Edward Quince’s Wisdom Bites: Are You Intelligent? Chapter 4

 Today we continue our exploration of Jason Zweig’s commentary on The Intelligent Investor.  In Chapter 4 the theme of portfolio construction and asset allocation begins to be covered.

Studies show that portfolio policy and more specifically how an investor allocates their portfolio across stocks, bonds, and cash can be responsible for up to 90% of the volatility experienced and returns earned by an investor relative to things like individual stock selection and market timing.  The big picture point is that investors should be thinking about why they own certain investment assets at all and how they fit together to support reaching their goals.  As Bogleheads investment philosophy would posit, when preparing to invest, one should never bear too much or too little risk. Given, as we just said, a majority of the risk an investor can experience is tied to how they allocate their assets across stocks and bonds, this concept of portfolio construction becomes crucial to investing intelligently.  Security selection sits downstream from the asset allocation decision.

Commenting on Commentary on Chapter 4

As Zweig reminds us, portfolio construction / asset allocation policies are not solely about the investments, it is very much about you, the investor. There is a financial mantra that is a riff on Socrates, that says ‘investor, know thyself’, hitting straight to the heart of one of the most overlooked areas of building an investment portfolio, you first have to understand what kind of investor you are, to better understand your own ability to stick to a plan when financial conditions and markets get difficult.

Before digging into thoughts on how an investor should determine the proportion of stocks, bonds, and cash they hold, Zweig via Graham detour slightly into what they see as the two main types of investors based more on personality traits than prowess.  They offer up two ways to be an intelligent investor based on who you are, the first is what is called ‘enterprising’, this is the investor who does his own research, selection, monitoring to build up a portfolio, while the second he calls ‘defensive’, the investor who owns portfolios of funds that largely can run on autopilot. In short the distinction is about effort and emotion.

The rest of the chapter focuses on the concept of ‘defensive’ or ‘passive’ investing, beginning with the decision of how much you should invest in stocks. If you were hoping for a quick answer to this question, you won’t get it.  Instead of providing an answer Zweig reviews several leading heuristics commonly discussed in investing circles, one being that investors should invest a percentage of their portfolio in stocks equal to 100 minus their age.  Overall Zweig cautions that relying on factors like age misses the bigger picture Graham is trying to discuss, which is it’s about your financial and emotional ability to bear risk, to survive volatility, and the unexpected based on your needs.

Graham had suggested that an investor should never hold more than 75% of their portfolio in stocks and never less than 25% in stocks, with the driver being factors specific to your ability to control yourself during the inevitable vagaries of the market, or as Bogleheads would say: “Aim to select an asset allocation that lets you sleep at night, and avoid the destructive urge to sell out in a panic the next time the market plummets, then having to worry over when is the time to get back in. This leads to selling low and buying high, the exact opposite of prudent investing.”  The more risk you can tolerate, the higher percentage of your portfolio can be allocated to stocks.

The rest of Zweig’s commentary on the chapter is devoted to providing the reader with an overview of some fixed-income securities, which I won’t cover here as I feel like it takes away from the central point of this chapter.  The real wisdom Zweig leaves us with in this chapter is that “Graham’s distinction between active and passive investors is another of his reminders that financial risk lies not only where most of us look for it - in the economy or in our investments - but also within ourselves.”

When we return we turn to how the defensive or passive investors should think about filling up the equity/stock portion of their portfolio.

Until then:
“When you leave it to chance, then all of a sudden you don’t have any more luck.” - Pat Riley

Edward Quince's Wisdom Bites: Are You Intelligent? Chapter 3

 We’re now 3 posts deep on exploring Jason Zweig’s commentary on the Ben Graham classic book, The Intelligent Investor.  In our last two posts we learned about the 3 elements that define investing vis a vis speculating and why inflation must be factored into the evaluation of investment returns and goals.

Today, in reviewing Chapter 3 (or more precisely Zweig’s commentary on Chapter 3) we learn of the perils of extrapolating the past, as Zweig puts it: “...the intelligent investor must never forecast the future by extrapolating the past.”

Commenting on Commentary on Chapter 3

Chapter 3 is all about reviewing historical investment performance. At first the cursory reader may be tempted to skip this chapter as it was titled in a manner that it was an exploration of stock market levels up to 1972, but in judging this chapter solely by its title one would miss the genius of the central lessons inherent in it.

As mentioned above one of the wise lessons in this chapter is what I mentioned above to not forecast the future solely based on the past, however, for me the bigger lesson is simply that what you pay for an investment matters - or succinctly price matters.

Zweig dives into the logic of some of the 1990s prominent investment gurus and the argument that effectively says that if you hold stocks long enough, you eliminate all of the risk, that stocks are a “free lunch” if the investor just has enough time.  You may be saying to yourself, but isn't it correct that over a long enough time line history does show stocks in the aggregate have positive returns?  And that would be correct, the nuance is that statement isn’t enough to guarantee that you as an investor actually earn those returns.  Why? Because over that time horizon some/many companies fail, leading to “survivorship bias” in aggregate returns, meaning that the individual investors' portfolio construction would have had to be able to overcome those losers, or maybe more succinctly, not everyone owned the market portfolio.  But all of the aforementioned is just a sidebar to the deeper truth in this chapter which is: “The value of an investment is, and always must be, a function of the price you pay for it.”

So long as profits are finite, the price an investor is willing to pay must also be finite. Reflecting on that for a second, it’s a simple message, for all investments there will be some price at or above which it is simply too high, it is an impossibility the profits will be earned to cover that price.  Graham calls it the “rule of opposites” that the more enthusiastic investors are in stocks for the long run, the more likely they are to be proven wrong in the short run.  Perhaps this is just saying that the more hopium the market prices into stocks the more likely they are to be disappointed.

Too high of prices should lead an investor to ask at this price how can future returns still be higher? Once everything is ‘priced in’ where can the new optimism come from?

Zweig challenges us to think about future returns with cold calculating logic, not with market punditry and ‘noise’ from gurus.  And exactly what is that cold calculating logic of stock returns, well it is 3 factors (Graham seemed to like 3s): 1) real growth (the rise of company earnings), 2) inflationary growth (general rise in prices that companies can pass through ) and 3) speculative growth or decline (the general appetite for investing in stocks).  We’re not going to dive into these factors, but I would like to again highlight the fundamental logic that underlies these which I think was perfectly summed up by Warren Buffett in this quote:

"The absolute most that the owners of a business, in aggregate, can get out of it in the end - between now and Judgment Day - is what that business earns over time." 

Your investments can’t ‘out-earn’ the economy in aggregate. Does that exclude some companies from earning a disproportionate share of economic output, of course not.  Can you or anyone consistently find and buy shares in just those companies at fair prices and then exit them at the right time? Probably also no.

This is where some themes start to converge. Graham defines an element of intelligent investing as aspiring for ‘adequate’ performance. If we use the formula above, one place an investor might find ‘adequate’ performance might simply be what Buffett has called the ‘American tailwind’, simply capturing the real growth of an economy and letting it compound.  

Of course betting on an economic tailwind to continue is not necessarily enough, as Zweig reminds us: “The only thing you can be confident about while forecasting future stock returns is that you will probably turn out to be wrong.”  

As investors, if we’re trying in some way to put the ‘odds on our side’, then for me this chapter is all about realizing that price matters.

Next post we’ll begin to explore Graham’s views on the topic of ‘Portfolio Construction’.

Until then:

“You’ve got to be careful if you don’t know where you’re going, ‘cause you might not get there.’ - Yogi Berra.

Edward Quince’s Wisdom Bites: Are You Intelligent? Chapter 2

In our last two posts we’ve provided an overview of the 3 powerful lessons taught in Graham’s famous work and the 3 key elements of investing.  Interestingly the next place The Intelligent Investor takes us is the topic of inflation.  It seems like an odd turn to jump from a narrative of ‘here’s what it means to be an intelligent investor’, to inflation. It’s kind of like Graham said: ‘oh by the way before we get into the meat of investing lets take a detour through inflation.’ Why?  

Well much like today the topic of inflation was on many people’s minds both when this book was first published but it was really front and center by the 4th edition in 1973. I recommend perusing the site here which chronicles some interesting stats after the USD was fully decoupled from any gold backing to get a sense of why inflation was really on people's minds in 1973.

Nevertheless, we all feel the effects of inflation in our day to day lives but we likely underestimate the potential impact of inflation in our investment portfolios.  Arguably inflation is very harmful, but often in ways we don’t fully grasp.  Famed economist Irving Fisher posited in his classic, 'The Money Illusion', that the harms of unstable money consist of three evils: social injustice, social discontent and social inefficiency. The impact of inflation on business and investments is a factor supporting all three of these evils.

But the central theme of Irving Fisher’s classic and the one that Zweig riffs on is found right in Fisher’s title, it’s the money illusion; that is the failure to perceive that the dollar, or any other unit of money, expands or shrinks in value.

Commenting on Commentary on Chapter 2

Interestingly when Zweig was writing his commentary the U.S. was experiencing a period of low and largely stable inflation. In fact low inflation and deflation became a “fear” of central bankers in the years that followed Zweig’s commentary up until recently.  But the genius of Zweig’s message in this section is that intelligent investors have to stay on guard “against whatever is unexpected and underestimated.”  He goes on to list reasons the investors reading this book in 2003 might want to question the narrative that inflation is “dead”, one of which he cites as: “Completely eradicating inflation runs against the economic self-interest of any government that regularly borrows money.”  Well put indeed and certainly a topic of recent discussion.

Zweig jumps right into the psychology of inflation, how we tend to think of rising nominal investment or wage values as a good thing, without first considering whether the after-inflation (or real) result was positive or negative.  For example, owning an investment that returns 2% when inflation is 4% is not a good result.

He then moves onto addressing what an investor might do to guard against inflation, first addressing the standard answer that investors can buy stocks as an inflation hedge, with a warning that high inflation can often have a depressing effect on economic activity.  If you need some back up for Zweig’s claim, look no further than Fisher who posited: “Business is always injured by uncertainty. Uncertainty paralyzes effort, and uncertainty in the purchasing power of the dollar is the worst of all business uncertainties.”  Paralyzed businesses don’t really sound like great investments to me.

So if it’s not “buy stocks” what does Zweig advise investors to do?  His answer is consider REITs and TIPS.  If I had all day to dive into this recommendation, we could pick through a million nuances as to whether or not this is good advice.  When it comes to REITs, Zweig flat out states his own somewhat skepticism by stating: “While a REIT fund is unlikely to be a foolproof inflation-fighter [in the long run it could provide some defense against lost purchasing power]”  As for TIPS (Treasury Inflation Protected Securities) he notes the “phantom income” for tax purposes as a challenge.  The point is, neither of these are perfect products for addressing.  

The real lesson from this lesson is simple: it is to at least think about the potential risk your investments face due to inflation and to focus on real returns rather than solely nominal returns.

The next Chapter of The Intelligent Investor is focused on “stock-market” history and the dangers of extrapolating the past.

 “Americans are getting stronger. Twenty years ago, it took two people to carry ten dollars’ worth of groceries. Today, a five year old can do it.” - Henry Youngman

Edward Quince's Wisdom Bites: Are You Intelligent? Chapter 1

In our last post we visited Jason Zweig’s commentary on the Introduction chapter of Ben Graham’s The Intelligent Investor where we learned the timeless wisdom that the chief enemy of most successful investors is himself. We often fall victim to the allure of “sure-thing” ideas especially when those ideas are anyone’s but our own. Not only are we capable of suspending our own thinking but we’re even worse, we often forget to consider or even ask “how much does it cost?” when we’re buying the next “sure-thing” investment product.  

If you’re reading this you should be open-minded to the possibility that Graham’s ideas are no longer applicable to the latest investment landscape. As you make that consideration, Zweig reminds us that back in February 2000, the renowned Jim Cramer of Mad Money fame said the following regarding Graham’s investment thinking: “You have to throw out all the matrices and formulas and texts that existed before the Web…If we used any of what Graham and Dodd teach us, we wouldn’t have a dime under management.”  That quote did not age well.

In this post we’ll tackle Zweig’s Commentary on Chapter 1: Investment versus Speculation.

I think it is likely that most “investors” have never considered what it actually means to be an “investor”, in other words if you asked your investor friend to define “investing” my gut says you’ll get a half-baked answer.  Graham, on the other hand, is clear-sighted in defining investing, giving us the clarity of the 3 necessary and equal elements required: 1) you must thoroughly analyze a company, and the soundness of the underlying businesses, before you buy its stock; 2) you must deliberately protect yourself against serious losses; 3) you must aspire to “adequate”, not extraordinary, performance.  When it comes to stocks Zweig summarizes Graham’s elements as: “An investor calculates what a stock is worth, based on the value of its businesses. A speculator gambles that a stock will go up in price because somebody will pay even more for it.”

Three elements which Graham views as equally important, endless ways in which we can completely miss any or all of them and many combinations of ways to deviate from this recipe.  If we’re being honest, how often do we actually analyze a company or fund before investing and I’m not even talking about CFA level financial statement analysis, just a baseline review and understanding of the business, its capitalization, some basis of forming an opinion on valuation?  Strike 1.  I would like to think that many of us are fairly solid when it comes to the second element of protecting against serious losses, at least at a total portfolio level, but I’d venture to guess many of us have approached that topic haphazardly and we only get worse at using that element when we move from the portfolio level down to the individual investment level. Strike 2.  And as for the aspiration of adequate returns, it seems like human nature to want to reach for extraordinary returns, especially when you hear of someone else who has done better than you. I think we all want the most return with no risk and no effort, but I’ve found very few, if any, examples of that being on offer in my personal experience. Strike 3. 

It is so tempting to fall for the quick dopamine hits, the trading systems or gurus who promise utopia in the market. As Zweig analogizes these gimmicks are like hearing from the driver who successfully traveled 130 miles in 1 hour while you were driving the 65 mph speed limit and believing that because he survived that journey it is the right thing to do and you should do it too, “Flashy gimmicks for beating the market in short streaks is much the same: In short streaks, so long as your luck holds out, they work. Over time, they will get you killed.”

Investing is really all about getting the odds of your success to be on your side where speculation is a sure-fire way of making sure the financial market intermediaries profit.  As early as this 2003 writing Zweig identified the dangers of what he titled “The Financial Video Game”, little did he know how much gamification would pervade markets over the next two decades.  If he thought early day trading was bad, and stock trading had become merely blips moving across the screen, today’s markets are probably have more in common with the speed of protons being accelerated in a large hadron collider (which honestly I have no idea if that analogy makes any sense, knowing nothing about that process).  Today’s markets feature apps that have UX and design experiences that copy much of what makes video game experiences addictive, many platforms have also taken cues from social media apps with the appearance of “community”, not to mention the overall role social media has played in marketing “investing” techniques and the rise of “finfluencers”.  

While the monikers are new, the underlying human condition, which all of the things under the gamification umbrella are designed to exploit, remains much unchanged.  I recently read a novel detailing a fictitious quest in medieval France, in which the author offered up the following quote via one of the characters: “Mankind does not much change. On the surface, we seem different. We evolve, we develop new rules, new stands of living. Each generation asserts modern values and dismisses the old, priding itself on its sophistication, its wisdom. We appear to have little in common with those that have gone before us.  But within [the human] flesh, the human heart beats the same as it ever did. Greed, desire for power, fear of death, these emotions do not change.”  Financial author Morgan Housel wrote his book Same as Ever identifying the various ways in which this manifest itself in financial markets.

But if we  fail to properly evaluate businesses that underlie our investments, or to recognize when a platform is purposely attempting to negatively modify our behavior for its own interest, it’s certainly not because we are lacking in data, it’s because of our own lack of knowledge or the frail desperation of our human condition.

Which is why Zweig includes his commentary summarily with a warning on the dangers of speculating (any activity which violates the three elements of investing above) reminding us that when speculating: 1) Never delude yourself into thinking that you are investing when you are speculating; 2) Speculating becomes mortally dangerous the moment you begin to take it seriously; 3) You must put strict limits on the amount you are willing to wager.

As you read the above you might reach the conclusion that it can be very difficult to actually engage in investing and that you lack the necessary time or education to be an investor and if that’s the case, what do Graham and Zweig say you should do?  Don’t worry, they eventually get there, but not yet.

We’ll next turn our attention to a topic near and dear to our 2020’s heart, inflation.

But before we get there, remember:

“All of human unhappiness comes from one simple thing: not knowing how to remain at rest in a room.” - Blaise Pascal

 

Edward Quince's Wisdom Bites: Are You Intelligent? An Introduction

One of my favorite books on investing is Benjamin Graham’s class, The Intelligent Investor. More specifically my go-to is the 2003 Revised Edition (I believe the 4th edition) which features commentary by Jason Zweig.  If you’re not familiar with Ben Graham, suffice to know that Buffett refers to him as the man who:  “More than any other man except my father, [sic] influenced my life.”  Relative to Graham and Buffett, few people are likely familiar with Jason Zweig, though for those of us who were curious about investing during a certain era, Jason’s financial columns, first in Money then in Forbes, and later in the WSJ, provided some of the most accessible and in my mind logical writing about investing.

When presented with statements such as: “I want to start investing.”, or “I want to learn about investing” or the derivations of “I want to trade stocks and make a lot of money.” my first inclination is to respond in a way that attempts to define “Investing” vis a vis “Speculating” and that brings me right to this book. And since public curiosity in using financial markets as a means to make money is an enduring trend, I thought I would run a series of posts on the wisdom contained in The Intelligent Investor, however, to spice things up a bit I’m going to solely focus on the wisdom contained in Jason Zweig’s commentary on Graham’s seminal work.  

This post and those that follow will essentially be commentary on commentary on The Intelligent Investor.

Commentary on Commentary On The Introduction

If anyone picked up Graham’s book in hopes it was a guide to beating the market, their hopes are severely dashed right out of the gates. Instead this book offers 3 powerful lessons: 1) how you can minimize the odds of suffering irreversible losses; 2) how you can maximize the chances of achieving sustainable gains; 3) how you can control the self-defeating behavior that keeps most investors from reaching their full potential.

When this commentary was written in 2003 many investors were still grappling with the fallout of the dot-com bust and an era where many investors had just learned the hard way, that some holes are too deep to easily climb out of and there was a reason that Graham consistently emphasized the importance of of avoiding losses, especially the ones that could prove irreversible. Unfortunately the lessons mostly fell on deaf ears as merely a few years later, in 2008, a global financial crisis ensued.

But of course those investors who so foolishly lost money investing in dot-com and telecom stocks, Enron, flipping houses, synthetic CDO's are just relics of a bygone era. Things have changed, with AI, prediction markets, 0DTE options, this time is different, these “powerful lessons” need not apply, at least that is the refrain you’ll hear from many of today’s leading cheerleaders.  However, there is a reason that there may be merit to the belief that “this time is different” are the four most dangerous words in finance, and Zweig quickly calls attention to some high-profile “intelligent” investors in history who have failed to learn Graham’s lessons to their own detriment.  If Nobel laureates can blow up Long Term Capital Management and if in 1720 Issac Newton can get caught up in the South Sea bubble, surely acting unintelligently in the investing sphere is something that can and does happen to humans throughout history.  Why? Because it is easy to believe we’re smart enough to not make bad decisions and that we can control our emotions and be patient, but the reality is we are often our own worst enemies.

Remember at this point we are just discussing the Introduction to this book, but already Zweig is reminding us that it’s easy to get swept up in the next sure thing and believe in our own or other’s high conviction as to what is sure to be the world’s next best thing.  If being wrong as to what the next sure thing is bad enough, what often ends up being just as bad (and perhaps feels worse) is to be exactly right about the next big thing but to still lose money.  Both Graham and Zweig caution that both obvious growth in a business doesn’t necessarily translate into profits for investors as it is often the cause that by the time everyone decides that some industry is the next sure thing investment, “the prices of its stocks have been bid up so high that the future returns have nowhere to go but down.”

Whether today’s “sure-things” related to industries like AI, Quantum computing, Space, cryptography, predictions, jpegs of monkies, etc. will be proven to have reached the point where no price seems too high to pay for these industries future prospects is a story for a future edition of this book.

In the meantime it’s up to you to decide if you’d be better off heeding what Zweig calls “The Silver Lining”, that “stocks become more risky, not less, as their prices rise - and less risky, not more, as their prices fall.  The intelligent investor dreads a bull market, since it makes stocks more costly to buy.  And conversely (so long as you keep enough cash on hand to meet your spending needs), you would welcome a bear market, since it puts stocks on sale.” The hard part is that this belief is tough to hold when it seems like everyone around you seems to be getting ahead of you by acting in an manner that appears to be the exact opposite.

On the next episode of Wisdom Bites we'll dive into the commentary on Chapter 1 and the distinction between investing and speculating.

“If you have built castles in the air, your work need not be lost; that is where they should be. Now put the foundations under them.” - Thoreau, Walden

 

Edward Quince’s Wisdom Bites: The Architecture of the Precise Con

"...and all the pieces matter." > — Lester Freamon (The Wire, Season 1, Episode 6)

The Financial Translation

The amateur investor treats the market as a collection of isolated, disjointed facts. They spend their days endlessly refreshing terminals, tracking daily market movements, and reacting to macro headlines as if they were arbitrary weather patterns that simply happen to them. They operate under the delusion that access to an abundant stockpile of real-time data equates to actual strategic insight.

In reality, an economy is a complex adaptive system constructed by the aggregate, interconnected choices of millions of human actors. Every legislative act, central bank intervention, and corporate transaction engenders a cascading sequence of effects. The bad analyst relies entirely on the immediate, visible effect that reveals itself simultaneously with the cause. The superior analyst looks deep beneath the surface, recognizing that the most critical, defining structural indicators are hidden multiple layers below the immediate appearance.

[Surface Macro Headlines] ➔ Visible/Lagging Indicators (The "What")
                                       │
                                (Systemic Time Lag)
                                       ▼
[Hidden Footnote Context] ➔ Underlying Credit Plumbing (The "Why")

The true operational risk of an enterprise is rarely highlighted in the promotional text of an annual report. Fund managers deploy complex vocabulary to mask mediocre baseline performance, and executives construct elaborate summaries to hide structural fragility. The real data is pushed away into the margin.

The Tactical Takeaway

Stop trying to out-compute the market through the rapid consumption of superficial headlines. Real baseline advantage belongs to those who develop the patience to look at the entire chessboard, focus on the underlying credit plumbing, and understand that corporate speech is designed for misdirection. Separate the short-term emotion of market risk from the long-term reality of business risk. If you want to identify where the real structural liabilities reside, bypass the billboard on the tape and read the footnotes. All the pieces matter.

"What the wise man does in the beginning, the fool does in the end". 

Edward Quince’s Wisdom Bites: The Architecture of the Precise Con

"The bigger the lie, the more they believe." > — Bunk Moreland (The Wire, Season 5, Episode 1)

The Financial Translation

Human nature possesses a deep-seated, insatiable craving for absolute certainty. We dread the reality that the future is an unmapped, non-linear system governed by odds rather than definitive constants. This psychological vulnerability leaves the public permanently exposed to financial charlatans and product innovators who specialize in supplying the exact illusion of risk-free wealth the crowd desires.

When Wall Street introduces an exotic, complex financial vehicle—whether it is a specialized derivative tranche, a novel SPAC structure, or a hyper-scaled AI projection model—they never describe it vaguely. They drown the allocator in a blizzard of precise, technical jargon and hyper-detailed "back-tested data".

[Anxiety of Uncertainty] ➔ Demand for Certainty ➔ Hyper-Specific Modeling Veneer ➔ Financial Engineering Trap

This hyper-precision is a rhetorical device designed to construct a pseudo-scientific veneer. It tricks the observer into confusing mathematical complexity with actual intelligence. The more intricate, multi-layered, and opaque the flowchart becomes, the more the public suspends its natural skepticism. They assume that an army of quants must have mastered the downside, entirely forgetting that more data often increases the ratio of noise to actual signal.

The Tactical Takeaway

Beware any pitch deck that relies on hyper-specific details about a future that has not happened yet; it is fiction written with numbers. Apply a strict intellectual razor to financial complexity: if you cannot understand the basic mechanics and the precise source of the return immediately, walk away. Complexity is almost always a structural transfer mechanism designed to migrate wealth from the captive client to the manager’s fee pool. Stick exclusively to simple ideas, and take them with absolute seriousness.