Don't be a Disaster. But Disasters are Normal.
February 18, 2021 11:57 AM Subscribe
Unfortunate Investing Traits. In the aftermath of the Gamestop episode, some thoughts on markets and investing.
"Napoleon’s definition of a military genius was “The man who can do the average thing when everyone else around him is losing his mind.” What he meant, I think, is that most wars are lost rather than won. The final outcome is driven more by one side’s blunder than the other’s brilliance. One screw up can overwhelm a dozen smart decisions that preceded it, so even if strategy is crucial the expert is rarely preoccupied asking, “How can I be great?” The obsession is, “How can I ensure I’m at least average and never a disaster during the most important moments?”
And isn’t investing the same?"
"If markets never crashed they wouldn’t be risky. If they weren’t risky they’d get very expensive as all potential returns were wrung out. When markets are expensive they’re fragile. And when they’re fragile they crash.
If you accept that logic – and I think it’s the punchline of all market history – you realize that huge market declines characterized as surprising and shocking and unexpected are in fact foreseeable. The timing isn’t predictable but the occurrence is inevitable. If you get caught in a period when you lose a third of your money and it stays that way for a year or two, you have not been hit by a 100-year storm; you’ve just experienced the base rate of investing, par for the course. That’s why they’re normal disasters."
"If markets never crashed they wouldn’t be risky. If they weren’t risky they’d get very expensive as all potential returns were wrung out. When markets are expensive they’re fragile. And when they’re fragile they crash.
If you accept that logic – and I think it’s the punchline of all market history – you realize that huge market declines characterized as surprising and shocking and unexpected are in fact foreseeable. The timing isn’t predictable but the occurrence is inevitable. If you get caught in a period when you lose a third of your money and it stays that way for a year or two, you have not been hit by a 100-year storm; you’ve just experienced the base rate of investing, par for the course. That’s why they’re normal disasters."
Jeff Fisher had to work really hard to go 8-8; all I have to do is buy an index.
posted by Huffy Puffy at 12:17 PM on February 18, 2021 [3 favorites]
posted by Huffy Puffy at 12:17 PM on February 18, 2021 [3 favorites]
The final outcome is driven more by one side’s blunder than the other’s brilliance.
You see a lot of this thinking in sports where certain teams will be drilled very strongly on defence in order to eliminate mistakes. It's a successful strategy, which is why people will often say that defence wins championships, but not particularly entertaining.
posted by any portmanteau in a storm at 12:20 PM on February 18, 2021 [6 favorites]
You see a lot of this thinking in sports where certain teams will be drilled very strongly on defence in order to eliminate mistakes. It's a successful strategy, which is why people will often say that defence wins championships, but not particularly entertaining.
posted by any portmanteau in a storm at 12:20 PM on February 18, 2021 [6 favorites]
This kind of tracks my thoughts about luck, as referenced in the recent post here about how to maximize it, and ultimately whether that's a great idea or not for me personally.
I fully agree with the article.
I have been investing long enough to see 30% and 50% losses of my boring portfolio in a year, and there is little that is smart you can do but wait and it eventually comes back fine.
It's interesting - as we all have different risk tolerances and risk triggers - but the past year of various disasters have shown that people handle risk differently - for ex: people who bought guns after hearing about the 'riots' over the summer and they are now collecting dust - or the willingness of some to pay any amount for a generator for a recent cold snap, just in case. I don't even know what mine are (as per the article) so one can only judge from afar.
posted by The_Vegetables at 12:48 PM on February 18, 2021 [2 favorites]
I fully agree with the article.
I have been investing long enough to see 30% and 50% losses of my boring portfolio in a year, and there is little that is smart you can do but wait and it eventually comes back fine.
It's interesting - as we all have different risk tolerances and risk triggers - but the past year of various disasters have shown that people handle risk differently - for ex: people who bought guns after hearing about the 'riots' over the summer and they are now collecting dust - or the willingness of some to pay any amount for a generator for a recent cold snap, just in case. I don't even know what mine are (as per the article) so one can only judge from afar.
posted by The_Vegetables at 12:48 PM on February 18, 2021 [2 favorites]
With investing these days, with a little up-front education and planning, once you've got surplus cash to invest, it is easy and simple to achieve average results with almost no expenditure of time or effort or large fees: pick a reasonable asset allocation, pick some low fee passive investment funds, structure things to take advantage of any tax discounts the government offers you, then regularly invest money into it (ideally automate it so you don't even get the opportunity to not do it). Hand your cash over to professionals who are charged with managing the money in a very disciplined, incredibly boring, low-cost way, and you will get average results. Average results over a few decades builds a lot of wealth. The hardest thing about this is having the discipline to avoid paying attention to market prices, the latest stock market news.
There's a logical fallacy where some investors think "it is easy for me to get average performance with almost no effort on my part by investing in passively managed stock market funds. So, if I put in a bit more effort to learn about some hot stock tips, then I must be able to do a bit better than average". This is wrong. If you're trying to actively pick winners, it's like you've volunteered yourself to compete in the NBA against world-class teams. You're investing in some hyped stock tip you heard about from a colleague at work without either of you understanding anything about the company or the market ... but you're playing against pros who are doing things like flying research teams to other countries to conduct clandestine surveillance operations on factories to try to figure out if the companies are lying to investors or not.
Like amateur tennis, investment is a loser's game, not a winners game, where you win by avoiding making unforced errors. Investing in passively managed stock market funds lets you outsource discipline & risk control to professional operations with carefully structured processes set up to avoid human behavioural errors. When you start trying to actively pick stocks or trade in and out of the market, you're suddenly responsible for all your own discipline and risk control, but you don't have the processes to avoid your own human behavioural errors.
posted by are-coral-made at 1:02 PM on February 18, 2021 [14 favorites]
There's a logical fallacy where some investors think "it is easy for me to get average performance with almost no effort on my part by investing in passively managed stock market funds. So, if I put in a bit more effort to learn about some hot stock tips, then I must be able to do a bit better than average". This is wrong. If you're trying to actively pick winners, it's like you've volunteered yourself to compete in the NBA against world-class teams. You're investing in some hyped stock tip you heard about from a colleague at work without either of you understanding anything about the company or the market ... but you're playing against pros who are doing things like flying research teams to other countries to conduct clandestine surveillance operations on factories to try to figure out if the companies are lying to investors or not.
Like amateur tennis, investment is a loser's game, not a winners game, where you win by avoiding making unforced errors. Investing in passively managed stock market funds lets you outsource discipline & risk control to professional operations with carefully structured processes set up to avoid human behavioural errors. When you start trying to actively pick stocks or trade in and out of the market, you're suddenly responsible for all your own discipline and risk control, but you don't have the processes to avoid your own human behavioural errors.
posted by are-coral-made at 1:02 PM on February 18, 2021 [14 favorites]
This good old tweet suggesting unequivocal noninvolvement in aggression is the foreign-policy equivalent of investing in index funds—in that it's both stupidly straightforward, boring, and obvious, and apparently something which geniuses in the field are unable to outperform—should really give us a new respect for not letting the mediocre be the enemy of the good.
While we're at it, the boring, unsexy, and naïve response to airborne disease spread (don't spend time with other people, and wear a mask if you do) is also embarrassingly effective.
posted by jackbishop at 1:44 PM on February 18, 2021 [4 favorites]
While we're at it, the boring, unsexy, and naïve response to airborne disease spread (don't spend time with other people, and wear a mask if you do) is also embarrassingly effective.
posted by jackbishop at 1:44 PM on February 18, 2021 [4 favorites]
There is also evidence on what leads to the generational preservation of social class (and to the ability of some but not others to climb up over generations) has little to do with increasing upside opportunities and a lot to do with preventing downside risk. In other words, families and larger groups that are somehow able to avoid catastrophic life events like addiction tend to slowly accumulate wealth because the time-series of wealth accumulation looks like a very slow upward slope interrupted by catastrophic downsides
posted by atrazine at 2:14 PM on February 18, 2021 [4 favorites]
posted by atrazine at 2:14 PM on February 18, 2021 [4 favorites]
Unregulated markets have a boom and bust cycle. Properly regulated markets do not. Don't turn this into a "there's nothing you can do about mass shootings"-style conversation.
posted by krisjohn at 2:18 PM on February 18, 2021 [4 favorites]
posted by krisjohn at 2:18 PM on February 18, 2021 [4 favorites]
hah, atrazine, one of my grandmothers used to say "Three generations, shirtsleeves to shirtsleeves" meaning that that's what usually happens to new family money -- not that it always does, or ought to, but that it's likely to. Like most new businesses don't survive long. (Indeed, most offspring of many species die, and most species vanish with a maximum population of 1).
krisjohn, on what basis do you say that? How much information does the regulation need to do that? To keep on the ecological kick, I would be surprised if there weren't chaotic cycles in any economy, and the more feedbacks in a system the more possible it is that it's self-regulating, but disaster is always possible.
posted by clew at 2:26 PM on February 18, 2021
krisjohn, on what basis do you say that? How much information does the regulation need to do that? To keep on the ecological kick, I would be surprised if there weren't chaotic cycles in any economy, and the more feedbacks in a system the more possible it is that it's self-regulating, but disaster is always possible.
posted by clew at 2:26 PM on February 18, 2021
Ever since Berkshire Hathaway created class B shares to acquire BNSF railway about 12 years ago, this class is within the reach of MANY investors at about $250 US/share (as opposed to the class A shares that go for around $350,000 US/share).
They are remarkably similar to index funds, given the VERY broad array of companies that BH holds. Mr. Buffett describes his view of success for his company as just slightly outperforming the S&P 500 over time.
The advantages of buying (and then holding) BH stock is that there is NO management fee, plus you get a copy of the Annual Report, which is always an interesting read.
posted by birdsquared at 2:34 PM on February 18, 2021 [1 favorite]
They are remarkably similar to index funds, given the VERY broad array of companies that BH holds. Mr. Buffett describes his view of success for his company as just slightly outperforming the S&P 500 over time.
The advantages of buying (and then holding) BH stock is that there is NO management fee, plus you get a copy of the Annual Report, which is always an interesting read.
posted by birdsquared at 2:34 PM on February 18, 2021 [1 favorite]
This is also part of Piketty's theory in Capital, that the natural trend of societies as currently set up is towards concentration and that it is chaotic and disruptive events that tend to level people down. (obviously not a great experience for the people going through it and preferably achieved through wealth taxation instead).
posted by atrazine at 2:45 PM on February 18, 2021
posted by atrazine at 2:45 PM on February 18, 2021
preferably achieved through wealth taxation
If you are relying on a wealth tax or even an income tax to even the score, you have already lost the game. As economist Dean Baker points out, you really need to change the rules and laws of the economy that redistribute income from wage earners upward to a few privileged individuals. Trying to tax those gains back from a rigged game is not the best way to fix the problem. You need to unrig the game.
posted by JackFlash at 3:01 PM on February 18, 2021 [5 favorites]
If you are relying on a wealth tax or even an income tax to even the score, you have already lost the game. As economist Dean Baker points out, you really need to change the rules and laws of the economy that redistribute income from wage earners upward to a few privileged individuals. Trying to tax those gains back from a rigged game is not the best way to fix the problem. You need to unrig the game.
posted by JackFlash at 3:01 PM on February 18, 2021 [5 favorites]
Unregulated markets have a boom and bust cycle. Properly regulated markets do not.
There's no regulation so perfect that it's going to prevent all market downturns. The regulator would need to have perfect information about everything going on in the economy, and have the authority and means to act on the market instantly, neither of which ever occur in reality.
Further, it's not clear that the business cycle is inherently bad, and something that regulators ought to make their primary focus suppressing. Fast-growing markets tend to lead to a lot of duplicated effort as firms compete with each other, which is wasteful. Downturns tend to force consolidation and efficiency improvements, which are desirable over the long haul. (In some cases that downturn might only be a decrease in growth, but long-term we need zero-growth economics, so you can't just assume this forever.)
In a sane world, we'd have a combination of a social safety net (including healthcare not tied to employment), ample job training resources separate from academia, and regulatory agencies that dampened the natural oscillations of the market into something that people could work with more easily. Nobody should be so married to their job that it's a catastrophic personal event if the company goes bankrupt.
The market should be allowed to have its ups and downs; the average person ought to be allowed to largely ignore it.
posted by Kadin2048 at 3:03 PM on February 18, 2021 [8 favorites]
There's no regulation so perfect that it's going to prevent all market downturns. The regulator would need to have perfect information about everything going on in the economy, and have the authority and means to act on the market instantly, neither of which ever occur in reality.
Further, it's not clear that the business cycle is inherently bad, and something that regulators ought to make their primary focus suppressing. Fast-growing markets tend to lead to a lot of duplicated effort as firms compete with each other, which is wasteful. Downturns tend to force consolidation and efficiency improvements, which are desirable over the long haul. (In some cases that downturn might only be a decrease in growth, but long-term we need zero-growth economics, so you can't just assume this forever.)
In a sane world, we'd have a combination of a social safety net (including healthcare not tied to employment), ample job training resources separate from academia, and regulatory agencies that dampened the natural oscillations of the market into something that people could work with more easily. Nobody should be so married to their job that it's a catastrophic personal event if the company goes bankrupt.
The market should be allowed to have its ups and downs; the average person ought to be allowed to largely ignore it.
posted by Kadin2048 at 3:03 PM on February 18, 2021 [8 favorites]
Unregulated markets have a boom and bust cycle. Properly regulated markets do not.
But has a "properly regulated market" defined thusly ever existed?
Markets have to allow people to make choices. And sometimes lots of people make remarkably bad choices -- perhaps the same remarkably bad choice.
posted by Artifice_Eternity at 3:28 PM on February 18, 2021
But has a "properly regulated market" defined thusly ever existed?
Markets have to allow people to make choices. And sometimes lots of people make remarkably bad choices -- perhaps the same remarkably bad choice.
posted by Artifice_Eternity at 3:28 PM on February 18, 2021
I'm not even sure how you'd ever prevent a bust, I guess depending on how you define what a bust is.
Take an extremely simplistic example (assume a cow is a sphere, etc). Say you take a subset of stocks, restaurants. Prices of stock represent the present value of all future earnings, as that is what the stockholder is effectively buying.
Covid happens. Say that the present value of future earnings of any surviving restaurant is only mildly affected - on an infinitely long timescale, one year of reduced earnings in a low interest rate environment is small - and therefore "sentiment" should not drive down the value of those stocks and bust should not happen.
... there's still the uncertainty factor of not knowing which restaurant would survive Covid or not. Say 1 in 4 restaurants will fail but no one knows which ones. At that point, every restaurant will take a 25% hit in their stock value, to factor in the risk that their future income stream drops to zero. Then you have a bust.
Does properly regulated mean that NO restaurants are allowed to fail, ever? Every one gets an infinite supply of bailouts from the government? Then you're back to "If they weren’t risky they’d get very expensive as all potential returns were wrung out. When markets are expensive they’re fragile. And when they’re fragile they crash."
posted by xdvesper at 3:49 PM on February 18, 2021
Take an extremely simplistic example (assume a cow is a sphere, etc). Say you take a subset of stocks, restaurants. Prices of stock represent the present value of all future earnings, as that is what the stockholder is effectively buying.
Covid happens. Say that the present value of future earnings of any surviving restaurant is only mildly affected - on an infinitely long timescale, one year of reduced earnings in a low interest rate environment is small - and therefore "sentiment" should not drive down the value of those stocks and bust should not happen.
... there's still the uncertainty factor of not knowing which restaurant would survive Covid or not. Say 1 in 4 restaurants will fail but no one knows which ones. At that point, every restaurant will take a 25% hit in their stock value, to factor in the risk that their future income stream drops to zero. Then you have a bust.
Does properly regulated mean that NO restaurants are allowed to fail, ever? Every one gets an infinite supply of bailouts from the government? Then you're back to "If they weren’t risky they’d get very expensive as all potential returns were wrung out. When markets are expensive they’re fragile. And when they’re fragile they crash."
posted by xdvesper at 3:49 PM on February 18, 2021
Does properly regulated mean that NO restaurants are allowed to fail, ever?
It should mean that a single restaurant failure is not catastrophic to society. Depending on the extent to which restaurants are a privately owned public good, then also you may also want to maintain investor/lender confidence in restaurants as a class by ensuring that a well run restaurant earns a suitable return / can repay its loans. You may also try to use regulation to reduce any information asymmetry between restaurants and their customers, and reduce cartel behaviour.
If you have not managed to do the first of those successfully, then you will have to bail all such restaurant failures out.
posted by plonkee at 4:03 PM on February 18, 2021
It should mean that a single restaurant failure is not catastrophic to society. Depending on the extent to which restaurants are a privately owned public good, then also you may also want to maintain investor/lender confidence in restaurants as a class by ensuring that a well run restaurant earns a suitable return / can repay its loans. You may also try to use regulation to reduce any information asymmetry between restaurants and their customers, and reduce cartel behaviour.
If you have not managed to do the first of those successfully, then you will have to bail all such restaurant failures out.
posted by plonkee at 4:03 PM on February 18, 2021
There's a modicum of wisdom in the maxim that one should be greedy when others are fearful and fearful when others are greedy.
So far I've managed to be greedy when others were fearful (topped up my stock portfolio by about 20% last March, right when the news was full of pundits yelling about the plague bringing on the collapse of capitalism) and that's worked out well; everything I bought in that round has gained since, one of them spectacularly faster than the overall market indexes.
But I watched my late father piss enough gains up the wall on attempts to be fearful when others were greedy to put me off that. As a result, I've seen the performance of my portfolio swing wildly between well over index to well under and back several times. But although this has brought on several episodes of feeling regret for missing out, I'm sticking with my overall strategy: buy a diversity of apparently well-managed things, about a quarter of which are new players in markets I expect to grow in the medium to long term, and then just hold them for as many years as I can possibly arrange to. I think it's pretty sound.
Prices of stock represent the present value of all future earnings
That might be true if the efficient market hypothesis held water, but I'm totally unconvinced that it does. Quite a lot of what stock prices do is much better explained by the thundering herd hypothesis.
posted by flabdablet at 4:19 AM on February 19, 2021 [4 favorites]
So far I've managed to be greedy when others were fearful (topped up my stock portfolio by about 20% last March, right when the news was full of pundits yelling about the plague bringing on the collapse of capitalism) and that's worked out well; everything I bought in that round has gained since, one of them spectacularly faster than the overall market indexes.
But I watched my late father piss enough gains up the wall on attempts to be fearful when others were greedy to put me off that. As a result, I've seen the performance of my portfolio swing wildly between well over index to well under and back several times. But although this has brought on several episodes of feeling regret for missing out, I'm sticking with my overall strategy: buy a diversity of apparently well-managed things, about a quarter of which are new players in markets I expect to grow in the medium to long term, and then just hold them for as many years as I can possibly arrange to. I think it's pretty sound.
Prices of stock represent the present value of all future earnings
That might be true if the efficient market hypothesis held water, but I'm totally unconvinced that it does. Quite a lot of what stock prices do is much better explained by the thundering herd hypothesis.
posted by flabdablet at 4:19 AM on February 19, 2021 [4 favorites]
On the plus side, Carlota Perez's theory is that in many cases bubbles and booms inject capital into areas that then become useful drivers of future growth. For instance many investors in the rail road booms of the 19th centuries, fibre optic craze around the tech boom, etc, lost money but the physical assets remained and were the basis for future growth. The problem comes when purely financial bubbles don't lead to real capital investment or of course lead to investment in things that don't turn out to be of any use to anyone.
posted by atrazine at 5:25 AM on February 19, 2021 [2 favorites]
posted by atrazine at 5:25 AM on February 19, 2021 [2 favorites]
or of course lead to investment in things that don't turn out to be of any use to anyone.
Just you wait, you’ll see how useful these tulip bulbs are for society.
posted by Special Agent Dale Cooper at 8:09 AM on February 19, 2021 [3 favorites]
Just you wait, you’ll see how useful these tulip bulbs are for society.
posted by Special Agent Dale Cooper at 8:09 AM on February 19, 2021 [3 favorites]
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I will do as well as the average of the market (minus cheap fees). The main bet I am taking is that the market will outperform inflation and the interest rates on savings. There is a risk that I am wrong but right now, given inflation and interest rates below 2% it feels like a very reasonable risk.
posted by plonkee at 12:10 PM on February 18, 2021 [10 favorites]