Lessons for Building a Winning Portfolio_6

160 The Four Pillars of Investing bubble and subsequent collapse would likely have been much less violent. A similar reaction occurred in the United States in the wake of the 1929 crash that should give pause to many involved in the most recent speculative excess. At the center of this titanic story was a brilliant attorney of Sicilian origin, Ferdinand Pecora. Just before the market bottom in 1932, with embittered investors everywhere demanding investigation of Wall Street’s chicanery, the Senate authorized a Banking and Currency Committee. It promptly hired Pecora, then a New York City assistant district attorney, as its counsel. In the follow-ing year, he skillfully guided the committee, and via it the public, through an investigation of the sordid mass of manipulation and fraud that characterized the era. The high and mighty of Wall Street were politely but devastatingly interrogated by Pecora, right up to J.P. “Jack” Morgan, scion of the House of Morgan and a formidable figure in his own right. But the real drama centered around New York Stock Exchange President Richard Whitney. Tall, cool, and aristocratic, he symbolized the “Old Guard” at the stock exchange, who sought to keep it the pri-vate preserve of the member firms, free of government regulation. In the drama of the October 1929 crash, Whitney was the closest thing Wall Street had to a popular hero. At the height of the bloodshed on Black Thursday—October 25, 1929—he strode to the U.S. Steel post and made the most famous single trade in the history of finance: a purchase of 10,000 shares of U.S. Steel at 205, even though at that point it was trading well below that price. This single-handedly stopped the panic. But Dick Whitney was a flawed hero. His arrogance in front of the committee alienated both the legislators and the public. He was also a lousy investor, with a weakness for cockamamie schemes and an inability to cut his losses. He wound up deeply in debt and began bor-rowing heavily, first from his brother (a Morgan partner), then from the Morgan Bank itself, and finally from other banks, friends, and even casual acquaintances. In order to secure bank loans, he pledged bonds belonging to the exchange’s Gratuity Fund—its charity pool for employees. This final act would be his downfall. Under almost any other circumstances, he would not have been treated harshly for this transgression. But Whitney had found himself at the wrong place at the wrong time. In 1935, he went to Sing Sing. He was not the only titan of finance who found himself a guest of the state, however, and many of the most prominent players of the 1920s met even more ignominious ends. The moral for the actors in the recent Internet drama is obvious. When enough investors find themselves shorn, scapegoats will be Bottoms: The Agony and the Opportunity 161 sought. Minor offenses, which in normal times would not attract notice, suddenly acquire a much greater legal significance. The next Pecora Committee drama already seems to be shaping up in the form of congressional inquiries into the Enron disaster and brokerage ana-lyst recommendations. It is likely that we are just seeing the beginning of renewed government interest in the investment industry. On the positive side, four major pieces of legislation came out of the Pecora hearings. Unlike the post-bubble English experience, the com-mittee’s effect was positive; three new laws were introduced that still shape our modern market structure. The Securities Act of 1933 made the issuance of stocks and bonds a more open and fair process. The Securities Act of 1934 regulated stock and bond trading and estab-lished the SEC. The Investment Company Act of 1940, passed in reac-tion to the investment trust debacle, allowed the development of the modern mutual fund industry. And finally, the Glass-Steagall Act sep-arated commercial and investment banking. This last statute has recently been repealed. Sooner or later, we will likely painfully relearn the reasons for its passage almost seven decades ago. This legislative ensemble made the U.S. securities markets the most tightly regulated in the world. If you seek an area where rigorous gov-ernment oversight contributes to the public good, you need look no further. The result is the planet’s most transparent and equitable finan-cial markets. If there is one industry where the U.S. has lapped the field, it is financial services, for which we can thank Ferdinand Pecora and the rogues he pursued. How to Handle the Panic What is the investor to do during the inevitable crashes that charac-terize the capital markets? At a minimum, you should not panic and sell out—simply stand pat. You should have a firm asset allocation pol-icy 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. In the book’s last section, we’ll talk about portfolio rebalancing—the process of maintaining a constant allocation; this is a technique which automatically commands you to sell when the market is euphoric and prices are high, and to buy when the market is morose and prices are low. Ideally, when prices fall dramatically, you should go even further and actually increase your percentage equity allocation, which would 162 The Four Pillars of Investing require buying yet more stocks. This requires nerves of steel and runs the risk that you may exhaust your cash long before the market final-ly 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 run-ning out of cash and risking complete demoralization in the event of a 1930s-style bear market. Bubbles and Busts: Summing Up In the last two chapters, I hope that I’ve accomplished four things. First, I hope I’ve told a good yarn. An appreciation of manias and crashes should be part of every educated person’s body of historical knowledge. It informs us, as almost no other subject can, about the psychology of peoples and nations. And most importantly, it is yet one more demonstration that there is really nothing new in this world. In the famous words of Alphonse Karr, Plus ça change, plus c’est la même chose: The more things change, the more they stay the same. Second, I hope I have shown you that from time to time, markets can indeed become either irrationally exuberant or morosely depressed. During the good times, it is important to remember that things can go to hell in a hand basket with brutal dispatch. And just as important, to remember in times of market pessimism that things almost always turn around. Third, it is fatuous to believe that the boom/bust cycle has been abolished. The market is no more capable of eliminating its extreme behavior than the tiger is of changing its stripes. As University of Chicago economics professor Dick Thaler points out, all finance is behavioral. Investors will forever be captives of the emotions and responses bred into their brains over the eons. As this book is being written, most readers should have no trouble believing that irrational exuberance happens. It is less obvious, but equally true, that the sort of pessimism seen in the markets 25 and 70 years ago is a near cer-tainty at some point in the future as well. And last, the most profitable thing we can learn from the history of booms and busts is that at times of great optimism, future returns are lowest; when things look bleakest, future returns are highest. Since risk and return are just different sides of the same coin, it cannot be any other way. PILLAR THREE The Psychology of Investing The Analyst’s Couch The biggest obstacle to your investment success is staring out at you from your mirror. Human nature overflows with behavioral traits that will rob you faster than an unlucky nighttime turn in Central Park. We discovered in Chapter 5 that raw brainpower alone is not suffi-cient for investment success, as demonstrated by Sir Isaac Newton, one of the most notable victims of the South Sea Bubble. We have no his-torical record of William Shakespeare’s investment returns, but I’m willing to bet that, given his keen eye for human foibles, his returns were far better than Sir Isaac’s. In Chapter 7, we identify the biggest culprits. I guarantee you’ll rec-ognize most of these as the face in the looking glass. In Chapter 8, we’ll devise strategies for dealing with them. This page intentionally left blank ... - tailieumienphi.vn