Novel Investor

Compounding investing wisdom...

Happy Hour: The Lesson from Ice Cream and the Crash of ’29

by Jon

While writing out my notes on Why You Win or Lose, two stories stuck out that are worth sharing. The first one is a simple analogy using ice cream to show how investors drive market prices to irrational levels, then see it all come crashing down:

My friend, Willard Kiplinger, well-known savant of Washington, gave me an extemporaneous explanation of how fictitious stock values, forced up by greed, must collapse.

He and I and another friend were having dinner together when Kiplinger remarked: “I suppose the stock market is like this: Here I have a dish of ice cream that cost me ten cents. Robert, the waiter, comes in and says the ice cream is all gone and no more is to be had tonight. My ice cream suddenly seems more valuable to you and you offer me, say, twelve cents for it. Then Bill, who had intended to order ice cream, makes you an offer of thirteen cents. You, being Scotch, can’t resist taking a profit. Bill brags so much about the ice cream that I decide I was foolish to let it go in the first place and buy it back for fourteen cents. About that time I discover, to my dismay, that the ice cream has melted.”

The second story is about the irrational crowd behavior leading up to and following the Great Crash of 1929 (emphasis mine): Continue Reading…

Peter Bernstein on Hidden Variety in Averages

by Jon

I’ve been reading a lot of Peter Bernstein lately. Bernstein wrote the book on risk, Against the Gods, along with several others, but my focus has been on his much shorter pieces. One that stuck out was a 2002 speech he gave to the Society of Actuaries.

In the speech, Bernstein makes it very clear that not only do we rely too much on averages, but we ignore the hidden lesson in the data being averaged — variety. Averages lead people to focus on “the whole rather than the doughnut,” as Bernstein puts it. So decisions revolve entirely around the averages.

One way to look at this is that the averages provide certainty where none exist. Basing decisions on averages work for most things, but investing comes with a nasty snag called uncertainty. Averages stop being perfect predictors once an unknown is involved. No matter how far back we go, the future makes asset return data incomplete.

Instead, we should view any output purely through the lens of only for the most part. The averages offer a rough guide of what’s possible but, just in case, we better understand the consequences of being wrong. Because being wrong can be devastating. And history — all that variety overlooked by averages — shows just how often results failed to live up to the averages and investors felt the consequences of being wrong. Continue Reading…

Happy Hour: S&P 500 Stocks: Three Cents on the Dollar

by Jon

Three cents on the dollar. Three cents is apparently a big deal. I know this because Fintwit (i.e. financial twitter) was abuzz about the market’s 3% down move on Wednesday.

What I’m not sure about is if the “calming reminders” are helpful in any way. So here’s my take.

If a 3% drop brings about a queasy feeling, I’ve got some bad news. Investing in stocks will be a horrendous experience for you.

Because, in the grand scheme of things, 3% is nothing. It’s normal. It’s also forgettable. Because 3% is noise. Making a big deal out of noise makes it louder. I don’t see how that helps anyone.

My guess is the only reason people see it as a big deal is that the market has been fairly boring this year. Continue Reading…

88 Year Old Contrarian Advice

by Jon

The art of successful investing is to act contrary to the crowd. That was the theory of one Fred C. Kelly back in 1930.

In Why You Win or Lose: The Psychology of Speculation, Kelly wrote about his experiences with the market and the timeless lesson he learned:

I learned that men win or lose not so much because of economic conditions as because of human psychology. Certain mental traits that we nearly all have are barriers to success.

Therein lies the crux of Kelly’s theory. If most market participants behave normally, and normal behavior typically leads to mistakes, then the answer is to not act normal. Continue Reading…

Happy Hour: Quarterly Reading – Fall ’18

by Jon

It’s time for another quarterly reading update. The goal is to read more books this year. So these updates are mostly for my own accountability, but if someone else finds something interesting, great.

Here’s what I’ve been reading over the last quarter. Continue Reading…

Australopithecus and The Money Game

by Jon

Markets are made of up of millions of people — emotional and biased — who do weirdly wild things for no apparent reason. And yet, somehow, the markets are rational?

Adam Smith (George Goodman) discredits the thought in an imaginative way in The Money Game. One of the running themes can be summed up by Australopithecus.

Australopithecus was the “missing link” in human evolution, an ape-human creature with a smaller-by-more-than-half sized brain.

Something with such a small brain can hardly be rational or logical. It must be driven by baser instincts. So Australopithecus represents the unknown and unmeasurable emotion of the crowd.

…the real test is how you behave when the crowd is roaring the other way. We know a little about some individual types, but the crowd, the elusive Australopithecus, is still largely an unknown, an exercise in mass psychology still not accomplished.

Smith’s subtle jab shouldn’t be lost either: evolution gave us bigger brains but kept the baser instincts. That interplay of the crowd and the constant pull on emotions is a feature of the Game. Continue Reading…

Learning

Return Tables

Connect