Henry Petroski, through historical examples, explains the paradox of the engineering design process. Successful designs bring an opportunity to take risks and stretch the limits of design while each failure is an opportunity to learn and innovate on the next one.
Weekend Reads – 4/19/24
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)
Challenging the Process
Investing, by nature, makes it hard to separate good decisions from good luck. Uncertainty, randomness, and noise muddy results. Anything can happen in markets in the short run.
In addition, human nature drives us to be outcome-biased. We tend to judge decisions based on the outcome instead of on the quality of the decision made.
We see this often in sports. Fans praise coaches and players when the team wins. They criticize them if they lose.
- Wins = Good Decision
- Losses = Bad Decision
That’s the outcome bias. There’s no accounting for the riskiness or soundness of the strategy or decisions during the game. There’s no nuance.
Yet, sports are dominated by uncertainty. Any team has a chance to win any one game. This is how great teams lose to underdogs. Everything seems to fall in line for the lesser team and they come out on top. Continue Reading…
Weekend Reads – 4/12/24
Quote for the Week
Volatility matters on only two levels. First, if two portfolios have equal average returns, the portfolio with the lower volatility will earn the higher compound return. On the other hand, investors understand this phenomenon – either intellectually or intuitively – and tend to price volatile securities accordingly. The second consideration in volatility is much more important: when is the owner of the principal of the fund going to disburse that principal? A fund that is tied up in perpetuity could fluctuate all over the place without any consequences whatsoever. It is my impression that too many funds with long horizons are managed as though they were going to be disbursed in the next couple of years, largely because volatility makes people uncomfortable – which is irrelevant to the conditions on which a rational decision should rest. Fear of volatility can be costly to long-run returns and can unnecessarily constrain the freedom of managers to do their best. — Peter Bernstein (source)
How to Avoid Losses in Your Investing by FPS
Buy the Book: eBook
The book, published in 1920, shows how little human nature changes in markets, especially around speculation, gambling, and greed. It also offers historical context on how markets operated pre-SEC and warns about the dangers of widespread leverage that led to the 1919 to 1921 crash and the 1929 bubble and bust a decade later.
The Notes
Weekend Reads – 4/5/24
Quote for the Week
There certainly are good reasons for selling, but they have nothing to do with the fear of making mistakes, experiencing regret and looking bad. Rather, opportunities for intelligent selling should be based on the outlook for the investment and they have to be identified through hardheaded financial analysis, rigour and discipline.
Most economies, companies and markets benefit from positive underlying trends. If investors use poor judgment and reduce market exposure through ill-conceived selling, they will fail to participate fully in those trends. That’s a cardinal sin in investing. It’s even more true of selling things in desperation after their prices have fallen, turning negative fluctuations into permanent losses and dismounting from the miracle of the long-term compounding of returns. What’s clear to me is that as opposed to selling for reasons of psyche, simply being invested is by far “the most important thing.” — Howard Marks (source)
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