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April, 2005


I like to offer the reader a variety of bargains to consider, for future fun and profits. Usually there are sufficient ideas from which to choose.

At this time, though, that is not the case. Aside from some very distressed value assets, and the company I have often mentioned here before, Berkshire Hathaway (BRK/A; BRK/B), which again seems at a good price to me, my metaphorical investing suggestions well is just about dry. [Added later: This essay was written just prior to the declines in the market week of 4/11-4/15, and thereafter. Doubtless, following those price drops, there are more good stock buys available.]

In 2002, when the market was at its lowest point in a number of years, there were lots of rewarding securities to feature. Now the market seems close to at least a short-term top, and the best deals may already have been snapped up.

Probably by next month I'll once more have new assets to suggest. But for the current issue, in recognition of this dearth of great opportunities, instead I'll mention some ideas of Peter Bernstein, touched on by Jason Zweig in a November, 2004, "Money" magazine article, "Peter's Uncertainty Principle" (pp. 143-149).

Bernstein's career extends back to World War II when he was an intelligence officer, and it has continued through to the present with work in economics, investing, and history. His book, Against the Gods, is considered an excellent and impressive analysis of financial risk.

Here is some of his investing and risk management wisdom:

  1. One is most vulnerable when correct. If folks feel sure they are right, they tend to have too much confidence in types of investing with which they are already familiar. In the late 1990s, for instance, this might have meant keeping large amounts of net worth in dot com and technology stocks, that for awhile just kept going to the moon, but which collapsed, of course, in 2000. Today, who knows what the equivalent error might be? Perhaps assuming the real estate market will remain relatively firm despite higher interest rates once we enter a new recession.

  2. Diversification is not simply a defensive strategy. We are prone to thinking we should spread our assets among several asset categories simply to keep from losing too much net worth in any one of them. But Bernstein says that, since one cannot accurately know the future, unexpected investment classes may well surprise us with excellent returns. In the 1970s, precious metals were among the very best performers, with gold climaxing a rise from around $35 to about $800 an ounce. In the 1980's previously modest seeming money market accounts were for awhile paying 15% a year. In the 1990s, real estate seemingly could only go up. Even during the recent great bull market for stocks, from 1982 to 2000, bonds sometimes for extended periods offered as good as or better than equities' total returns. And from 2000 on, REITs have had compound annual total returns of around 19%, right through a terrible bear market for most stocks.

  3. Bernstein suggests one is not adequately diversified until uneasy with the holdings. What might make me uncomfortable today? Savings bonds perhaps, or commodities. He suggests some exposure to gold, foreign currencies, and Treasury Inflation-Protected Securities (TIPS). Diversification, he says, is an admission that one does not know what will occur, and this goes against the grain. We like to think we have much better understanding and control than we really do.

  4. Wise investing implies also smart risk avoidance. The question is not simply what a new investment asset or strategy has to offer, but what might be the costs to one's total net worth if things go sour. Into the equation one needs to consider both good times and bad. Never "bet the farm." Comes another great depression, you may then have no place to grow a subsistence living. The sad fact, though, is that most investors, even the majority of money managers with their clients' nest eggs, significantly underperform the market by investing too much in risky assets or sectors, typically buying when the market is already substantially up and not selling till it is down. The opposite rule makes more sense in investing, to "buy low and sell high."

    Before taking any investment action, Bernstein suggests we consider the consequences, just in case we are wrong. As Warren Buffett has said, there are two main rules for investing: The first is not to lose money. The second is never to forget rule number one.

    With respect to an attractive investment vs. risk avoidance, I "love" Buffett's company, Berkshire Hathaway, more than any other asset that comes to mind. Had I invested $10,000 with Buffett in the late 1950s and held onto all my shares, I could be worth over $200,000,000 today. But I don't have more than 10-20% of our portfolio in even this stock at any one time. After all, things may not work out as I expect about Berkshire Hathaway either.

  5. Investors may, either by accident or by taking big risks, luck out and acquire an enormous windfall. Should they then hold onto the asset(s) which have been so good for them, seeking every possible tenth of a percent return?

    Each person must answer that for him or herself, weighing the benefits of any extra profits against the pain of great losses.

    But in general Bernstein would favor reducing the risk by diversifying and then avoiding even once lucrative large gambles. This is consistent with a truth from psychology: We are more prone to suffering over big losses than to feeling contentment from outsize profits.

A transcript with portions of Jason Zweig's Peter Bernstein "Money" interview is available.


Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)

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