Quote for the Week

Understanding that we do not know the future is such a simple statement, but it’s so important. Investors do better where risk management is a conscious part of the process. Maximizing return is a strategy that makes sense only in very specific circumstances. In general, survival is the only road to riches. Let me say that again: Survival is the only road to riches. You should try to maximize return only if losses would not threaten your survival and if you have a compelling future need for the extra gains you might earn.

The riskiest moment is when you’re right. That’s when you’re in the most trouble, because you tend to overstay the good decisions. So, in many ways, it’s better not to be so right. That’s what diversification is for. It’s an explicit recognition of ignorance. And I view diversification not only as a survival strategy but as an aggressive strategy, because the next windfall might come from a surprising place. I want to make sure I’m exposed to it. Somebody once said that if you’re comfortable with everything you own, you’re not diversified. — Peter Bernstein (source)

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History is a funny thing. Despite being over and done with, it’s changing. It’s fluid. Our understanding of history is in a state of flux.

Our knowledge of any past event is always incomplete, probably inaccurate, beclouded by ambivalent evidence and biased historians, and perhaps distorted by our own patriotic or religious partisanship. “Most history is guessing, and the rest is prejudice.”

To top it off, we may not have enough information — yet or ever — to piece it all together. New ideas and discoveries can rewrite what we thought we knew about the past.

So historians make do with what they have. The result is an incomplete, biased, and often simplistic story that brings order to past events.

That’s roughly how The Lessons of History, a book by Will and Ariel Durant, presents it. And it relates surprisingly well to investing. For instance, the above describes how media present headlines and narratives around market moves. Continue Reading…

Quote for the Week

I refer to a cartoon whose caption is: “Everything that was good for the market yesterday is no good for it today.” I wrote that “in the real world, things generally fluctuate between ‘pretty good’ and ‘not so hot.’ But in the world of investing, perception often swings from ‘flawless’ to ‘hopeless.’” Nobody can say why this happens or why the tipping point was reached. But the psychology of the market is so irrational and excessive in its swings…

You just can’t think of the market as this machine. There is no schematic for how it works. It just picks funny things to obsess about on the positive side for a while and then the negative side. This could be the beginning of a down leg or not — but you just can’t attach too much intelligence to the market’s daily fluctuations. — Howard Marks (source)

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Quote for the Week

The fact that Black Swans can and do happen in our financial system holds important lessons for how we think about risk. While we look for corroboration of what we believe (confirmation bias), what we really ought to be looking for is the opposite—that observation that would prove us wrong. Sad to relate, we know what is wrong with a lot more confidence than what we know is right. Yet we continue to look ahead with apparent confidence that the past is prologue, based on our assumptions that the probabilities established by history will endure.

The idea of seeking out evidence that contradicts our belief goes far beyond the financial markets. It goes to the very nature of knowledge itself. For the eminent British philosopher Sir Karl Popper—well-known for his use of the Black Swan metaphor—the key question was “what if science didn’t proceed from observation to theory? What if it was the other way around?” Writing in The New Yorker, journalist Adam Gopnik described Popper’s reasoning: “No number of white swans could tell you that all swans were white, but a single black swan could tell you that they weren’t… Science, Popper proposed, didn’t proceed through observations confirmed by verification; it proceeded through wild, overarching conjectures which generalized ‘beyond the data,’ but were always controlled and sharpened by falsification (i.e., proof that the theory was wrong).”

“It was the conscious, purposeful search for falsification by refutation, by the single decisive experiment” (or swan), Popper believed, “that allowed science to proceed and objective knowledge to grow.” Yet most of us—in our investment ideas and political ideas alike—do quite the reverse: we search for facts that confirm our beliefs (reinforcement bias), not for the facts that would negate them. — John Bogle (source)

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