5 From Robert Rubin’s commencement address, University of Pennsylvania, 1999, http://www.upenn.edu/almanac/v45/n33/speeches99.html.
6 See chapter 5.
7 Sarah Lichenstein, Baruch Fischhoff, and Lawrence D. Phillips, “Calibration of Probabilities,” in Judgment Under Uncertainty: Heuristics and Biases, ed. Daniel Kahneman, Paul Slovic, and Amos Tversky (Cambridge: Cambridge University Press, 1982), 306-34.
8 Peter Schwartz, Inevitable Surprises: Thinking Ahead in a Time of Turbulence (New York: Gotham Books, 2003).
9 Roger Lowenstein, When Genius Failed: The Rise and Fall of Long-Term Capital Management (New York: Random House, 2000); Nassim Nicholas Taleb, The Black Swan: The Impact of the Highly Improbable (New York: Random House, 2007).
10 Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica 47 (1979): 263-91.
11 Nassim Nicholas Taleb, Fooled By Randomness: The Hidden Role of Chance in Markets and in Life (New York: Texere, 2001), 89-90. Taleb takes to task the well-known investor Jim Rogers for arguing against investing in options because of the frequency of loss. Says Taleb, “Mr. Jim Rogers seems to have gone very far in life for someone who does not distinguish between probability and expectation.”
12 See chapter 3.
13 Russo and Schoemaker, Winning Decisions, 123-24.
14 Rubin, commencement address, University of Pennsylvania, 1999.
2. Investing—Profession or Business?
1 Burton G. Malkiel, “The Efficient Market Hypothesis and Its Critics,” Journal of Economic Perspectives 17, no. 1 (Winter 2003): 78. This is not a new finding. See also Burton G. Malkiel, “Returns from Investing in Equity Mutual Funds, 1971-1991,” Journal of Finance 50, no. 2 (June 1995): 549-72; Michael C. Jensen, “The Performance of Mutual Funds in the Period 1945-1964,” Journal of Finance 23 (1968): 389-416.
2 Special thanks to Gary Mishuris for creating the initial list and prompting this line of inquiry.
3 Jack Bogle, using John Maynard Keynes’s terminology, contrasts speculation (“forecasting the psychology of the market”) with enterprise (“forecasting the prospective yield of an asset”). Bogle argues that the turnover ratios suggest most investors are speculators. See John C. Bogle, “Mutual Fund Industry in 2003: Back to the Future,” 14 January 2003, http://www.vanguard.com/bogle_site/sp20030114.html.
4 See Charles D. Ellis, “Will Business Success Spoil the Investment Management Profession?” The Journal of Portfolio Management (Spring 2001): 11-15, for an excellent exposition of this tension.
5 Bogle, “Mutual Fund Industry in 2003.” Also see, “Other People’s Money: A Survey of Asset Management,” The Economist, July 5, 2003; John C. Bogle, “The Emperor’s New Mutual Funds,” The Wall Street Journal, July 8, 2003; and John C. Bogle, “The Mutual Fund Industry Sixty Years Later: For Better or Worse?” Financial Analysts Journal 61, no. 1 (January-February 2005): 15-24.
6 Ellis, “Will Business Success Spoil the Investment Management Profession?” 14.
3. The Babe Ruth Effect
1 I am not equating investing to gambling. In fact, long-term investing is really the opposite of gambling. In gambling, the more you play the greater the odds that you lose. In investing, the longer you invest, the greater the odds that you generate positive returns.
2 Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica 47 (1979): 263-91.
3 Nassim Nicholas Taleb, Fooled By Randomness: The Hidden Role of Chance in Markets and in Life (New York: Texere, 2001), 87-88.
4 Taleb points out that well-known investor Jim Rogers avoids options because “90 percent of all options expire as losses.” Rogers is confusing frequency with how much money is made on average.
5 Brent Schlender, “The Bill and Warren Show,” Fortune, July 20, 1998.
6 Charlie Munger, “A Lesson on Elementary, Worldly Wisdom As It Relates to Investment Management and Business” Outstanding Investor Digest, May 5, 1995, 50.
7 Warren Buffett, speech given at the Berkshire Hathaway Annual Meeting, 1989.
8 Alfred Rappaport and Michael J. Mauboussin, Expectations Investing (Boston, Mass.: Harvard Business School Press, 2001), 105-8.
9 Steven Crist, “Crist on Value,” in Andrew Beyer et al., Bet with the Best: All New Strategies From America’s Leading Handicappers (New York: Daily Racing Form Press, 2001), 63-64.
10 Edward O. Thorp, Beat the Dealer (New York: Vintage Books, 1966), 56-57.
4. Sound Theory for the Attribute Weary
1 See Mitchel Resnick, Turtles, Termites, and Traffic Jams (Cambridge, Mass.: MIT Press, 1994), 50-52. Also see, Steven Johnson, Emergence: The Connected Lives of Ants, Brains, Cities, and Software (New York: Scribner, 2001), 12-13.
2 Professor Burton Malkiel: “It’s like giving up a belief in Santa Claus. Even though you know Santa Claus doesn’t exist, you kind of cling to that belief. I’m not saying that this is a scam. They generally believe they can do it. The evidence is, however, that they can’t.” 20/20, ABC News, November 27, 1992. See http://www.ifa.tv/Library/Support/Articles/Popular/NewsShowTranscript.htm.
3 Clayton M. Christensen, Paul Carlile, and David Sundahl, “The Process of Theory-Building,” Working Paper, 02-016, 4. For an updated version of this paper, see http://www.innosight.com/documents/Theory%20Building.pdf.
4 Phil Rosenzweig, The Halo Effect: ... and Eight Other Business Delusions That Deceive Managers (New York: Free Press, 2006).
5 Peter L. Bernstein, Capital Ideas: The Improbable Origins of Modern Wall Street (New York: The Free Press, 1992), 129-30.
6 Richard Roll, “A Critique of the Asset Pricing Theory’s Tests: Part 1: On Past and Potential Testability of the Theory,” Journal of Financial Economics 4 (1977): 129-76.
7 Clayton M. Christensen, “The Past and Future of Competitive Advantage,” MIT Sloan Management Review (Winter 2001): 105-9.
8 Kenneth L. Fisher and Meir Statman, “Cognitive Biases in Market Forecasts,” Journal of Portfolio Management 27, no. 1 (Fall 2000): 72-81.
9 Mercer Bullard, “Despite SEC Efforts, Accuracy in Fund Names Still Elusive,” The Street.com, January 30, 2001. See http://www.thestreet.com/funds/mercerbullard/1282823.html.
5. Risky Business
1 Gerd Gigerenzer, Calculated Risks (New York: Simon & Schuster, 2002), 28-29.
2 John Rennie, “Editor’s Commentary: The Cold Odds Against Columbia,” Scientific American, February 7, 2003.
3 Gigerenzer, Calculated Risks, 26-28.
4 Jeremy J. Siegel, Stocks for the Long Run, 3rd ed. (New York: McGraw Hill, 2002), 13.
5 Michael J. Mauboussin and Kristen Bartholdson, “Long Strange Trip: Thoughts on Stock Market Returns,” Credit Suisse First Boston Equity Research, January 9, 2003.
6 See chapter 3.
6. Are You an Expert?
1 J. Scott Armstrong, “The Seer-Sucker Theory: The Value of Experts in Forecasting,” Technology Review 83 (June-July 1980): 16-24.
2 Atul Gawande, Complications: A Surgeon’s Notes on an Imperfect Science (New York: Picador, 2002), 35-37.
3 Paul J. Feltovich, Rand J. Spiro, and Richard L. Coulsen, “Issues of Expert Flexibility in Contexts Characterized by Complexity and Change,” in Expertise in Context: Human and Machine, ed. Paul J. Feltovich, Kenneth M. Ford, and Robert R. Hoffman (Menlo Park, Cal.: AAAI Press and Cambridge, Mass.: MIT Press, 1997): 125-146.
4 R.J. Spiro, W. Vispoel, J. Schmitz, A. Samarapungavan, and A. Boerger, “Knowledge Acquisition for Application: Cognitive Flexibility and Transfer in Complex Content Domains,” in Executive Control Processes, ed. B.C. Britton (Hillsdale, N.J.: Lawrence Erlbaum Associates, 1987), 177-99.
5 Robyn M. Dawes, David Faust, and Paul E. Meehl, “Clinical Versus Actuarial Judgment,” in Heuristics and Biases: The Psychology of Intuitive Judgment, ed. Thomas Gilovich, Dale Griffin, and Daniel Kahneman (Cambridge: Cambridge University Press, 2002), 716-29.
6 Gawan
de, Complications, 44.
7 Katie Haffner, “In an Ancient Game, Computing’s Future,” The New York Times, August 1, 2002.
8 James Surowiecki, The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations (New York: Doubleday, 2004).
9 Joe Nocera, “On Oil Supply, Opinions Aren’t Scarce,” The New York Times, September 10, 2005.
10 Philip E. Tetlock, Expert Political Judgment: How Good Is It? How Can We Know? (Princeton, N.J.: Princeton University Press, 2005), 68.
11 Ibid., 73-75.
7. The Hot Hand in Investing
1 Thomas Gilovich, Robert Valone, and Amos Tversky, “The Hot Hand in Basketball: On the Misperception of Random Sequences,” Cognitive Psychology 17 (1985): 295-314.
2 Amos Tversky and Daniel Kahneman, “Belief in the Law of Small Numbers,” Psychological Bulletin 76 (1971): 105-10. For an illustration, see Chris Wetzel, Randomness Web site, http://www.rhodes.edu/psych/faculty/wetzel/courses/wetzelsyllabus223.htm.
3 Adapted from Stephen Jay Gould, “The Streak of Streaks,” New York Review of Books, August 18, 1988, available from http://www.nybooks.com/articles/4337, accessed 25 May 2005.
4 Stephen Jay Gould, Triumph and Tragedy in Mudville (New York: W. W. Norton & Company, 2003), 151-72. See http://mlb.mlb.com/mlb/history/rare_feats/index.jsp?feature=hitting_streaks.
5 Gould, “The Streak of Streaks.”
6 Here’s the math: DiMaggio had 7,671 plate appearances in 1,736 career games, or 4.42 plate appearances per game. He also had 2,214 career hits, for a 0.289 hit-per-plate appearance average. With a 0.289 hit-per-appearance average, DiMaggio would be expected to get a hit in 0.778 percent of his games. So the probability of getting a hit in fifty-six straight games is (0.778)56 , or 1-in- 1.279 million. See Rob Neyer, ESPN Baseball Archives, January 2002, http://espn.go.com/mlb/s/2002/0107/1307254.html. For DiMaggio’s career statistics, see Major League Baseball Historical Player Stats, http://mlb.mlb.com/NASApp/mlb/stats/historical/individual_stats_player.jsp?c_id=mlb&playerID=113376.
7 Amazingly, DiMaggio’s fifty-six-game streak wasn’t his longest. As a teenager in the Pacific Coast League, DiMaggio had a sixty-one-game streak. Of note, too, is immediately after DiMaggio’s fifty-six-game streak was broken, he went on to a sixteen-game hitting streak. So he got a hit in seventy-two of seventy-three games during the course of the 1941 season.
8 Here’s a sample of some references (there are too many to list exhaustively): Burton G. Malkiel, A Random Walk Down Wall Street (New York: W. W. Norton & Company, 2003), 191; Nassim Taleb, Fooled By Randomness: The Hidden Role of Chance in Markets and in Life (New York: Texere, 2001), 128-131; Gregory Baer and Gary Gensler, The Great Mutual Fund Trap (New York: Broadway Books, 2002), 16-17; Peter L. Bernstein, Capital Ideas: The Improbable Origins of Modern Wall Street (New York: Free Press, 1992), 141-43.
9 Baer and Gensler, The Great Mutual Fund Trap, 17. Baer and Gensler only consider the streak’s first ten years (even though the book came out after the eleventh year was complete). The difference between ten- and fifteen-year streaks is significant.
10 Miller also ran a second fund, Opportunity Trust, which has a different composition but beat the market for the six years ended 2005. The probability of beating the market twenty-one years consecutively (assuming a 44 percent fund outperformance rate) is roughly 1 in 31 million.
11 While the Value Trust streak is Miller’s longest, it is not his only streak. In the six years that ended with 1993, Miller’s Special Investment Trust beat the market every year.
8. Time Is on My Side
1 Paul A. Samuelson, “Risk and Uncertainty: A Fallacy of Large Numbers,” Scientia 98 (1963): 108-13; reprinted at www.casact.org/pubs/forum/94sforum/94sf049.pdf. Shlomo Benartzi and Richard H. Thaler, “Myopic Loss Aversion and the Equity Premium Puzzle,” The Quarterly Journal of Economics 110, no. 1 (February 1995): 73-92, available from http://gsbwww.uchicago.edu/fac/richard.thaler/research/myopic.pdf, write: “Specifically, the theorem says that if someone is unwilling to accept a single play of a bet at any wealth level that could occur over the course of some number of repetitions of the bet, then accepting the multiple bet is inconsistent with expected utility theory.”
2 Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica 47 (1979): 263-91.
3 Nicholas Barberis and Ming Huang, “Mental Accounting, Loss Aversion, and Individual Stock Returns,” Journal of Finance 56, no. 4 (August 2001): 1247-92.
4 Elroy Dimson, Paul Marsh, and Mike Staunton, “Global Evidence on the Equity Risk Premium,” Journal of Applied Corporate Finance 15, no. 4 (Fall 2003): 27-38.
5 Benartzi and Thaler, “Myopic Loss Aversion.”
6 This and following exhibits closely follow William J. Bernstein, “Of Risk and Myopia.” See http://www.efficientfrontier.com/ef/102/taleb.htm. Also, see Nassim Nicholas Taleb, Fooled By Randomness: The Hidden Role of Chance in the Markets and in Life (New York: Texere, 2001), 56-59.
7 Michael J. Mauboussin and Kristen Bartholdson, “Long Strange Trip: Thoughts on Stock Market Returns,” Credit Suisse First Boston Equity Research, January 9, 2003.
8 Benartzi and Thaler, “Myopic Loss Aversion,” 80.
9 James K. Glassman and Kevin A. Hassett, Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market (New York: Times Books, 1999).
10 Josef Lakonishok, Andrei Shleifer, and Robert W. Vishny, “Contrarian Investment, Extrapolation, and Risk,” Journal of Finance 49, no. 5 (December 1994): 1541-78.
11 Bernstein, “Of Risk and Myopia.”
9. The Low Down on the Top Brass
1 Berkshire Hathaway Annual Letter to Shareholders, 1993, http://berkshire-hathaway. com/letters/1993.html.
2 Jim Collins, Good to Great (New York: HarperBusiness, 2001), 21.
3 Meghan Felicelli, “2006 YTD CEO Turnover,” SpencerStuart, December 31, 2006. Also, Chuck Lucier, Paul Kocourek, and Rolf Habbel, “CEO Succession 2005: The Crest of the Wave,” strategy+business, Summer 2006.
4 When an interviewer recently asked Nokia CEO Jorma Ollila how he ensures that he knows all that he needs to know, he replied, “I think you just have to read a lot.” (See David Pringle and Raju Narisetti, “Nokia’s Chief Guides Company Amid Technology’s Rough Seas,” The Wall Street Journal, November 24, 2003.) Charlie Munger said it more bluntly, “In my whole life, I haven’t known any wise person who didn’t read all the time.”
5 http://csfb.com/thoughtleaderforum/2003/harrington_sidecolumn.shtml.
6 Robert E. Rubin and Jacob Weisberg, In an Uncertain World (New York: Random House, 2003), 20.
7 Alfred Rappaport and Michael J. Mauboussin, Expectations Investing (Boston: Harvard Business School Press, 2001), 191-94.
8 Bethany McLean and Peter Elkind, The Smartest Guys in the Room (New York: Penguin Group, 2003), 132.
9 Take Pfizer as an example. From 1998 to 2002, roughly 85 percent of Pfizer’s $192 billion in investments have been M&A related.
10 Berkshire Hathaway Annual Letter to Shareholders, 1987, http://berkshirehathaway.com/letters/1987.html.
10. Good Morning, Let the Stress Begin
1 Sapolsky has spent over twenty summers in Africa studying baboons to understand the link between stress and social hierarchy in primates. Writes Sapolsky: “The baboons work maybe four hours a day to feed themselves; hardly anyone is likely to eat them. Basically, baboons have about a half dozen solid hours of sunlight a day to devote to being rotten to each other. Just like our society . . . We live well enough to have the luxury to get ourselves sick with purely social, psychological stress.” See Robert M. Sapolsky, A Primate’s Memoir (New York: Scribner, 2001).
2 Robert M. Sapolsky, Why Zebras Don’t Get Ulcers: An Updated Guide to Stress, Stress-Related Disease, and Coping (New York: W. H. Freeman and Company, 1994), 4-13.
3 Richard Foster and Sarah Kaplan, Creative Dest
ruction: Why Companies That Are Built to Last Underperform the Market—and How to Successfully Transform Them (New York: Doubleday, 2001), 13.
4 John Y. Campbell, Martin Lettau, Burton Malkiel, and Yexiao Xu, “Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk,” Journal of Finance 54 (February 2001): 1-43.
5 This does not mean that stock prices reflect short-term expectations.
6 John C. Bogle, “Mutual Fund Directors: The Dog that Didn’t Bark,” January, 28, 2001, http://www.vanguard.com/bogle_site/sp20010128.html. Updated data are from John C. Bogle, “The Mutual Fund Industry Sixty Years Later: For Better or Worse?” Financial Analysts Journal (January-February 2005).
7 Kathryn Kranhold, “Florida Might Sue Alliance Capital Over Pension Fund’s Enron Losses,” The Wall Street Journal, April 23, 2002.
8 This is not to say that the stock market is short-term oriented. The research consistently shows that stocks reflect expectations for ten to twenty years of value-creating cash flow. Increasingly, though, investors are making short-term bets on long-term outcomes.
9 Ernst Fehr, “The Economics of Impatience,” Nature, January 17, 2002, 269-70.
10 John Spence, “Bogle Calls for a Federation of Long-Term Investors,” Index Funds, Inc., http://www.indexfunds.com/articles/20020221_boglespeech_com_gen_JS.htm. By my calculations, the weighted average return in 2001 was-4.8 percent for the funds with 20 percent turnover or less, -7.8 percent for the funds with turnover over 100 percent, and -10.5 percent for the funds that had over 200 percent turnover. See http://www.indexfunds.com/articles/20020221_boglespeech_com_gen_JS.htm.
11 Alice Lowenstein, “The Low Turnover Advantage,” Morningstar Research, September 7, 1997, http://news.morningstar.com/news/ms/FundFocus/lowturnover1.html.
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