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January 15 - January 23, 2021
By three methods may we learn wisdom: First, by reflection, which is noblest; second, by imitation, which is easiest; and third by experience, which is the bitterest. —Confucius
The most important thing successful investors have in common is worrying about what they can control. They don't waste time worrying about which way the market will go or what the Federal Reserve will do or what inflation or interest rates will be next year. They stay within their circle of competence, however narrow that might be. Warren Buffett said, “What counts for most people in investing is not how much they know, but rather how realistically they define what they don't know.”
At just 20 years old, in his final semester at Columbia, he was offered three invitations, from the English, mathematics, and philosophy departments. Overwhelmed by these offers, he turned to Columbia's dean for advice. By a stroke of luck, a member of the New York Stock Exchange happened to come in to see the dean at the same time and asked him to recommend one of his strongest students. Without hesitation, he introduced him to Ben Graham.
Graham taught his students and his readers that prices fluctuate more than value, because it is humans who set price, while businesses set value.
If Graham were still alive, he wouldn't understand how some companies are valued today. For example, over the last five years, Walmart has earned $75 billion on $2.4 trillion in revenue. Its net margins have been 3.15% and it's lost $3.6 billion in market capitalization. Amazon, on the other hand, has earned $3.5 billion on $490 billion of revenue. Its net margins have been 0.73%, and over this time it has added $350 billion in market capitalization.
In the four years from 1929 to the bottom in 1932, Graham lost 70%. If such a careful and thoughtful analyst can lose 70% of his money, we should be very careful to understand that while value investing is a wonderful option over the long term, it is not immune to the short‐term vicissitudes of the market.
After an 89% peak‐to‐trough decline in the Dow Jones Industrial Average, it was understandable why people would behave this way, and why a generation of investors would never return to the market. The fact that he remained steadfast in his conviction that security analysis was a worthwhile endeavor is nothing short of remarkable.
everybody in Wall Street is so smart that their brilliance offsets each other. And that whatever they know is already reflected in the level of stock prices pretty much and consequently what happens in the future represents what they don't know.
Jesse Livermore is the most famous, maybe the first famous, market speculator. The lesson that investors should learn from Livermore is how dangerous rules of thumb can be.
“Always sell what shows you a loss and keep what shows you a profit. That was so obviously the wise thing to do and was so well known to me that even now I marvel at myself for doing the reverse.”
“A man must believe in himself and his judgment if he expects to make a living at this game. That is why I don't believe in tips. If I buy stocks on Smith's tip. I must sell those stocks on Smith's tip…. No sir, nobody can make big money on what someone else tells him to do.”
Stocks exploded higher in World War I, and 1915 was the best year ever for the Dow, gaining 82%. Stocks doubled in less than two years, and he was once again on the right side, bullish in a bull market. A year shy of his 40th birthday, Jesse Livermore was back.
The stock market finally bottomed in July 1932. The crash left nothing unscathed, the stock market was worth just 11% of what it was three years ago. When the bottom arrived, the rubber band had been stretched so far that stocks experienced the greatest snapback bounce ever, even to this day. Over the next 42 days, the Dow gained 93%, but this time, Livermore was on the wrong side. He got crushed. And after covering his shorts, he made his final mistake, going long at the top. That bounce would prove to be of the “dead cat” variety, and stocks came crashing back down, losing nearly 40% from
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But in 1939 his final attempt at a comeback fell short, he was unable to pull off another miracle, and he was out of opportunities. On November 29, 1940, he took his own life. Court records show that his assets, listed at $107,047, were several hundred thousand dollars less than his liabilities, which totaled $463,517.
“I'll get out when I'm even.” Anybody who has ever bought a stock has experienced this poisonous thought floating between their ears. The unfortunate reality about declines is that the math required to make them whole requires extraordinary acts. A 20% loss requires not a 20% gain to break even, but rather a 25% advance. The deeper the hole, the harder it is to climb out; an 80% loss requires a 400% gain to make your money back.
“What do you call a stock that's down 90%? A stock that was down 80% and then got cut in half.”
“I was seldom able to see an opportunity until it had ceased to be one.”
He tried his hand at gold mining, both with a shovel and with stock certificates. Jaded by the experience he said, “A mine is a hole in the ground with a liar standing next to it.”
When asked about the direction of the markets, Newton replied, “I can calculate the motions of the heavenly bodies, but not the madness of the people.” Isaac Newton actually was one of the smartest people to ever walk the earth, and not even he was able to resist the sight of other people getting rich without him.
Intelligence combined with overconfidence is a dangerous recipe when it comes to the markets.
Investors who confine themselves to what they know, as difficult as that may be, have a considerable advantage over everyone else.
Wandering outside of your comfort zone can be a very expensive journey. You don't see lawyers performing oral surgery or accountants drawing blueprints. Similarly, it is your job as an investor to define your circle of competence and stay within that circle.
Bad behavior is one of the greatest dangers investors face, and traveling outside your circle of competence is one of the most common ways that investors misbehave.
Tsai did have “ten good games,” but the game he was playing was like bowling with bumpers in the gutters. He was throwing the ball as hard as he could, and it was working. But when the bumpers were taken away, in 1968, his investors learned a very hard and important lesson. The Manhattan Fund would lose 90% of its assets over the next few years; by 1974, it had the worst eight‐year performance in mutual fund history to date. A rising market lifts all ships, and Tsai's investors learned a very important lesson: Don't confuse brains with a bull market!
It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so.
Imagine you're wagering on a football game in which the two teams competing are of no rooting interest to you. It's a coin toss. You go back and forth several times, but finally decide to pull the trigger on the team with the less talented quarterback but a stronger defense. After you've walked to the counter and placed your bet, you'll immediately feel much better about your decision than before you parted with your dollars. Kahneman, Knetsch, and Thaler documented this in an experiment in their 1991 paper, “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias.”1
“Intuitive judgments are overly influenced by the degree to which the available evidence is representative of the hypothesis in question.”
And because there are so many lousy stocks, there's a high probability that over time, you will be exposed as an ordinary person, possessing no superior stock‐picking ability than the person sitting next to you. And being wrong again and again and again is mentally exhausting, especially when it comes to something as personal as money. Investors would be a lot better off financially if they would just keep their personal finances personal. We can learn a lot from somebody who takes the exact opposite approach, who is one of the most vocal and public investors of all time.
The key to successful investing, especially when you're a contrarian, is to have people agree with you later. But when you're so public about your investments, whether you're running a hedge fund or your own brokerage account, it makes it so much harder. Dealing with your own emotions is challenging enough. Dealing with the emotions and pressure of others is even harder.
In a winner's game the outcome is determined by the correct actions of the winner. In a loser's game, the outcome is determined by mistakes made by the loser.
Amateur investors, and I'm painting with a broad brush, buy after stocks advance and sell after they decline. Cullen Roche said, “The stock market is the only market where things go on sale and all the customers run out of the store….”
“Fundamentals are how fast the horse runs and expectations are the odds.”
A colleague said, “Druckenmiller understood the stock market better than economists and understood economics better than stock pickers.”6 This was a unique combination.
The first thing I heard when I got in the business, not from my mentor, was bulls make money, bears make money, and pigs get slaughtered. I'm here to tell you I was a pig. And I strongly believe the only way to make long‐term returns in our business that are superior is by being a pig.
In August 1992, Druckenmiller was looking to short the British pound. At the time, Quantum had $7 billion in assets under management and, inspired by his mentor Soros, Druckenmiller looked at selling $5.5 billion in pounds and putting the money in Deutsche marks. It seemed risky to have almost the entire fund invested in a single trade, but Druckenmiller had worked the numbers and was confident it was a winner. Before taking action, he decided to run his idea past Soros. As he described his plan, Soros got a pained expression on his face. Just as Druckenmiller started to second guess his plan,
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The idea of caring that someone is making money faster [than you] is one of the deadly sins. Envy is a really stupid sin because it's the only one you could never possibly have any fun at. There's a lot of pain and no fun. Why would you want to get on that trolley?24
Maybe we all need to have this happen once or twice. Some things can't be taught, they have to be learned the hard way, even if we don't learn anything at all.
There's an old adage in finance, “Concentrate to get rich, diversify to stay rich.”
Mike Pearson was certainly shareholder focused, but that is where he and Warren Buffett's similarities ended. Talking about Pearson, Buffett said, “If you're looking for a manager you want someone who is intelligent, energetic, and moral. But if they don't have the last one, you don't want them to have the first two.”
“Even a horse with a very high likelihood of winning can be either a very good or a very bad bet, and the difference between the two is determined by only one thing: the odds.”5
“Although Keynes was well known for his arrogance and his air of intellectual superiority, the humbling experience of having nearly lost two fortunes changed his thinking on the best way to invest.”21 Keynes did a complete 180, shifting his thinking from being a short‐term speculator to a long‐term investor.
He was able to achieve these results because he stopped trying to play the impossible game of outthinking everybody else in the near term. Figuring out what the average opinion expects the average opinion to be was beyond even one of the most brilliant men to ever lace 'em up. The lesson for us mortals is obvious: Do not play this game! Think long term and focus on asset allocation.
Successful investors construct portfolios that allow them to capture enough of the upside in a bull market without feeling as if they're getting left behind, and a portfolio that allows them to survive a bear market when everyone around them is losing their mind. This is no small feat, simple as this sounds; this is a very difficult exercise.
You only need to get rich once. If you've worked hard or just got lucky and now find yourself in the top 1%, stop trying to hit home runs, you've already won.
The average intra‐year decline for US stocks is 14%, so a little wind in the bushes is to be expected.2 But saber‐toothed tigers, or backbreaking bear markets, are few and far between.
You cannot avoid regrets in this game. You'll buy stuff you wish you hadn't and sell things you wish you held onto. We can learn all about regret by studying one of the most successful investors of all time, Chris Sacca, who has arguably left more money on the table than anyone in the twenty‐first century. There are only eight private companies currently valued at 10 billion or more. Chris Sacca passed on two of them.5
Sacca has four rules of investing, which he shared on The Tim Ferriss Show podcast: He must know that he can have a direct and personal impact on the outcome. The investment must be excellent before he gets involved. Sacca looks to make good things better. He doesn't try to fix something that's not good to begin with. He allows time for a deal to make him rich. He selects deals he will be proud of and commits to them.11
The best way to minimize future regret when you have big gains or losses is to sell some. There's no right amount, but for example, if you sell 20% and the stock doubles, hey, at least you still have 80% of it. On the other hand, if the stock gets cut in half, hey, at least you sold some of it. People tend to think in all or nothing terms, but it doesn't have to be that way. Thinking in absolutes is almost guaranteed to end with regret. Minimize regret and you'll maximize the chances of you being a successful investor over the long term.
I thought that by trading a lot, I could control my destiny. I would later find out that this cognitive bias is so common that there's a name for it; it's called “the illusion of control.” By buying and selling within minutes or hours of each other, I wouldn't be held hostage to the market. It's hard to put into words the level of dumb this line of thinking is. Overtrading is probably the most common mistake that novice investors make, and I was no exception.
What stands out to me, as far as lessons I've learned in the market, is that if you have a liability coming due in the next few months or even few years, do not invest.
