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Notes on Investing

Published Jul 21, 2020 (Updated Aug 23, 2020)

Recently, I’ve been trying to learn more about stock-market investing so that I can have better control over my money. To guide my learning process, I’ve been using the Simple Programmer course “10 Steps To Learn Anything Quickly.” Here are some of the notes I’ve written with minimal edits apart from organization and formatting.

Risk and Reward

  • Risk is basically the possibility of losing money. We can observe it as early in 1300-1500 in Venetian prestiti (historical European annuity that only paid interest) prices.
  • “the most important concept in finance, that risk and return are inextricably connected” - Four Pillars. If you want a chance at high returns, you have to shoulder high risks. If you want safety, you have to deal with “meager” rewards.
    • The lower price you pay now, the higher future returns will be, and vice versa.
    • Don’t confuse the future with the past: high previous returns often mean low future returns and vice versa.
    • So buy when prices are low. Unfortunately, this is usually scary because low prices are not possible without risk.
  • Two flavors of risk: short/long-term
  • Promises of safety + very high returns → probably fraud
  • Historical returns are of limited use in predicting future returns; the historical record is better as a gauge of risk

Stocks, Bills, Bonds, and ETFs

  • A short/long-term obligation is a bill/bond
  • Don’t use bond returns in the 20th century to predict future bond returns, because there was the monetary shock of moving away from gold
  • End-period wealth a better indicator of long-term risk than annualized returns
  • Stocks are mean reverting: bad/good years are likely to be followed by good/bad years
  • Bond returns don’t mean revert
  • market cap(tialization)
    total value of a company's outstanding stock
  • most market indices are market cap weighted
  • stocks of small companies have higher returns than large companies
  • ETFs are ok, but you can do better if you’re willing to take on more risk

Fear and Greed

  • Fear and greed will ruin returns
  • “Be fearful when others are greedy. Be greedy when others are fearful.” — Warren Buffet

  • Avoid idolizing wealth and security
  • Don’t invest in anything you don’t understand
  • Understand the incentives of people giving advice

Managing Funds

  • Pay off high-interest debt and have an emergency fund before starting

Booms and Busts

The various quotations that appear in this section are from Four Pillars.

Booms: Overconfidence

  • You must understand the history to have a chance at surviving booms and busts
  • “the great engine of stock returns is the rate of technological progress, not its absolute level.”
  • “But that does not mean that the economic and financial effects of technological revolutions occur immediately. Not at all. The steam and internal combustion engines did not completely displace horses in the transport of bulk goods for nearly a century, and it took several decades for computers to travel from the laboratory into the office, and, finally, into the home. Immediately after their invention, the telegraph and telephone were the toys and tools of the wealthy. Ordinary people did not begin to routinely make long-distance calls until relatively recently.”
    • “technological progress comes in spurts, but that the economic and investment rewards driven by economic activity occur relatively evenly.”
  • “the capitalization of the nation’s great companies occurs largely during brief periods of public enthusiasm. Second, our society owes its success and prosperity to both the inventors and the financial backers of the technological process. And last, the returns to technology’s investors are low.”
  • “an object lesson for those who become enthusiastic over the investment possibilities of new technology. Even if it is initially highly profitable, nothing attracts competition like a cash cow.”
    • “The canals established a pattern that has held to this day-of transformative inventions that bring long-run progress and prosperity to society as a whole, short-run profits to an early lucky few, and ruin to most later investors.”
  • “the basic rule of technology investing: it is the users, and not the makers, who profit most.”
    • “consumer companies-Phillip Morris, Gillette, and Coke. They did not produce the era’s technology, but they certainly used it to advantage. So history once again demonstrated that the spoils went not to technology’s makers, but to its users.”
  • How to tell when you’re entering a bubble
    • “technological or financial ‘displacement,’ excessive use of credit, amnesia for the last bubble, and the flood of new investors who swallow plausible stories in place of doing the hard math.”
    • You can’t tell when you’re entering a bubble, though. These indicators can be seen after the fact.

Busts: Crashes and Pessimism

  • “One concept that is ignored by even the most sophisticated financial players is that over the long haul, risk and return become the same thing.”
  • “severe bear markets are usually followed by powerful bull markets.”
  • “do not underestimate the amount of courage it takes to act on your beliefs.”
    • “and buying assets that everyone else has been running from takes … fortitude”
  • “A generalized loss in the faith of the new technologies to cure the system’s ills is usually the triggering factor. A contraction of liquidity almost always follows, with the losses of faith and liquidity reinforcing each other. The third criterion is an amnesia for the recoveries that usually follow collapses. And finally, investors incapable of doing the math on the way up do not miraculously regain it on the way down. Cheap stocks excite only the dispassionate, the analytical, and the aged.”
  • How to survive
    • “At a minimum, you should not panic and sell out-simply stand pat. You should have a firm asset allocation policy in place. What separates the professional from the amateur are two things: First, the knowledge that brutal bear markets are a fact of life and that there is no way to avoid their effects.”
    • “And second, that when times get tough, the former stays the course; the latter abandons the blueprints, or, more often than not, has no blueprints at all.”
    • “Ideally, when prices fall dramatically, you should go even further and actually increase your percentage equity allocation, which would require buying yet more stocks. This requires nerves of steel and runs the risk that you may exhaust your cash long before the market finally touches bottom. I don’t recommend this course of action to all but the hardiest and experienced of souls. If you decide to go this route, you should increase your stock allocation only by very small amounts-say by 5% after a fall of 25% in prices-so as to avoid running out of cash and risking complete demoralization in the event of a 1930s-style bear market.”

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