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Here is the latest issue of The Journal of Investing Wisdom, where I share insightful stuff on investing I am reading and thinking about. Let’s get started.
Howard Marks of Oaktree Capital, wrote this in his seminal book The Most Important Thing –
In bull markets – usually when things have been going well for a while – people tend to say ‘Risk is my friend. The more risk I take, the greater my return will be. I’d like more risk, please.’
The truth is, risk tolerance is antithetical to successful investing. When people aren’t afraid of risk, they’ll accept risk without being compensated for doing so… and risk compensation will disappear. But only when investors are sufficiently risk-averse will markets offer adequate risk premiums. When worry is in short supply, risky borrowers and questionable schemes will have easy access to capital, and the financial system will become precarious. Too much money will chase the risky and the new, driving up asset prices and driving down prospective returns and safety.
Risk, which Marks and Warren Buffett have often defined as losing significant amounts of money and permanently, often moves in the same direction as valuations.
In other words, risk increases/decreases as valuations rise/fall. At the same time, high valuations imply weak prospective returns, while depressed valuations imply strong prospective returns. Consequently, both Marks and Buffett suggest that risk is lowest precisely when prospective returns are the highest, and risk is highest precisely when prospective returns are the lowest.
Economist and investment strategist Peter Bernstein said –
The riskiest moment is when you are right.
In much of life, doing things right over and over again is a sign of skill. Consider chess players or expert musicians. They rarely make a wrong move or hit a wrong note. Also, the skill of one good musician does not cancel out the skill of other musicians, that is, it does not make it harder for others to be equally good. This is not true of financial markets. ‘Skilled’ investors’ actions cancel each other out as they quickly bid up the prices of any bargains, which makes luck the main factor that distinguishes one investor from another.
Skill in investing shines through over the long term, but a streak of being right in the short term can make anyone forget how important luck is in determining the outcome.
Watch out for that streak of being right, dear investor.
A Super Text
The general question of the relation of intrinsic value to the market quotation may be made clearer by the following chart, which traces the various steps culminating in the market price. It will be evident from the chart that the influence of what we call analytical factors over the market price is both partial and indirect — partial, because it frequently competes with purely speculative factors which influence the price in the opposite direction; and indirect, because it acts through the intermediary of people’s sentiments and decisions. In other words, the market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities. Rather should we say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion.
~ Ben Graham and David Dodd, Security Analysis
Jack Bogle’s Rules for Investing by Barry Ritholtz
Bogle argued for an approach to investing defined by simplicity and common sense. His book The Clash of the Cultures: Investment vs. Speculation has 10 rules laid out in great detail in Chapter 9, and they sum up the Bogle philosophy as:
Investing Versus Speculation
1. Remember Reversion to the Mean
2. Time Is Your Friend, Impulse Is Your Enemy
3. Buy Right and Hold Tight
4. Have Realistic Expectations: The Bagel and the Doughnut
5. Forget the Needle, Buy the Haystack
6. Minimize the Croupier’s Take
7. There’s No Escaping Risk
8. Beware of Fighting the Last War
9. The Hedgehog Bests the Fox
10. Stay the Course
It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.
~ Charlie Munger
That’s about it from me for today.
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