Quote for the Week

The pendulum of investment psychology is constantly fluctuating between optimism and pessimism, between greed and fear, between credulousness and skepticism, between risk tolerance and risk aversion. It will always swing, and it is the presence of optimism, greed, credulousness, and risk tolerance that makes markets most dangerous…

One of the first lessons I heard about pendulums and the swing of investor behavior regarded something I was taught in the early 1970s: the three stages of a bull market. These succinctly capture the essence of investor psychology.

The first stage comes when a few people begin to realize that there will be improvement. The second stage occurs when most people realize that improvement is already taking place. The third stage comes when everyone thinks that things will be getting better forever. Clearly, the first is early; the last is laughably late. One of my favorite adages – perhaps my favorite of all – is that what the wise man does in the beginning, the fool does in the end. So it’s the buyer in the third stage – who buys when optimism is incorporated, under the assumption that things will always get better – who pays the price. — Howard Marks (source)

Quote for the Week

In the fund industry, the average manager lasts five years, and the average investor owns four funds, so that’s four managers in the first five years, eight managers after ten years, sixteen after twenty years, and fifty-two over the entire sixty-five years. What is the possibility that fifty-two managers, coming and going, cleaning out their portfolios time after time, could with remote conceivability do as well as the index? The return you get from holding the market portfolio over sixty-five years—even a modest return—demonstrates the “miracle of compounding returns,” and the tremendous impact the cost of active management makes is “the tyranny of compounding costs.” The way mathematics works, this tyranny absolutely overwhelms the miracle of compounding returns; to wit, over an investment lifetime the active equity fund investor captures about 20 percent of the return available simply by holding an all-market index fund. — John Bogle (source)

Samual Curtis Johnson had an idea. This wasn’t new. He had many ideas throughout life. But at age 53, he gave his idea a try. He started a parquet floor business in 1886.

Within two years, he had a small but thriving flooring business. He also had a customer base that wanted a better way to take care of their new floors. Soap and water ruined the floor finish and shellacs chipped and were a pain to deal with. His customers wanted something better.

With a little experimentation and a bathtub, Johnson created a floor wax. He gave it away, as an added service, with every new floor sold. What Johnson had done, though he didn’t know it yet, was diversify his business.

Soon, people he never sold new floors to, wanted to buy his floor wax. A happy accident turned a parquet floor company into a wax company that sold parquet floors. And another idea sprung from that. What if the wax could be used for things other than floors?

Quote for the Week

Volatility matters on only two levels. First, if two portfolios have equal average returns, the portfolio with the lower volatility will earn the higher compound return. On the other hand, investors understand this phenomenon – either intellectually or intuitively – and tend to price volatile securities accordingly. The second consideration in volatility is much more important: when is the owner of the principal of the fund going to disburse that principal? A fund that is tied up in perpetuity could fluctuate all over the place without any consequences whatsoever. It is my impression that too many funds with long horizons are managed as though they were going to be disbursed in the next couple of years, largely because volatility makes people uncomfortable – which is irrelevant to the conditions on which a rational decision should rest. Fear of volatility can be costly to long-run returns and can unnecessarily constrain the freedom of managers to do their best. — Peter Bernstein (source)