Quote for the Week

As Justice Holmes pointed out, though, “Certitude is not the test of certainty.” What I believe will happen in financial markets and what ends up happening have no necessary relationship. The future is uncertain, and the returns investors earn will depend on the nexus of actions taken and how events unfold. Financial history provides just that: history. Its ability to inform how we think about the future and to affect how we position assets would be dispositive if it were not for the most important feature of capital markets: nonstationarity.

Nonstationarity refers to the degree to which the future does not resemble the past. If it were not for nonstationarity, we could just look to the past and unfailingly predict the future. The richest people would be those with the best databases. Librarians would be firing young aspirants to wealth on reality TV shows. Nonstationarity means that investment judgments are probabilistic and that even the best investment process will lead to undesirable results from time to time. Investment theorist Peter Bernstein noted that even if the expected value of the future were known with certainty, the standard deviation around that value would guarantee results that diverged from the averages, sometimes dramatically, and not always positively. — Bill Miller (source)

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Alot of things must go right to perpetuate a massive fraud. It certainly did for Tino De Angelis and his salad oil swindle in the early 1960s.

How does someone commit fraud with salad oil, you ask? Tino started Allied, a vegetable oil refining business with the goal of becoming the industry leader. He needed growth to achieve that end. So, he borrowed money in a unique way.

Tino used Allied’s existing inventory as collateral for loans. Tanks full of soybean and cottonseed oil were pledged to secure loans. The initial loans came from exporters. Banks, brokerage firms, and more eventually became willing lenders because the warehousing receipts tied to Allied’s inventory carried the name American Express.

Tino scheme was simple. He only needed people to believe the vegetable oil existed, so he created that illusion. He built a network of over 70 tanks that allowed him to pump contents from one tank into another while inspectors checked the contents of a third.

And the contents? A few tanks held petroleum, gasoline, soap stock, and sludge. The majority held salt water…with a thin layer of oil floating on top. In the end, 1.85 billion pounds of inventory was unaccounted for!

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Quote for the Week

I refuse to attach a permanence to anything I see around me — including the pessimism I read today in The Wall Street Journal. With my 60 years of experience, I can’t tell you that any of the enormous developments I’ve witnessed, including two world wars and the spread of communism, have had any identifiable long-term effect on common stock investment.

When I started in the investment business, the first thing that happened was that World War I closed down the New York Stock Exchange for five months. It looked as if the end of the world had happened, but after a year and a half we were in the midst of a raging bull market.

Six months ago all you needed was a minimum of intelligence and a maximum of courage to be bullish. That’s changed, of course. Now it requires less courage but more intelligence to find the values. — Benjamin Graham (source)

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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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