Against the Gods - The remarkable Story of Risk - by Peter L. Bernstein, Wiley 1996
“diversification if not a guarantee against loss, only against losing everything at once” 336
“If you are not going to sell a stock, what happens to its price is a matter of indifference. For true long term investors - that small group of people like Warren Buffet who can shut their eyes to short term fluctuations and who have no doubt that what goes down will come back - volatility represents opportunity rather than risk….”
There is next to nothing in Against the Gods on dividends. The following statement, however, is a beauty. The context is the period after WWII from 1941 to 1959 when inflation averaged 4.0% a year. “The relentlessly rising price levels transformed bonds from a financial instrument that had appeared inviolate into an extremely risky investment.” In the period 1945 to 1959, stock dividends tripled. “What mattered was the rising stream of dividends that the future would bring. Over time, those dividends could be expected to exceed the interest payments from bonds, with a commensurate rise in the capital value of the stocks. The smart move was to buy stocks at a premium because of the opportunities for growth they provided, and to pass up bonds and their fixed-dollar yield.” 185
Here are more of the kind of ideas you'll find in Against the Gods.
“Nature has established patterns originating in the return of events, but only for the most part. As I pointed out in the Introduction, that qualification is the key to the whole story. Without it, there would be no risk, for everything would be predicable. Without it there would be no change, for every event would be identical to a previous event. Without it, life would have no mystery.” 329
“changes in stock prices are normally distributed” 145
“new information arrives in random fashion. Consequently, stock prices move in unpredictable ways.” 145
“Investors must expect to lose occasionally on the risk they take. Any other assumption would be foolish.” 284
“most of them [active portfolio managers] fail to outperform the major market indexes over the long run” 285
Past performance is a frail guide to the future.“ 298
“Mediocrity always outnumbers talent.” 166
“Fear of harm ought to be proportional not merely to the gravity of the harm, but also to the probability of the event.”
SURPRISE:
“The past seldom obliges by revealing to us when the wildness will break out in the future. Wars, depressions, stock market booms and crashes…come and go, but they always seem to arrive as surprises.” 334
“Surprise is endemic above all in the world of finance. 334
“The element of surprise…is common in a system where so many decisions depend on forecasts of the future.”
volatility - “most of the time, an increase in volatility is associated with the decline in the price of an asset” 260
“volatility sets in when the unexpected happens”
“The consensus forecasts embedded in security prices mean that those prices will not change if the expected happens. The volatility of stock and bond prices is evidence of the frequency with which the expected fails to happen and investors turn out to be wrong. Volatility is a proxy for uncertainty and must be accommodated in measuring investment risk.” 222 Notice that Bernstein has stated that bonds are volatile too. Bonds are volatile. Yet most people think bonds are safe. It's interesting.
“the credo to which so-called contrarian investors pay obeisance: when they say that a certain stock is 'undervalued' or 'overvalued' they mean that fear or greed has encouraged the crowd to drive a stock's price away from an intrinsic value to which it is certain to return.”
“Our faith in risk management encourages us to take risks we would not otherwise take.” 335 Think about the failure of portfolio insurance in the late 1970s, as a good example. And, in my view, derivatives today.
“If God is not, whether you lead your life piously or sinfully is immaterial. But suppose that God is. Then if you bet against the existence of God by refusing to live a life of piety and sacraments, you run the risk of eternal damnation; the winner of the bet that God exists has the possibility of salvation. As salvation is clearly preferable to eternal damnation, the correct decision is to act on the basis that God is.” 70
Peter Bernstein divides the book up into people chapters. Chapter 1 the Greeks, C-2 Fibonacci and the invention of zero, C-3 Blaise Pascal and Fermat, C-5 John Graunt, William Petty and Halley (the comet guy), C-6 Daniel Bernoulli, C-8 Gauss, C-9 Francis Galton (1822-1911 - reversion to the mean, peapods p.166) and Quetelet, C13 after WWI Frank Knight and Keynes, C-14 game theory and Von Neumann, C-15 Markowitz,
At the end of it all, I found myself wondering who, of all these people was right. There were so many different ideas over the centuries. I liked Frank Knight's ideas the best and intend to find his book: Risk, Uncertainty & Profit originally published in 1921, but re-published in 1964…the year we were married.
I'm not good with numbers…don't like them in fact. Against the Gods is about numbers, odds, probability, the bell curve, statistics, sampling, forecasting, outliers, the average man, reversion to the mean and things like that but I had little trouble with it. As you can probably tell from the quotations I picked out above, I found Against the Gods to be an interesting book. I would not add it to my top ten, but the top twenty. Against the Gods got me thinking about some ideas in a different way and exposed me to a few ideas I had not thought of. What else does one want in a book? Against the Gods is well referenced from pages 339 to 383. Stay away from investment books which are not referenced. They usually contain a lot of hocum.