Quote for the Week

Risk means more things can happen than will happen, that there is a range of outcomes out there. This is a fancy way of saying we don’t know what’s going to happen, but it’s a good way to think about it. If more things are going to happen than will happen, how large is that range, what are the extremes of it, what are the best kinds — risk means good things as well as bad things…

What’s the upside, what’s the downside? What are the consequences to me if I do something wrong and the outcome is different from what I want, different from what I expect? This is how you begin to think about it. It really kind of begins with this idea, first of all, we don’t know what the future holds. This is — heads always shake up and down when you say that, but we tend to act as though we do know, but we have to keep reminding ourselves, particularly in this business.

Particularly, you only look at the last week’s news, and we don’t know what’s going to happen. So you have to think about where am I placed in relation to the possible range of outcomes and where the surprises might be. — Peter Bernstein (source)

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Rules of thumb have existed in investing ever since people looked for patterns in stock price movements. Market timing was the goal, of course, along with a shortcut to quicker wealth. And it didn’t take much to find one. A limited experience, maybe a modicum of study, could unearth a market timing rule.

The first half of the 1900s had its rules of thumb that worked for a while. Charles Amos Dice wrote about the more popular rules in the decades leading up to 1929:

In the first place, there was the conviction that whatever goes up must sooner or later come down. This seeming truism carried tucked safely away the implication that the distance of the fall would approximate the number of points gained in the preceding rise. Furthermore, it implied that the major advances and declines followed one another in more or less regular recurrence…

In the second place, it was a common prewar and also post war belief that the market might reasonably be expected to be at the end of a major advance after 20 to 24 months of consistent climbing. Even as late as 1923, the old yardstick did not fail the trader… Furthermore, major declines might well be expected to run their course in about 11 to 15 months. Before the trajedy of 1920, there was but one exception to this almost mechanical rule since 1903…

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Quote for the Week

While all the chatter and excitement is taking place about big stocks, big gains, and “three-baggers,” long-term investment success really depends on not losing — not taking major losses.

We all know that a 50 percent loss requires a double the next time up just to get even, but still we strive for the Big Score, even though we also know full well that accidents happen most often to too-fast drivers; that Icarus got too close to the sun; that Enron Corporation, WorldCom, and many dot-coms had very high “new era” multiples before their obliteration.

Large losses are forever — in investing, in teenage driving, and in fidelity. If you avoid large losses with a strong defense, the winnings will have every opportunity to take care of themselves. And large losses are almost always caused by trying to get too much by taking too much risk. — Charley Ellis (source)

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Hype around IPOs is nothing new. You can go back to the 1700s, during the South Sea Bubble, to see it play out.

All it took was a company with wonderous possibilities, a chance to get rich, and a public eager to buy. The booming bull market helped set the stage for crazier offerings. And it worked.

The craziest by far was not the company trying to extract silver from lead or trade in human hair or build a perpetual motion wheel but for “a subscription advertised, and actually opened, for an undertaking, which shall in due time be revealed.” Just think of the possibilities!

The Dotcom Bubble is a more recent, perfect, example of the craziness. In 1999 alone, there were 478 IPOs. Almost 80% percent were tech stocks. Over 70% had no earnings. It didn’t matter.

The average first-day return for IPOs in 1999 was 71%! The environment was perfect. Public enthusiasm was at its peak, the internet brought infinite possibilities, and the stocks brought a chance for instant wealth. And the first-day pop was manufactured.

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Quote for the Week

All booms are alike. The stage varies, but fundamentally they are as drops of water. Customs, like costumes, change from force of environment and economic conditions, but human nature remains the same. The autumn boom in Wall Street resembled all other stock booms, because the psychology of the boomers has not changed and cannot change. The Tulip Craze in Holland, or John Law’s Mississippi Scheme in France, or the South Sea Bubble in England in most things were the counterparts of the present speculation in the country. After all, booms are made by men, and not by stocks or flowers or town lots or wheat or mines or war. — Edwin Lefevre 1915 (source)

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