How not to invest

Public stock markets are exchanges to buy and sell shares in big companies. Most days most people involved are trying to solve some problem. Share prices go up when there is more demand, reflecting market conditions, innovations and/or a story about the future, and they go down when there is less demand.

Shorter-term business cycles (a few years) rotate longer-term secular trends (decades). Investors try to make money by putting this all together into a theory about the world. Different eras call for different strategies. For example, more than three-quarters of the gains in the American stock market between 1982 and 2000 were from rising price-to-earnings multiples (how much more expensive stocks got), rather than rising corporate profit (how much more efficient companies got). Over those 20 years, one could have called stocks “too expensive” and been wrong, until the very end, when a correction brought a big reset. “Fair value” is just just a mark in a continuum on the path from the start to the end of a bull market. Gotta pick your bets.

That’s from How Not to Invest, a book out this year from the investor Barry Ritholtz, who is a frequent writer and speaker.

The reason his book as a negative title? His big idea? A tiny sliver of any competitive field, including wealth accumulation, play the “winner’s game,” in which they’re competing on expertise. The rest of us play the “loser’s game,” as an analyst called it, in which we just try to avoid unforced errors. It’s true in tennis, and in money management. Just be smart, cautious and consistent and you’ll outperform most of the rest.

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The book’s foreward was written by Morgan Housel, another wealth manager who is active online and whose Psychology of Money was a bestseller in this tradition of the approachable personal finance books. Ritholtz’s book is longer and more tactical, but continues the tradition of introducing broader strategy and worldview.

He brings up lots of familiar, but effective, truths from psychology and other social sciences.

For one, he brings up the evolutionary mismatch hypothesis, which suggests that traits beneficial in our ancestral past, like craving sugar or storing fat, become detrimental in the rapid, modern world, leading to modern diseases like diabetes, obesity, and inflammation, because our ancient biology hasn’t caught up to today’s vastly different environments (e.g., sedentary lifestyles, abundant processed foods, constant stress). It’s also why basic personal finance strategies are so hard, even if the research has been so dependably clear for decades: put little bits into a diversified portfolio with the lowest fees possible.

Then again, when it goes wrong, as investor Howard Marks wrote: “Experience is what you got when you didn’t get what you wanted.”

Below I share my notes from the book for future reference.

My notes:

• Charley Ellis in 1975 writes “the losers game:” investing is like tennis, have fewer unforced errors than the rest
• Investment strategist Michael Mauboussin writes of the “paradox of skills:” as a field gets more crowded and competitive, luck plays a bigger role
• Raymond Loewy: MAYA “most advanced yet acceptable” neophiloa and neophobia
• [[My early read: In his first several chapters, he keeps introducing movie and tv shows that were super popular after being turned down for years by financiers but he seems to overlook an obvious point: why should we assume Squid Game could have been as popular in 2015 as it was in 2020?]]
• Paul Graham: “When experts are wrong, it’s often because they’re experts on an earlier version of the world”
• Legendary 1999 “Dow 36,000” book that is published right before the dot com bubble crashes
• As William Bernstein wrote “the reason that guru is such a popular word is because charlatan is so hard to spell“
• As John Kenneth Galbraith wrote “there are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know “
• “All forecasting is marketing”
• Phillip Tetlock: no expert forecasting works
• Richard Feynman: “imagine how much harder physics would be if electrons had feelings”
• Paul Macrae Montgomery: magazine cover indicator
• Crichton wet streets cause Roin stories in newspapers, he says in 2002 — ((reminds me of AI: expert in everything we don’t know but not in what we do)$)
• March 23, 2020: Wall Street journal story noting banks warn that the worst has yet to come, a day before market bottom and 69% boom
• Saying I don’t know “would have kept investors from Theranos or Madoff or Enron
• Max Planck: “Truth never triumphs, its opponents just die out. Science advance is one funeral at a time.”
• Morgan Housel: earnings didn’t miss estimates; estimates missed earnings
• Daniel Boorstein: “ I write to discover what I think. (After all the bars aren’t open that early.)”
• Ted Sturgeon: 90% of everything is crap
• George EP Box: “all models are wrong but some are useful”
• William Goldman: nobody knows anything
• Joan Robinson: learn economics “to learn how to avoid being deceived by economists”
• Frank Luntz: death tax a name for something fewer than 0.5% of Americans experience
• US dollars are not a long term store of value; it’s a medium of exchange
• Rule of 72: divide 72 by ARR (so 10% ARR doubles every 7 years)
• Secular bull and bear markets (decade-plus)
• Research in 2013 from Fidelity noted the specifics of secular markets: Average secular bull market lasted 21.2 years and produced a total (annual) return of 17.2% in nominal terms and 15.9% in real terms.?The market’s P/E more or less doubled, from to. at the start to 20.5 at the end.
• Average secular bear market lasted 14.5 years and had a nominal total return of +1.0% and a real return of -2.3%. The market’s P/E compressed by an average of 9 points, from 20.5 at the start to 11.3 at the end.

• Cyclical moves inside secular ones (eg the covid crash did not end the secular bull)
• Author: 75%+ of the gains of the 1982-2000 bull market were from price to earnings multiple expansion, not rising corporate profit — “fair value” is just a mark in a continuum on the path from the start to the end of a bull market
• Howard Marks: experience is what you earn from not getting what you want
• Just 1.3% of all public companies account for all market gains over the last three decades: Hendrik Bessembinder
• Don’t be a stock picker, be a stock unpicker
• 2019 research: money managers are good at picking but bad at selling stocks: the research used counter factual randomized buys and sells and the randomized sell outperformed
• Index trading also gets taxed less than stock picking: Michael Batnick, meaning it outperformed
• Ben Carlson: dollar cost averaging performs better than market timing
• Canvas is a tax loss harvesting software and there are others (does my broker?))
• Belfor family: Enron, Madoff and FTX scandals, they didn’t steal money they stole time (much was recovered of their principal)
• “The flip side of all high expected returns is increased risk of lower returns. This is the single most important rule of investing. To get better than average returns you must be willing to accept higher-sometimes much higher—levels of risk. This means that sometimes, you will receive lower returns or even losses. This is how investing works. The inverse is that if you want safety you must accept the inevitability of lower returns.“
• David Swenson set the Yale Standard for endowment management — Harvard hired Jack Meyer who beat Yale until kinds Terry Bennett in 2004 New York Times story talked against Meyer’s high comp and Harvard’s performance slid from there
• Process versus outcome (luck)
• Donald Luskin and Collins research on “politics and investing don’t mix”: returns in the S&P are overwhelming higher when not accounting for political party switching

• Nber research showing partisan stock buying
• Difference between risk and uncertainty: risk is when it’s unknown but we know the “distribution set” (or possible outcomes!), uncertainty is when we don’t know the distribution set — like markets
• The evolutionary mismatch hypothesis suggests that traits beneficial in our ancestral past, like craving sugar or storing fat, become detrimental in the rapid, modern world, leading to modern diseases like diabetes, obesity, and inflammation, because our ancient biology hasn’t caught up to today’s vastly different environments (e.g., sedentary lifestyles, abundant processed foods, constant stress)
• Endowment effect, hindsight bias, sunk cost and loss aversion all have investment consequences
• Famous 1999 paper is origin of the Dunning-Kruger effect
• Epistemic trespass by Nathan Ballantyne: “Epistemic trespassers are thinkers who have competence or expertise to make good judgments in one field, but move to another field”
• Narrative fallacy, coined by Nassim Taleb in The Black Swan, describes our innate tendency to weave simple, compelling stories out of random facts to make sense of the world, even when these stories lack true causal links.
• 10 year annualized returned by class research from JP Morgan Guide

• Blaise Pascal: “all of humanities problems stem from man’s inability to sit quietly in a room alone”
• Suitability vs fiduciary standard for registered representatives vs registered investment advisor
• Larry Swedroe: institutional benchmark scorecard shows 90% of funds underperform the S&P benchmark
• DI software (own all equities inside a fund, and then sell losses) versus / for tax loss harvesting
• Author’s take on alternative assets like PE and VC: only take advantage if you have access to the top 10% of alternative fund performance and avoid the rest
• The allure of VC is low correlation to public markets and chance for massive wins but very few perform
• Don’t confuse spending with spending beyond your means (one is the point of doing well, and the other is a risk)