Quote for the Week

Another very simple effect I very seldom see discussed either by investment managers or anybody else is the effect of taxes. If you’re going to buy something which compounds for 30 years at 15% per annum and you pay one 35% tax at the very end, the way that works out is that after taxes, you keep 13.3% per annum.

In contrast, if you bought the same investment, but had to pay taxes every year of 35% out of the 15% that you earned, then your return would be 15% minus 35% of 15% or only 9.75% per year compounded. So the difference there is over 3.5%. And what 3.5% does to the numbers over long holding periods like 30 years is truly eye-opening. If you sit back for long, long stretches in great companies, you can get a huge edge from nothing but the way that income taxes work.

Even with a 10% per annum investment, paying a 35% tax at the end gives you 8.3% after taxes as an annual compounded result after 30 years. In contrast, if you pay the 35% each year instead of at the end, your annual result goes down to 6.5%. So, you add nearly 2% of after-tax return per annum if you only achieve an average return by historical standards from common stock investments in companies with tiny dividend payout ratios…

There are huge advantages for an individual to get into a position where you make a few great investments and just sit back and wait: You’re paying less to brokers. You’re listening to less nonsense. And if it works, the governmental tax system gives you an extra 1, 2 or 3 percentage points per annum compounded. – Charlie Munger (source)

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Quote for the Week

I think the idea of timing or hedging is a very difficult thing for investors to pull off. It is in the nature of the human psyche, we are much more likely—this is a behavioralist kind of argument—to make the wrong choices at the wrong time. We’ve compared returns earned by mutual fund investors—dollar-weighted returns—with returns earned by mutual funds themselves, or time-weighted returns, and the investors seem to lag the funds themselves by almost 3 percent per year. Fund investors put almost no money into equity funds in the late 1980s and early 1990s when stocks were cheap, and then they poured huge amounts of money into equity mutual funds between 1998 and the crash in 2000. Investors also bought the wrong kinds of funds, that is, in the three years leading up to the crash, they put nearly $500 billion into technology funds, telecommunications funds, and a whole new breed of aggressive growth funds we can describe as “new economy” funds. At the same time, they took about $100 billion out of value funds. Then, after the market crashed, they took money out of those aggressive growth funds and put it into value funds. Overall, investors seem to have an innate sense of bad timing. You can actually measure this. – John Bogle (source)

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Ben Graham once alluded to the idea that the market cycle might as well be called the human-nature cycle. Because the rise and fall of speculative behavior follow the same path.

Graham, of course, meant it as a warning.

He saw speculation as an attempt to profit purely off of moves in market prices. Nothing else matters. Not valuation, earnings, cash flows, or what management is doing to improve the business. Just price.

In other words, if you’re buying a stock with the hope of flipping it to someone else at a higher price, then you’re speculating.

The keyword being hope. When you buy a stock for no reason other than you believe the price is going up, you’re going to need it. You might as well be gambling. Decisions based on price alone are almost always emotional and emotions ruin returns.

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Quote for the Week

Being able to recognize when you’re wrong is a godsend… A good bit of the Munger fortune came from liquidating things we originally purchased because we were wrong. Of course, you have to learn to change your mind when you’re wrong. And I actually work at trying to discard beliefs. And most people try and cherish whatever idiotic notion they already have, because they think if it’s their notion, it must be good. And I think, of course you want to be re-examining what you previously thought, particularly when disconfirming evidence comes through. And there’s hardly anything more important than being rational and objective. Just think of all the dumb things you can do in life. Think of the brilliant people who are just utterly brilliant, who’s doing some of the dumbest things. You won’t have any trouble thinking of examples. Most of us can think about our own actions in the last year or two, and we can all pull up an example or two. It’s hard to be rational. — Charlie Munger (source)

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Every great bull market hides some level of fraud, unbeknownst to its victims. Its unique in that the fraudster and the defrauded feel wealthier despite it being an illusion.

It’s Enron before everything blew up. The shareholders felt richer, as did Jeff Skilling and his cohorts, until it all unraveled.

The difference between real wealth versus illusory wealth is what John Kenneth Galbraith called “the bezzle.”

To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in—or more precisely not in—the country’s businesses and banks. This inventory—it should perhaps be called the bezzle—amounts at any moment to many millions of dollars. It also varies in size with the business cycle.

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