Bernard Baruch once said that Wall Street provided an extended course on investor behavior. It taught him that human nature was the driving force behind markets and investing mistakes.
Baruch was born in 1870 and began his career as a broker. He quickly learned that every investment carries some risk. It’s always a gamble.
What we can try to do perhaps is to come to a better understanding of how to reduce the element of risk in whatever we undertake. Or put another way…our problem is how to remain properly venturesome and experimental without making fools of ourselves.
He must have figured it out because, by the turn of the century, he had his own brokerage firm, a seat on the NYSE, a few million to his name, and a reputation as a savvy financier.
His fortune continued to grow during the 1920s bull market. But as luck would have it, he sidestepped the crash.
Outside my old office in Wall Street there used to be an old beggar to whom I often gave gratuities. One day during the 1929 madness he stopped me and said, “I have a good tip for you.”
Baruch learned early on that “tips” become more prevalent when markets are booming. Unfortunately, tips work out for a while, at least, simply because the market’s rising. Which draws more people into markets.
For Baruch, it was one more sign of the craziness of the times. By the time the market crashed, he had already sold everything and moved to cash.
A cash reserve was a staple of his philosophy after a few too many “youthful reversals” got him into trouble. He was caught a few too many times fully invested, over-leveraged, and forced to sell positions to cover his margin. A cash position gave him options to cover mistakes and let him sleep better at night.
He realized the hardest part of investing or speculation was separating emotions from decisions. Investing is a game where rational, thoughtful decisions often take a backseat to emotionally-driven actions.
What drives the price of stocks up or down is not impersonal economic forces or changing events but the human reactions to these happenings. The constant problem of the speculator or analyst is how to disentangle the cold, hard economic facts from the rather warm feelings of the people dealing with these facts.
Few things are more difficult to do. The main obstacle lies in disentangling ourselves from our own emotions.
Baruch was not immune to the problem. In his memoir, Baruch: My Own Story, he shares several stories of his failures. His inability to cut his losses is a recurring theme.
Rather than admitting his mistake by taking a small loss, he compounds the problem. He sells a position he’s made money in, to plow more money into a losing bet.
In fact, one of his biggest failures came in 1905 — a bet that coffee prices would jump. His theory was based on the fact that Brazil had limited planting a few years earlier — supply wouldn’t keep up with demand.
It turns out he was wrong. 1906 produced a bountiful coffee crop. The price of coffee fell.
One of the worst mistakes anyone can make is to hold on blindly and refuse to admit that his judgment has been wrong.
Baruch failed to heed his own warning. What’s worse, he had placed his bet using a margin account in the hopes of boosting his returns. He only needed coffee to rise a few cents to make a small fortune. Instead, it compounded his losses.
Rather than cut his losses on the spot, he sold shares of Canadian Pacific — at a tidy profit — to cover his rising margin cost on coffee. It wasn’t until after he sold out all his Canadian Pacific shares that he finally came to his senses.
His mistake cost him $800,000! In 1905 dollars! He knew better and still did everything wrong.
Baruch would reiterate this lesson in a list of rules on how to invest. The list is pulled from the lessons he learned over a lifetime in the markets.
- Don’t speculate unless you can make it a full-time job.
- Beware of barbers, beauticians, waiters — of anyone — bringing gifts of “inside” information or “tips.”
- Before you buy a security, find out everything you can about the company, its management and competitors, its earnings and possibilities of growth.
- Don’t try to buy at the bottom and sell at the top. This can’t be done — except by liars.
- Learn how to take your losses quickly and cleanly. Don’t expect to be right all the time. If you have made a mistake, cut your losses as quickly as possible.
- Don’t buy too many different securities. Better have only a few investments which can be watched.
- Make a periodic reappraisal of all your investments to see whether changing developments have altered their prospects.
- Study your tax position to know when you can sell to greatest advantage.
- Always keep a good part of your capital in a cash reserve. Never invest all your funds.
- Don’t try to be a jack of all investments. Stick to the field you know best.
These “rules” mainly reflect two lessons that experience has taught me — that getting the facts of a situation before acting is of crucial importance, and that getting these facts is a continuous job which requires eternal vigilance.
Admittedly, Baruch was reluctant to put this list together. He was skeptical of its effectiveness. As he put it, people either lack the discipline to follow it or think they’re the exception that can outsmart the game Baruch played for decades.
Simply put, most people need to make the mistakes themselves before the painful lessons sink in.
- How Much Has the Market Benefited from Investor Optimism? – J. Rekanthaler
- Are Financial Crises Predictable? – Verdad
- Short-Termism and Momentum Investing – Klement on Investing
- Hanging By A Thread – M. Housel
- Magic Beans – Reformed Broker
- Studying Predators – Neckar’s Notes
- On the MesoAmerican Reef: A Model for Insuring Nature’s Future – Struggles from Below