Category: Behavioral Finance & The Value Investor

Higher expected returns can be quantified by measuring a portfolio
— Read on www.ifa.com/articles/never-ending-pursuit-alpha/

Mr. Wonderful talks with the “Industry Focus” podcast.
— Read on www.fool.com/investing/2020/12/24/shark-tank-star-kevin-oleary-talks-about-financial/

Daniel Kahneman gives a great breakdown of 6 cognitive biases and illusions that affect both our everyday lives and our investing success: availability heuristic, WYSIATI…
— Read on www.vintagevalueinvesting.com/6-cognitive-biases-heuristics-and-illusions-that-daniel-kahneman-thinks-investors-should-know/

If you have ever spent any time in a casino, it is likely that you have seen supposedly random events that appeared to be non-random.
— Read on www.ifa.com/articles/gambler_fallacy_misuse_large_numbers/

It
— Read on www.ifa.com/articles/stock_drops_signal_down_year/

The spectacle of oil prices falling below zero demonstrates the outsize impact that various derivative financial products can play in setting the price in markets.
— Read on www.barrons.com/articles/negative-oil-prices-from-the-folks-who-brought-you-the-financial-crisis-51587549601

“In bear markets, stocks return to their rightful owners.”
— Read on ofdollarsanddata.com/investment-quotes/amp/

The secret is out; the S&P 500 has had a terrific year of performance. With today the final trading day left in the year (or decade depending on who you ask), 2019 is on the heels of being the best performing year in for the index since 1997, when the return was 31%.
— Read on www.etftrends.com/etf-strategist-channel/dont-look-down-investing-at-all-time-highs/

Wondering why you’re no good at stock picking? The odds are stacked dramatically against you. Do yourself a favor and don’t play this loser’s game.
— Read on www.whitecoatinvestor.com/picking-individual-stocks-is-a-losers-game/

The first article in the original Reminiscences of a Stock Operator series was left out of the book but had this lesson against greed and ignorance.
— Read on novelinvestor.com/the-lost-intro-to-reminiscences-of-a-stock-operator/

John Kenneth Galbraith breaks down the three common features in every Bubble found over history of past few hundred years.
— Read on novelinvestor.com/the-common-traits-in-every-bubble/

The history of the early banana businesses, during the late 1800s to early 1900s, offers several great lessons for investors.
— Read on novelinvestor.com/investing-lessons-from-the-banana-business/

Mark Sellers believes the great investors have a competitive advantage, like an economic moat, over everyone else, and other weekend reads.
— Read on novelinvestor.com/7-moats-of-great-investors/

Joel Greenblatt explains in the gaping investment opportunity created by misbehavior, assuming you can behave better than everyone else.
— Read on novelinvestor.com/joel-greenblatt-on-the-opportunity-in-misbehavior/

Dean Williams, in 1981 kenote to financial analysts, relayed the important role of simplicity and consistency in investing.
— Read on novelinvestor.com/where-less-is-more/

The flattening of the world is much exaggerated.
— Read on www.etf.com/sections/index-investor-corner/swedroe-benefits-intl-diversification

The next time you hear Cramer or a glib “analyst”, “strategist” or “technician”, confidently predict where the stock market is headed, ignore them and engage in tyromancy instead.
— Read on danielsolin.com/a-tasty-way-to-predict-the-stock-market/

Beware of those designated as “experts”, “strategists” or “technicians” by the financial media. They’re wolves in sheep’s clothing.
— Read on danielsolin.com/experts-are-wolves-in-sheeps-clothing/

Some investment strategies are overhyped.
— Read on www.morningstar.com/articles/920113/dont-fall-for-a-good-story.html

Life guarantees: 1. A perpetually moving goalpost Median family income adjusted for inflation was $29,000 in 1955. In 1965 it was $42,000. Today it’s just over $62,000. There’s widespread belief that the 1950s and ‘60s were peak time for middle America to secure a good-paying job. But it’s a quantitative fact that the median American household earned more in 2018 than they did at any point in the 1950s or 1960s, adjusted for inflation. That’s true for hourly wages too. Part of the disconnect between feelings and reality can be explained by the shift in expectations over the last 60 years. To generalize only a little: In the 1950s camping was an acceptable vacation. Hand-me-downs were acceptable clothes. A 983 square foot house was an acceptable size. Kids sharing a room was an acceptable arrangement. A tire swing was acceptable entertainment. Few of those things would be acceptable baselines by most households today. But – and this is the important part – they were acceptable back then because other median households accepted it. John D. Rockefeller never had penicillin, sunscreen, or Advil. But you can’t say a low-income American with Advil and sunscreen should feel better off than Rockefeller, because that’s not how people’s heads work. People gauge their wellbeing relative to those around them. Everyone does. And goalposts move both ways: Sebastian Junger’s book Tribes details the long history of comradery during shared disasters, like soldiers during war and neighbors during natural disasters. Hardship is more palatable when everyone around you is in the same boat. You can be an optimist and say living standards will keep improving, which I think is likely. But you can’t say that people will feel proportionally better off, because the goalpost will always move up with improvements in living standards. There is a correlation between money and happiness, but it diminishes with each additional dollar gained. This is especially true at the micro level where people live their day to day – the hedge fund manager who makes $100 million a year compares their life to other hedge fund managers who make $100 million per year, so their life doesn’t feel nearly as amazing as others imagine. Their goalpost moved to the next town over. If the 1950s and 1960s felt like a better time, it’s because there was less dispersion between income groups, with fewer extremely wealthy people inflating the lifestyle aspirations of everyone else. But that highlights the point here: when you watch other people live a better life, your benchmark for normal and acceptable rises. The goalposts moves. This isn’t necessarily bad or good, and I don’t have a solution; it’s one of those things that just is. Like death and taxes. 2. Periods of excess After each bubble there’s well-meaning attempt to ensure it never happens again. Governments make new regulations, and individuals say “I’ve learned my lesson and I’ll never do that again.” But you will do it again. Maybe not you. But the drive toward financial excess is an inevitable part of how markets work. There are two reasons why. One is that the most important variables of investment returns are unknown. How much will investors pay for this asset? How much debt is too much? How high do interest rates need to go before businesses stop investing? These are more psychological than analytical, so there are no predictable answers. And when there are no predictable answers the only way we can identify the “breaking point” is to go beyond it, then look back and say, “Oh, OK, apparently 50 times earnings was too much,” which is something we didn’t know at 49 times earnings. The only way to know how much food you can eat is to eat until you’re sick. Same for markets, which occasionally vomit. And we have to find that breaking point because until we find it there’s potential profit on the table, and market potential will always be tested. Put up a sign that says “There’s potentially a prize in this box” and someone will eventually open the box. Human nature. The second has to do with volatility. If returns came at predictable times there would be no risk, because you could just show up, collect the prize, and go home. If there’s no risk, investors will bid up the price of an asset until there’s no reward, because free money on the sidewalk is always picked up. Then, once there’s no reward, the people who show up to collect their predictable prize realize they’ve been stiffed, so they get mad and storm off and the asset price falls. Which is to say: If markets weren’t volatile, prices would rise until volatility is triggered. Which is why there’s volatility, and always will be. As certain as death and taxes. 3. Intense debate about economic policy In late 2009 the unemployment rate for African American males age 16 to 19 without a high school diploma was 48.5%. For Caucasian females over age 45 with a college degree it was 3.7%. That’s the most extreme unemployment skew you can find. But the point is that when there’s such a wide disparity of personal experiences it’s very hard to get everyone on the same page about economic policy, financial goals, or philosophies around things like risk-taking and opportunity. Some argue certain economic policies with bad faith, knowing they’re talking their own book. But more common and potentially more dangerous are those whose personal experience makes it hard to even fathom those who have experienced a different world, in a way that innocently makes their arguments oppose huge groups of other people. Empathy and putting-yourself-in-others’-shoes only go so far. Daniel Kahneman put it recently, “Anything you experience is so much more vivid than if you’re just told about it.” This is not the case for something like, say, physics, which everyone experiences more or less equally. There are physics debates, down to the Flat Earthers. But they aren’t as widespread or passionate as economic debates, which can rival religious debates. There is an implicit feeling by many that if you can just get the other side to hear you out, listen to your story, look at your data, they’ll be able to agree with your economic view. That’s sometimes the case. But as long as people have wildly different economic experiences there will be wildly different economic views. As reliable as death and taxes.
— Read on www.collaborativefund.com/blog/death-taxes-and-a-few-other-things/

John Maynard Keynes explains his investment policy following a 1938 post-mortem on the King’s College investment funds.
— Read on novelinvestor.com/john-maynard-keyness-investment-policy/

Summary

• In this commentary, we discuss what we mean by the phrase, “no pain, no premium.”
• We re-frame the discussion of portfolio construction from one about returns to one about risk and argue that without risk, there should be no expectation of return.
• With a risk-based framework, we argue that investors inherently act as insurance companies, earning a premium for bearing risk.  This risk often manifests as significant negative skew and kurtosis in the distribution of asset returns.
• We introduce the philosophical limits of diversification, arguing that we should not be able to eliminate risk from the portfolio without eliminating return as well.
• Therefore, we should seek to eliminate uncompensated risks while diversifying across compensated ones.
• We explore the three axes of diversification – what, how, and when – and demonstrate how thinking in a correlation-driven, payoff-driven, and opportunity-driven framework may help investors find better diversification.

Read the full article right here: https://blog.thinknewfound.com/2019/02/no-pain-no-premium/amp/

Wall Street has a secret. A big one. Here’s what it doesn’t want you to know.
— Read on danielsolin.com/the-secret-wall-street-doesnt-want-you-to-know/

This is a transcript of Seek Wealth, Not Money or Status. Summary: Wealth is assets that earn while you sleep: businesses, products, media, robots, investments, land. Wealth is for freedom, not conspicuous consumption. // Money is how we transfer wealth; it’s the social credits and debits of other people’s time. Money isn’t going to solve all…
— Read on startupboy.com/2019/02/28/seek-wealth/

In his book Succeeding, John Reed wrote one of the smartest things I’ve ever read: When you first start to study a field, it seems like you have to memorize a zillion things. You don’t. What you need is to identify the core principles – generally three to twelve of them – that govern the field. The million things you thought you had to memorize are simply various combinations of the core principles. This extends beyond those learning a new field. I think it’s most relevant for those who consider themselves experts. The root of a lot of professional error is ignoring simple ideas that seem too basic for those with experience to pay attention to. Having seen the investing world from several different angles, four skills stand out as governing most of outcomes. 1. The ability to distinguish “temporarily out of favor” from “wrong.” The two strongest forces in investing are “This investment looks broken because that’s how opportunity presents itself” and “This investment looks broken because it’s actually broken.” It’s hard to tell the difference in real time. Distinguishing between the two relies on accurately calculating the odds that something will eventually come along to heal or promote the market or company that looks broken. And since those odds are always less than 100%, it can take a while to tell if you’re any good at it, because even when the odds are in your favor the outcome can go the wrong way. It’s hard to do. But worse, and more common, is forgetting that a distinction needs to be made in the first place. 2. The willingness to adapt views you wish were permanent. Economies grow because businesses, consumers, and technology change and adapt. It’s ironic how many investors attempt to ride this wave of change with rigid beliefs. There are a set of truly timeless investing ideas. But most of what guides us are beliefs that reflect what we’ve happened to experience in the narrow view of our own lives. Even when investors study history, they put more weight on stories that align with their own experiences, because those stories are easier to understand and confirm their beliefs. It’s painful to contemplate, but a lot of what all of us believe about investing is either right but temporary, or wrong but convincing. If you’re unwilling to update your views when the world changes, or be open-minded enough to realize that some of your views were anecdotal to begin with, boy, you will be eaten alive in this field. 3. The ability to be comfortable being miserable. This is the most fundamental of all investment principles. You can’t enjoy the benefits of exercise without some sort of discomfort, because being out of breath, sore, or tired is the sign that you’ve put in enough effort to deserve a reward. Same in investing. The financial rewards for being comfortable as an investor are the same as the physical rewards for sitting on the couch. Returns do not come for free. They demand a price, and they accept payment in uncertainty, confusion, short-term loss, surprise, nonsense, stretches of boredom, regret, anxiety, and fear. Most markets are efficient enough to not offer any coupons. You have to pay the bill. There are four psychological states of investing, in order of lucrativeness: Miserable but confident in its eventual rewards. Miserable and giving up. Comfortable and accepting of its future downside. Comfortable and oblivious of what’s to come. Some are better at coping than others, but that’s the complete list. 4. The ability to distinguish when analytics vs. psychology is necessary. If investing were only about numbers, no one would be good at it, because computers would arbitrage away all opportunities. And if it were only about psychology, no one would be good at it, because every investor has different, arbitrary, goals and markets would never coalesce around something objective. Good investing is some part analytical and some part psychological. An art and a science. The trick is knowing when which skill is necessary, and how one affects the other. Parts of investing are counterintuitive – like the prevalence of volatility, margin analysis, or moats repelling competition – and require data to understand. But there are things data can’t help with, like the tendency to embrace false narratives that justify your actions, or your willingness to throw your strategy out the window after the emotions of a big win or loss. Data doesn’t teach you about fear or patience, and psychology doesn’t teach you about discount rates and EBITDA. The hard part is that analytics and psychology couldn’t be more different. One is rational and stable, the other makes no sense and changes all the time. One is numbers you can see, the other is emotions you can sort of feel, sometimes. Attacking a problem with two different skills is hard. But attacking a problem with two conflicting skills can make you question what you’re doing. And even harder is the frustration that comes from attacking an analytical problem with psychology, or vice versa.
— Read on www.collaborativefund.com/blog/the-four-fundamental-skills-of-all-investing/

Edges That Won’t Go Away
— Read on awealthofcommonsense.com/2019/02/edges-that-wont-go-away/

Investment fads come and go. Letting short-term trends influence your approach may be counterproductive to pursuing your financial goals.
— Read on www.ifa.com/articles/deja-vu-all-over-again/