Background: What is MicroStrategy?

In 2020, Michael Saylor turned MicroStrategy (MSTR) from a sleepy software company into the world’s first publicly traded Bitcoin treasury vehicle. By raising billions through debt and equity, then converting that capital into Bitcoin, MicroStrategy pioneered a corporate structure that gave investors a stock-market proxy for the world’s most volatile asset.

This strategy has inspired both admiration and criticism. While admirers call it visionary financial engineering, skeptics call it a Ponzi in disguise. The truth, with like most things, lies somewhere in between. Understanding it requires breaking down how it raises capital, how leverage works, what mNAV means, and why tax treatment makes MSTR especially compelling for international investors.

1. The Mechanics: How It Works

• Capital Raising: MicroStrategy issues convertible notes, preferred stock, or new equity.

• Treasury Allocation: Proceeds are used to buy Bitcoin, now the dominant asset on its balance sheet.

• mNAV (Market Net Asset Value): Investors track how much Bitcoin sits behind each share, net of debt.

• Premiums and Discounts: MSTR often trades above its mNAV, reflecting liquidity, accessibility, and the “Saylor premium.”

In essence, MicroStrategy functions like a leveraged Bitcoin ETF - without the ETF wrapper.

2. Leverage: The Turbocharger

Why They Call It “Intelligent Leverage”:

• MicroStrategy uses a mix of debt + equity issuance to buy Bitcoin.

• By selling shares of its Class A common stock, the company capitalizes on its market valuation, particularly during periods of high public interest in Bitcoin

• But the rate of Bitcoin accumulation outpaced dilution, so each share now represents more Bitcoin than before. The slide is management’s way of saying: “Yes, we dilute shares, but we’re adding Bitcoin at a much faster pace - so shareholders are net winners.”

• How do they do this? Leverage.

Leverage is what makes MSTR different from just holding Bitcoin. So far, until in August 2025:

• Debt Raised: ~$7.2B in low coupon, long maturity convertible notes over the past five years.

• Total Debt + Preferred (2025): ~$11.6B.

• Bitcoin Holdings: 592,100 BTC ($63B).

• Net Bitcoin Exposure: ~$51.4B after subtracting liabilities.

That’s a leverage ratio of ~1.2×. Meaning, theoretically:

• If Bitcoin rises 10%, MSTR equity rises ~12-13%.

• If Bitcoin falls 10%, MSTR falls ~12-13%.

• In practice, premiums expand in bull markets and collapse in bear markets -making MSTR’s swing closer to 1.2-1.5× Bitcoin’s move.

Leverage amplifies outcomes for investors. It’s what makes MSTR beloved in bull markets and brutal in bear ones.

3. mNAV: Measuring the Premium

mNAV is the core valuation yardstick for Bitcoin treasuries. Simply, mNAV if a Bitcoin treasury stock is trading above or below the value of the Bitcoin it holds.

• MSTR mNAV urrent Levels (Aug 2025):

  • Self-reported mNAV: ~1.61

  • Diluted share mNAV: ~1.57

  • External estimate: ~1.4

That means MSTR trades at a 40-60% premium to the Bitcoin on its balance sheet. Investors are paying extra for:

• Simplicity (stock vs crypto wallet).

• Accessibility (fits into brokerages, retirement accounts, funds).

• Tax efficiency (lower LTCG of 12.5% vs direct Bitcoin tax of 30% in India).

• Saylor’s conviction and relentless accumulation strategy.

But premiums cut both ways. If sentiment turns, they can collapse - dragging MSTR down harder than Bitcoin itself.

4. The Ponzi Debate

Why Critics Call It a Ponzi

• Reflexive Issuance Cycle: Stock rises → new equity issuance → buy more Bitcoin → stock rises again. This loop depends on continuous new buyers.

• Dependence on Confidence: If the market refuses to buy new stock or bonds, the flywheel stalls.

• Detachment from Operations: Core revenues are irrelevant - the business model is financial engineering.

Why It’s Not a Ponzi

• Transparency: SEC filings disclose every Bitcoin purchase, debt issuance, and share count.

• Real Assets: Bitcoin is liquid and verifiable, unlike fictitious assets in real Ponzi schemes.

• No False Promises: MSTR doesn’t guarantee returns - risk and volatility are front and center.

• Market Choice: Paying a premium above mNAV is voluntary, not fraudulent.

Verdict: Legally speaking, it’s not a Ponzi - but it is reflexive, reliant on market enthusiasm, and vulnerable if capital inflows dry up.

5. Got it, not a Ponzi. So then is it a bubble?

Funnily, MSTR actually trades like a bubble on top of a bubble:

• If Bitcoin itself is in a bubble, MSTR inherits that froth.

• Add leverage and premiums, and MSTR becomes a high-beta Bitcoin bet.

• That doesn’t make it fraudulent - just very speculative.

6. Why Indian Investors Choose One Over the Other?

Reasons to Buy MSTR

• Easy access through international brokerage accounts.

• Embedded leverage for higher upside.

• Stock-market liquidity, options, and institutional eligibility.

• Crypto ETFs fall in a regulatory gray area.

• For Indian investors, the tax code also flips the equation:

  

  This alone makes MSTR structurally more attractive for long-term investors in India. A 100% Bitcoin rally could translate into a post-tax return nearly double via MSTR versus direct BTC.

Reasons to Buy Bitcoin

• Pure exposure, no corporate risk.

• 24/7 liquidity.

• No premium - you get Bitcoin at spot.

• No dilution or dependence on Michael Saylor’s strategy.

• Now if Bitcoin itself becomes just as accessible - say, through spot ETFs globally, simpler custody in traditional brokerages, or tax treatment that equalizes it with equities - then much of this premium (wrapper value) disappears.

Implication: The premium could shrink or even vanish, bringing mNAV closer to 1. In that world, treasury listings behave more like leveraged Bitcoin trackers than unique vehicles with embedded advantages.

Final Take

MicroStrategy is not a Ponzi scheme - but it is a leveraged, reflexive Bitcoin proxy that trades at a premium. For some, that premium is worth it: lower taxes, easier access, and turbocharged upside. For others, the purity of Bitcoin itself is preferable.

The reality is that MSTR is a Bitcoin Bubble. What you’re buying is not Bitcoin, but the mechanics of leverage, premiums, corporate governance, and tax arbitrage.

And that makes it one of the most fascinating financial experiments of our time.

Before you rush in, though, there’s one question worth asking: How do fund managers actually get paid? Because understanding that is key to understanding how your money works in these funds.

Two words: 1Management Fees and Carry. They sound simple, but they’re the building blocks of fund manager compensation and they come with nuances that can shape your returns.

1. Management Fees: The Fund’s Fuel

Think of management fees as the fund’s salary- fixed, predictable, and paid whether or not the fund knocks it out of the park. These fees usually hover between 1.5% to 2.5% of the fund’s committed capital or assets under management (AUM).

What do these fees cover?

• Salaries for the investment team and operations

• Endless research, deal sourcing, and due diligence

• Office rent, legal costs, compliance, etc

Management fees keep the fund running smoothly, but they’re not tied to the overall performance of the fund manager. Whether the fund wins big or falls flat, these fees are still paid.

That’s why carry exists: to reward real performance.

2. Carried Interest (Carry): The Real Prize

Carried interest or simply, carry — is the fun part. It’s the slice of profits fund managers earn after investors get their capital back (and sometimes, after hitting a minimum return).

Typically, carry is set at 20% of the fund’s profits, but for elite funds with a track record to outperform other Tier 1 funds (2Sequoia Capital), it can go up to as high as 30%. For newer funds trying to build trust, it might drop to 15%.

Carry exists for a reason:

• It keeps fund managers hungry to deliver outsized returns

• It aligns the manager’s success with their LPs (investors)

• It rewards the fund’s skill in picking winners and building portfolios

The Hurdle Rate: No Free Lunch

Here’s where it gets interesting. Most funds set a hurdle rate — a minimum return (often around 8% annually) that LPs must receive before the GP (fund manager) gets to taste any carry.

If the fund doesn’t clear that bar, there’s no carry

Why?

• It protects investors from paying for mediocre performance

• It ensures fund managers don’t profit from average returns

Waterfall Structures: Who Gets Paid First

Once profits come rolling in, how they’re distributed depends on the waterfall structure. There are two main ways fund managers decide who gets what, and when:

1. The American Waterfall (Deal-by-Deal)

In this setup, GPs start earning carry as soon as individual deals are exited. So even if the fund does great early on and flops later, managers could still walk away with carry. It’s great for GPs but riskier for LPs.

2. The European Waterfall (Whole-Fund Model)

This is the more LP-friendly structure. GPs only earn carry after the entire fund has returned all invested capital plus the hurdle rate. No shortcuts. It ensures investors are taken care of before fund managers start celebrating.

“Reputational Capital”- The Secret Sauce

At the end of the day, it all comes down to trust. The more established and reputable the fund, the greater their track record, the better terms they can command.

That means higher fees and carry percentages and GP-advantageous structures.

On the flip side, if you’re a first-time fund manager, you may need to sweeten the deal for LPs: lower management fee and carry, and investor-friendly terms until you’ve proven your mettle.

Bottom Line: Why Should You Care?

If you’re an investor dipping your toes into alternative assets or an aspiring fund manager looking to raise your first fund, understanding these mechanics is crucial.

A well-structured fee and carry model ensures that everyone’s rowing in the same direction.

Fund managers make money when they make money for you.

So before committing capital, look beyond the pitch deck and glossy returns. Ask about:

· Management fee

· Carry

· Hurdle Rate

· Waterfall Structure

Because in this game, how the fund manager gets paid can tell you a lot about how your investment might perform.

So what is a mutual fund? Well it’s a relatively simple concept. Several people pool together their money and give it to a fund manager. The fund manager, an expert, buys certain stocks which he/she feels will perform well and give the participants in the fund the returns they are looking for. A mutual fund therefore involves stock-picking, with the fund manager using their expertise to choose specific stocks. Their goal is to build a portfolio which will outperform a benchmark index, the S&P 500 for example.

Sounds great right? It is. Mutual funds are simple and safe products. There are strict regulations on the liquidity management of the funds, and you can withdraw your money at any point in time. However, there are certain downsides. As the saying goes, past performance is no guarantee of future performance, and this is true for mutual funds - there is no guarantee that a fund that has beat the market in the past 5 years will continue to do so over the long-term. Additionally, there is enough academic evidence showing that consistently beating the market over the long-term is near-impossible, particularly when accounting for the higher fees charged by active funds1.

Realising that beating the market consistently in the long-run is near-impossible, asset managers came up with a new type of product - index funds2. The logic behind it was simple. If beating the market is impossible, then the safest and best possible returns can only be derived in one way - by becoming the market. That’s what an index is, it's a weighted average of all the publicly listed companies on the market.

At first, index funds were developed along the structure of a mutual fund. They were priced once a day (at the end of the trading day), according to their net asset value (NAV). The NAV is the sum of the value of all the assets owned by the fund, minus liabilities, and divided by the number of units of the fund sold to investors. However, realising that there was even more efficiencies to be found, in 1990 the Toronto 35 Index Participation Units was launched on the Toronto Stock Exchange. Three years later, State Street Global Investors launched the first major ETF, the S&P 500 Trust ETF, which remains among the largest ETFs to this day. ETFs differ from mutual funds in that they are traded throughout the day, with their market prices fluctuating like stocks depending on supply and demand. Investors can also use margin trading and stop-losses on ETFs, while they cannot do this for mutual funds. These factors make ETFs far more liquid and indeed responsive to market movements. Adding to their benefits over mutual funds, ETFs typically have lower expense ratios (the percentage of fees paid to the investment house for their services), and some don’t even have minimum investment amount requirements, making them far more accessible.

To conclude, ETFs took the idea of index mutual funds, and created a more liquid, cheaper, and more accessible product. Recent years have even witnessed the proliferation of active ETFs. These products create an index, actively picked by the fund manager, and create an index to mirror the performance of the underlying assets. The difference here is that while for an index ETF, the composition of the index is dictated by the market, for an active ETF the members of the index are being chosen with the goal of delivering higher returns. Similar to active mutual funds, active ETFs charge higher fees. While the development of active ETFs is certainly welcome, those who prefer passive investment may want to stick with index ETFs.

Frankly, I never felt the need to write this post as I assumed most are intimately familiar with the concept - some know DCA as recurring investments, others know it as SIPs (Systematic Investment Plans). But a recent check-in made it empirically clear to me that many struggle practicing it. Over the last month, U.S. equities have seen a slight correction, while bonds and emerging markets (China specifically) have outperformed. Yet, 3 out of 5 high-risk investors hesitate to continue investing and want the volatility to cool off. Hearing this, I decided to do a full post explaining DCA.

What is dollar-cost averaging?

Instead of attempting to time the market, investors allocate capital consistently over time, accumulating shares at both highs and lows.

For example, an investor committing $1,000 per month to a collection of tech stocks:

• When prices are high, fewer shares are acquired.

• When prices are low, more shares are acquired.

Mathematically, this leads to an average cost per share that is lower than making a single lump-sum investment at an inopportune time.

Why DCA works in volatile markets

No more timing-risk
Most investors - retail or professional - struggle to predict market tops and bottoms consistently. DCA eliminates the need for precision, ensuring continued market participation. This is especially useful if you’re allocating to passive strategies.

Turns volatility into an advantage
Market fluctuations are inevitable, particularly in high-growth sectors like technology. DCA enables investors to accumulate more shares during downturns, improving long-term returns.

Reduces emotional bias
Investors often buy into rising markets out of a Fear Of Missing Out (FOMO) and hesitate during downturns due to a Fear Of Further Losses (FOFL?) DCA brings discipline to investing, ensuring you’re well poised for the long term.

DCA in the context of U.S. Technology stocks today

Recent corrections in technology stocks, particularly following DeepSeek’s announcement, are another reminder that even strong sectors experience drawdowns. These are often opportunities, not signals to pause investments.

• In 2020, the Nasdaq fell over 30% before rallying to all-time highs.

• In 2022, technology stocks experienced a sharp correction, only to recover in 2023.

• Today, AI-driven stocks have surged, followed by expected consolidation.

A sub-optimal decision in 2020 and 2022 was to stop investing.

Where DCA works best

DCA works particularly well for broad market indices (S&P 500, Nasdaq), sectoral growth themes (AI, clean energy), and collections of stocks. It is not as commonly applied to individual stocks or niche opportunities, where valuation and fundamentals play a larger role. It is optimal to DCA into diversified investment-portfolios, where each asset class is uncorrelated. You get in on the ups-and-downs of each holding at different points in time.

Here’s Jack Bogle, the founder of Vanguard, explaining why DCA is important:

Final thought

DCA is great. But make sure the portfolio you’re averaging into aligns with your risk tolerance. DCA only works if you can stay invested - no point if the market uncertainty keeps you up at night.

The S&P 500 is an incredible index. It’s packed with some of the most valuable companies in the world - Apple, Microsoft, NVIDIA - and it’s grown steadily over the decades. It’s simple, low-cost, and has consistently delivered strong returns. So logically the question I get most from investors is “why not just put all your money in the S&P 500 and call it a day?”

Well, the answer depends on what you’re investing for, how long you’re investing, and how much risk you can handle. The S&P 500 is a powerful tool, but like any tool, it works best when used the right way.

But before we talk about why it might not always be the perfect fit, let’s take a moment to appreciate why it’s so great.

Why beating the S&P 500 is so hard

Marc Rowan, CEO of Apollo Global Management, put it best when he said: “How have active managers done? Well, basically 90 plus percent of the time for the past 20 years, they have failed to beat the index. Did they get stupider? No. The structure of our market has changed. It doesn't mean bad, it just means indexed and correlated. And so an investor, particularly an international investor who wants to express an opinion in the US no longer comes in and buys a basket of securities. They buy the index.” [4:47 in the video above]

That’s what makes the S&P 500 so special. It’s tough to beat. Even the most experienced wealth managers with all the resources in the world often struggle to deliver better returns without taking on more risk.

It’s no wonder the S&P 500 has become a go-to for many investors. Its simplicity and consistent growth make it a hard act to follow. Over the long run, it has outperformed most actively managed funds, and on a risk-adjusted basis, it’s one of the most efficient tools out there for building wealth.

But it’s not always the right tool for every situation.

Why it shouldn’t be 100% of your portfolio

The S&P 500 is great, but depending on your goals, it might not give you everything you need.

1. Different goals, different strategies
Imagine you’re saving for your child’s education. When the goal is 15 years away, you might start with a portfolio heavily invested in equities like the S&P 500. But as college gets closer, sticking with all stocks becomes risky. You’d want to gradually shift toward more stable investments like bonds to protect what you’ve built.

2. Diversification matters
The S&P 500 only covers large U.S. companies. It leaves out international stocks, bonds, real estate, and other asset classes that help reduce risk and smooth out returns over time. A well-diversified portfolio across asset classes and geographies can perform better in different market conditions.

3. Markets aren’t always predictable
The S&P 500 has had long stretches of growth—but also periods of decline. If you’re investing for retirement or a short-term goal, riding out a downturn may not be an option. Adjusting your strategy to balance growth and protection is key.

A full toolbox for building wealth

At Paasa, we’re big fans of the S&P 500, but we go beyond it. Our portfolios fit different goals, time horizons, and hence risk profiles.

We mix passive strategies (like the S&P 500) with rebalances when needed. We diversify across multiple asset classes and use mean-variance optimization, based on Modern Portfolio Theory, to aim for the best balance of risk and reward. And as your life and market conditions change, we adjust your portfolio to keep it on track. This is the exact strategies that companies like Vanguard, Schwab, and Wealthfront use for their HNI clients in the U.S.

Think of the S&P 500 as a hammer—it’s great for certain jobs, but it’s not the only tool you need. We give you the full toolbox.

The bottom line

The S&P 500 is an incredible starting point. But building sustainable wealth takes more than one index. Your portfolio should reflect you—your goals, your time frame, your tolerance for risk.

We believe smart investing is about creating a plan that grows with you, balancing long-term growth with preservation along the way.

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This practice is known as currency hedging, and on paper, it almost seems like a no-brainer. Interestingly, we learned that all that glitters may not be gold.

Here, we explore the nuances to currency hedging.

Studying in the UK

The UK is a popular destination for students who want to pursue higher education. Close cultural links with India, simple(r) immigration policies, and ease of access all make it ideal. However, the sliding value of the Indian rupee has made studying in the UK a far more expensive endeavor in recent years. But what if you had saved in 2020, for studies in 2022-2025, two to five years in advance.

A top-tier university in London costs roughly between £20,000 to £27,000, depending on the course. Combined with living expenses, the bill rises to close to at least £100,000 for a three-year undergraduate degree. Today, this translates to ₹1.05 crores at today’s value. But five years ago, this figure was 13.58% lower, at ₹93.44 lakhs.

The solution seems simple right? Save in pounds. But there are a few key points. First of all, every currency has its vulnerabilities, influenced by foreign and domestic policy. The pound saw massive falls in early 2020 (Russia’s Ukraine invasion) and mid-2022 (Liz Truss’ disastrous economic policies). While the currency has since recovered steadily for a myriad of factors, such shocks can hardly be protected against.

This model also doesn’t account for two of our favorite topics: opportunity cost and taking risks.

Opportunity cost of the hedge

Education requires dedicating saving, which means no high-risk assets and stable savings accounts or overnight mutual funds. In January 2020, the Bank of England's interest rate stood at 0.1%, spiking to 5.25% to combat inflation in 2023, and now stands at 4.75%.

If £100,000 is held in a savings account, assuming a bank rate, five years later, you would have £113,073. (Note that this figure is almost exactly the same as the difference in GBP vs INR over five years). That’s an increase of 13% over the five years.

Now let’s assume you saved the same amount in India, taking advantage of the much higher interest rates. Given the impact of COVID and inflation, rates in India fluctuated too, falling to 4% and all the way up to 6.5% at their peak and current rate.

Over our five-year period, the initial ₹92.44 lakhs would increase to ₹1.22 crores, or £115,000 after 5 years, an increase of 32.91%. Notably, this increase covers both the currency depreciation (13.6%) and the interest in GBP (13%) and adds another 6.9% on top. This final amount is the opportunity cost the hedge.

In an ideal free market, currency appreciation in one country is covered by higher interests in the other.

Risk

Currency can quickly move against you as well. As we saw in our pound vs rupee analysis, sharp decreases can suddenly leave you exposed, and with the entire corpus already in one currency, there are few options other than waiting. This means holding in INR is the better solution over a long period, assuming a similar high-yield savings account.

It should be noted that education savings should never be conflated with investments. We’ve gone into great detail about how diversification of assets is key to a burgeoning portfolio and long-term benefits. Moreover, given the instability of even major currencies that we’ve seen above, having a nest egg abroad is vital to planning.

An efficient market will be able to balance the risk of currency arbitrage with higher interest rates, making risk unnecessary. While markets can face plenty of bubbles and shock changes, the rupee follows this hypothesis today.

Learn more about Paasa and our investment thesis here.

John Templeton, among others, made rebalancing a cornerstone of his approach. Templeton used an early version of the cyclically adjusted price-to-earnings (CAPE) ratio to estimate valuations for the overall U.S. stock market. Essentially, his advice was: if valuations are too bubbly, sell; if less bubbly, buy.

And you guessed right: he is the Templeton in Franklin Templeton.

Rebalancing, in a nutshell

So what is rebalancing? You’ve picked a portfolio that has a certain allocation - say it’s a 90-10 portfolio (90% equity, 10% bonds). Over time, the portfolio drifts away from that allocation - perhaps after a long bull cycle, the composition is now 95-5. ‘Rebalancing’ brings it back to the original allocation. An advisor would ‘rebalance’ in order to normalize the allocation back to 90-10.

Why do we bring it back?

The simple answer is you don’t want to take on too much or too little risk. You want to take on the level of risk you agreed to take.

When your portfolio shifts from 90-10 to 95-5, you become overexposed to equity. This means the portfolio is more volatile - more risky - than you had initially started off with. So when the market corrects, a 95-5 portfolio will get hit harder because there’s lesser cushion from the bonds and more swing from the equity.

For more on how risk impacts gains, check out our detailed piece on risk.

Back to rebalancing.

For investors, the alpha often lies in 1) how and 2) when the rebalancing happens. This, empirically, is the difference between a good and bad financial advisor.

How should I rebalance?

1. Sell here, buy there: You use the proceeds from a sale of one asset to rebalance your portfolio. If you’re selling at a profit, i.e, paying capital gains tax, you should avoid this method unless absolutely necessary.

2. Draw money from bank: Not so bad if you have dry powder (uninvested cash).

3. Use dividends: Second best way to rebalance. You’re not dipping into your bank account - just effectively using the dividends from your existing holdings.

4. Tax Loss Harvesting (TLH): Best.

   1. Example: Suppose your equity allocation drifts from 60% to 70%. To rebalance, you identify underperforming stocks within your equity holdings and sell them. The losses offset gains elsewhere, minimizing the tax impact, while the proceeds fund the bond purchases needed to restore balance.

So according to Paasa’s Hierarchy of Rebalancing ∆:

When should I rebalance?

Fixed period

Fixed-period implies the rebalance happens every month, quarter, half-year.

The key here is frequency. Ideally, the frequency would align with market cycles. Too much rebalancing could take away the gains, especially if there are transaction costs. Too little rebalancing could worsen the ‘drawdowns’ (another term for downswings).

You want your fixed-period rebalance frequency to ideally coincide with the market cycles. So you rebalance just before the down trend or up trend starts.

Data Point: A Morningstar study found that quarterly rebalancing balances returns and risk more effectively than monthly or annual rebalancing in most cases.

Drift band

This method ignores the calendar. Instead, it focuses on how much your portfolio has deviated from the target composition. For example, if your equity allocation is off by ±5%, rebalance!

Paasa uses a ±5% drift-band to rebalance.

Limitations of rebalancing

Let your winners win

Many investors sold NVIDIA too early when it surged from 10% to 40% of their portfolio. You might think, “If it’s going up, then why don’t you let it go up.” This sounds reasonable. But this is hindsight bias: most stocks don’t trend upwards indefinitely.

However, overbalancing can stifle growth. Broad Market ETFs might benefit from regular rebalancing, but for concentrated bets (like NVIDIA or angel investments), rebalancing could reduce outsized gains. Venture capitalists often write-off most investments, relying on a single winner to return their entire fund. Rebalancing is clearly counterintuitive in such cases.

If you think you have a potential winner in your portfolio, evaluate fundamentals and market outlook before agreeing to an algorithmic rebalance.

I didn’t know they were related!

A diverse portfolio typically includes assets with varying degrees of correlation. Equities and bonds are usually uncorrelated, except during times of economic stress, like when inflation and real interest rates are both high. In these cases, they can move in sync.

In such cases, you might want to reconsider your entire portfolio composition rather than just rebalancing.

Transaction Costs

Frequent rebalancing incurs trading commissions, which can eat into returns. While Paasa offers zero-commission transactions, investors should still generally be cautious of overtrading.

Final thoughts

When done systematically, rebalancing helps prevent your investments from becoming suboptimal. At the same time, recognize situations where rebalancing might not be appropriate or when you need to rethink your portfolio strategy altogether.

So, (how) do you rebalance?

When it comes to index investing, you might also notice terms like ETFs and mutual funds. In short, ETFs are exchange-traded funds that can be bought and sold in real-time with the markets and ‘passively’ follow the index. Mutual funds, in comparison, are actively managed by fund managers and can only be bought and sold at the end of each day based on their value. Each fund has its own pros and cons, with ETFs promising lower fees and mutual funds promising higher returns.

Today, let’s talk about index funds and why you should consider them.

Compounding gains

If you’re investing abroad for the first time it’s hard to look past names such as Nvidia or Tesla, which have given shareholders outsized returns over the last few years. Last year, Nvidia's stock surged by 239% and Tesla's by 102%. The S&P, meanwhile, returned a more modest 24% in the same period. However, what makes the S&P, or most index funds for that matter, more promising is the stability of returns. While Tesla stock may go up or down based on the word of the CEO, with the stock seeing some worrying drops several times over the years, the S&P has provided an impressive 10.26% return on average since its founding in 1957.

While each individual year’s performance might vary, history has shown the S&P to be a safe haven for investors, allowing money to compound at over 10% without significant risk. The same reasons that apply to diversification of wealth can be transferred over to stocks: don’t keep your eggs in one basket. But with index funds changing composition based on the size of companies, your benefit rises as one outperforms the other, ensuring you don’t miss out on all the action of a single stock.

A classic example to illustrate the power of compounding is if you invested $100 in an S&P 500 index fund ten years ago. Today, that amount would have risen to $290, or $345 if you reinvest the dividends. But investing is never a one-off task; dollar-cost averaging calls for smaller investments at regular intervals to prevent sudden shocks to your portfolio.

Regular investing is where the compound interest truly shines. If you start with $100 and put in the same amount every year for 20 years, you’ve invested $24,100 in that period. Assuming the same 10.26% average S&P 500 return from earlier, you will now be sitting on $79,319 and change. Continue this practice for 30 years and that figure rises to $241,121 and if you start at 25 and withdraw your money upon retirement at 65, you’ll have an impressive $690,566, all with $100 every month. It’s no wonder that Albert Einstein called compound interest the “eighth wonder of the world.” Here’s that number visualized.

Learn more

If you still are wary of risking a good chunk of your savings in a single index, there are more options out there. Investors with more risk might opt for the NASQAD 100, which excludes financial stocks in favor of other fast-growing categories, or a basket of stocks that are specific to an industry. Each come with their own risks, a topic we covered in detail a few weeks ago.

At Paasa, you can choose between low-, medium-, and high-risk portfolios depending on your personal goals. If you want to look at how we pick our ETFs, read here. At the end of the day, every opportunity comes with risk, but as far as investing goes, index funds might be the closest thing you find to a ‘safe bet.’

The Power of a Well-Chosen ETF

Think of an ETF as the engine under the hood of your investment vehicle. The sturdier and more efficient that engine is, the smoother your financial journey becomes. A poorly chosen ETF can slow you down with high fees, make you swerve off track with unexpected performance issues, or leave you stuck in traffic when you need liquidity the most. On the other hand, a carefully selected ETF can help you glide toward your goals with minimal friction.

Criteria for Selecting ETFs at Paasa

At Paasa, we do not just pick ETFs off a shelf. We use a meticulous, criteria-based approach to ensure that every ETF we include has what it takes to help your investments thrive. Here are the key factors we evaluate:

1. UCITS Compliance:
   UCITS (Undertakings for Collective Investment in Transferable Securities) standards exist to protect investors and improve transparency. UCITS-compliant ETFs are typically easier to own across multiple countries in Europe and often feature robust regulatory safeguards. In short, UCITS compliance helps ensure that the ETF you are buying is held to high investor protection standards.
   

2. Low Expense Ratios:
   Every euro you pay in fees is one euro less working for you. We look for ETFs with low expense ratios so that the majority of your investment gains remain in your pocket. Over time, these savings can add up to a significant difference in your total returns.

   

   
   

3. Reputable Asset Managers:
   Trust matters. We focus on ETFs from well-established brands like iShares and Vanguard. They have a proven track record, strong risk management frameworks, and robust infrastructures to handle market turbulence. By selecting ETFs from these managers, we know that the fund is in expert hands.
   

   

   
   

4. High Liquidity:
   Liquidity is your ability to get in and out of the market easily. High liquidity means tighter bid-ask spreads and quicker execution times. This reduces the hidden costs of trading and ensures that when you need to rebalance or withdraw, you can do so without unnecessary hassle.
   

5. Low Tracking Error:
   The point of an index ETF is to mirror its benchmark. A low tracking error means the ETF closely follows the index it is designed to track, so you get what you expect. If you invest in an S&P 500 ETF, you want it to follow the S&P 500, not meander away from it. By choosing ETFs with low tracking errors, we ensure performance reliability.
   

Pulling It All Together

By following these criteria, Paasa strives to give you an investment experience that is both rewarding and reassuring. UCITS compliance ensures investor protection and broad accessibility, low costs keep more gains in your hands, and reputable managers maintain product quality. With high liquidity and minimal tracking errors, you stay close to your intended benchmarks and maintain the flexibility to pivot as needed.

In a world flooded with ETF choices, Paasa takes the guesswork out of selection, enabling you to focus on your goals. Whether you are eyeing developed markets, emerging economies, corporate bonds, or tech-heavy indexes, our approach aims to help your investments stay on the right track.

Imagine a farmers’ market where

• Everyone knows exactly what each apple is worth

• Vendors adjust their prices instantly based on demand

• Shoppers move quickly to get the best deals.

There’s no room for overpriced apples - or underpriced ones - because everyone has the same information and acts on it immediately. This is an efficient market.

An efficient stock market is one where every stock's price reflects all available information. If new information comes out, prices adjust quickly, leaving little room for hidden opportunities or outsized profits.

Efficiency doesn’t happen naturally, though. Markets evolve, often after major disruptions that force them to become more transparent and reliable.

The Enron Fiasco: A Catalyst for Market Efficiency

One such disruption was the Enron scandal. My father started his career at Arthur Andersen, an accounting firm with a long history—and a dramatic fall. Enron, one of Andersen’s clients, manipulated its financials to inflate its stock price. When the fraud unraveled, it destroyed the companies and broke investor trust.

This led to the Sarbanes-Oxley Act of 2002, a law requiring stricter financial disclosures from public companies. The impact was immediate:

• Stock prices became less volatile around earnings announcements.

• Investors had better information, reducing surprises.

• Markets became more predictable (or at least, less unpredictable)

I’ve heard the Enron story many times now, but only recently did I contextualize how Sarbane’s Oxley shaped the way markets work today.

The tl;dr is markets are efficient because traders, analysts, and institutions are constantly processing information. A company releases earnings? Prices adjust. Interest rates change? Markets react. More transparency, more accuracy.

The speed and accuracy of these adjustments define how efficient a market is.

Why Beating Efficient Markets Is So Difficult

This shift toward efficiency has made beating the market in developed economies like the U.S. extremely hard. Over 90% of active fund managers fail to outperform the S&P 500 over a decade.1 Why? Developed markets are generally dominated by institutions and investors with:

• Better data

• Faster systems

• More experience

• More literacy

This makes the market very efficient.

Still, no market is perfect. The dot-com bubble and, more recently, the GameStop saga showed that even efficient markets can be swayed by hype and human behavior.

I think these moments are reminders that markets are made of people, and people aren’t always rational. But outliers are exceptions from the norm: they don’t change the fact that developed markets are tough to beat.

The Opportunity in Developing Markets

In developing markets, the story is different. Challenges like:

• Limited information

• Cronyism

• Financial illiteracy

distort prices in these economies. For those who analyze and act decisively, these inefficiencies do lead to rewards. This creates more opportunities for skilled investors. For example:

India

• Large-Cap Funds: About 52% of actively managed large-cap funds fail to outperform their benchmark: S&P BSE 100

• Mid and Small-Cap Funds: About 74% of mid and small-cap funds fail to outperform their benchmark: S&P BSE 400 MidSmallCap Index

Japan

• About 70% of Japanese equity funds fail to outperform the S&P Japan 500 index

These numbers may not be stellar for most financial advisors, but they’re still a clear improvement over the 90% failure rate among U.S. advisors. However, even this edge is fading. As regulations tighten, tools improve, and financial literacy grows, less-efficient markets are steadily catching up, becoming more efficient over time:

The Bottom Line

For Paasa, the key is understanding the market in and choosing the right strategy where needed.

In efficient markets, we prefer riding the wave with a collection of index funds. Eugene Fama’s work on Efficient Market Hypothesis (Nobel Prize winner) explains why investors should prefer index funds. These funds don’t try to beat the market—they simply match its performance, offering a low-cost, reliable way to invest.2

John Bogle said it best, “Don’t find the needle in the haystack, buy the haystack.”

I think most people don’t think about risk deeply enough. They see it as something to avoid or something to endure, but rarely as something they can quantify and manage to drive better outcomes. But risk isn’t inherently good or bad. It’s a tool - and when you understand how to use it, you can create outcomes most people never imagine.

What’s counter-intuitive is you don’t always have to take on more risk to achieve better returns. This isn’t just a theory. It’s a principle grounded in math, strategy, and a willingness to look at the bigger picture.

Before we get into how to do this financially, let’s break down risk.

What is Risk?

At its core, risk is the possibility of loss. In finance, it’s the chance your investments won’t perform as expected. But risk is interesting: it’s also the mechanism that makes growth possible. Without it, there’s no progress - or there is risk-free progress, which generally is the slowest form of progress.

In a portfolio, there are two main types of risk to understand: systematic risk and unsystematic risk.

Systematic Risk is the kind of risk you can’t avoid. It’s the big - macro - stuff: inflation, interest rates, geopolitical uncertainty. Think of it as the weather: you can’t control it, but you can prepare for it.

Unsystematic Risk, on the other hand, is specific to individual companies or sectors - more micro. Imagine putting all your money into one company. If it fails, your portfolio fails.

Measuring Risk

In finance, risk is something you can measure. Every asset has a level of risk, often expressed as standard deviation, which tells you how volatile assets are, or, how much its returns might fluctuate.

• Stocks: Relatively high risk, with a standard deviation of ~15% annually.

• Bonds: More stable, around 3-5%.

• Cryptocurrencies: Wildly unpredictable, often exceeding 80%.

But these numbers only tell part of the story. What matters most is how the assets in your portfolio interact with each other. This is where diversification comes into play.

Diversification: Smarter Risk, Better Outcomes

Diversification is about spreading your investments - thoughtfully. It’s the difference between throwing darts and playing chess.

Start with unsystematic risk. This one’s easy. Spread your investments across different industries and companies, and this kind of risk largely disappears. You can do this with a Broad Market ETF or Mutual Fund.

Systematic risk? That’s trickier. Even so, diversification can help here too. By spreading your investments across:

• Asset Classes: Stocks, bonds, real estate, and commodities. These react differently to changes in the economy.

• Currencies: Holding assets in multiple currencies hedges against the risk of one losing value.

• Geographies: Investing globally reduces dependence on any single region’s economy.

I imagine diversification as building a network of safety nets. If one fails, another is there to catch you. It doesn’t eliminate risk, but it transforms it into something more manageable - and even more valuable.

The Math Behind Diversification

This is where diversification becomes more than common sense. Statistics prove it. The key is covariance, which measures how two assets move relative to each other.

If one asset zigs while another asset zags, their covariance is low. A portfolio built with low-covariance assets is less volatile, which means it’s less likely to experience wild swings.

I feel like this is a lot like running a casino. A single blackjack table is risky - a lucky player could cost you a lot. But with 500 tables, randomness evens out, and the casino’s returns become predictable. Diversifying your portfolio works the same way. It takes what might look risky in isolation and turns it into a much more stable system.

This chart shows how each asset class is correlated with another asset class. High correlation mean they tend to zig together; low correlation means they don’t necessarily have to. For example, it’s clear that ‘Gold and other precious metals’ have low correlation with ‘U.S. large company stocks’.

Image Credits: Schwab Intelligent Portfolios™ Asset Allocation White Paper

Risk vs Return: A Real Comparison

Let’s consider the S&P 500 (^GSPC), a benchmark for U.S. equities.

Turns out, by building a portfolio that includes U.S. stocks, international equities, and bonds, you can beat S&P’s returns while taking less risk. We did this with our Paasa High risk portfolio, a globally-diversified collection of assets. See the comparison below.

Returns - The chart below shows the total returns over the last 5 years -

Charted on Nov 16, 2024.

Risk - The chart below shows the rolling one-month volatility over the last 5 years -

Charted on Nov 16, 2024.

That ~5.5% delta in returns over 5 years might not seem like much, but over decades, it compounds into a transformative financial advantage. All this while dealing with a noticeably lesser degree of fluctuations than the S&P.

You can learn more about this portfolio on the Paasa app.

The Takeaway

Risk is one of the most misunderstood concepts in finance and in life. It’s not something to avoid. It’s something to understand and manage. The people who succeed aren’t the ones who fear risk or take it blindly. They’re the ones who approach it with strategy and a clear vision.

So, the next time your financial advisor talks about risk, ask yourself: is this the kind of risk that creates opportunity, or is it the kind that leads to failure?