset destined to be Harvested (Bucket 3) will rarely become a 100-bagger.
-
An asset destined to Endure (Bucket 2) must never be optimized via trading.
Final Synthesis:
-
Bucket 1: Survive the System.
-
Bucket 2: Let Time Create Wealth.
-
Bucket 3: Accelerate without Ruin.
Wealth does not come from what you optimize. It comes from what you identify correctly—and then leave alone for a very long time.