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  #1  
Old 12-29-2008, 11:52 AM
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More Madoff: Ben Stein's Take

ABOUT two years ago, a little delegation from a major investment bank arrived at my home in Beverly Hills. These nice young people were from the bank’s “wealth management division.” I told them straight away that I didn’t have anywhere near enough wealth to make their trip worth their time, but they smilingly insisted that we could help each other.

They told me that if I invested a certain sum with them, they would make sure that a large chunk of it was managed by a money manager of stupendous acumen. This genius, so they said, never lost money. He did better in up markets than in down markets, but even in down markets he did well. They said he used a strategy of buying stocks and hedging with options.

I protested that a perfect hedge would not allow making any money, because money made on the one side would be lost on the other. They assured me that this genius had found a way to spot market inefficiencies and, indeed, to make money off a perfect hedge.

I thanked them for their time and promptly looked up Bernard Madoff online. Nothing I saw was even a bit convincing that he had made a breakthrough in financial theory. Besides, this large financial firm was going to charge me roughly 2 percent to put my money with Mr. Madoff’s firm. I could invest my few shekels with Warren Buffett for no management fee at all.

I checked with my investment gurus, Phil DeMuth, Raymond J. Lucia and Kevin Hanley. None of us could see how Mr. Madoff could do what his friends said he could do. I politely passed and went on my way, finding my own inventive ways to lose money on a colossal scale during these last 15 months.

My point is not that I was so smart. I am not and I was not. Mistakes are a big part of my life. My point is that, as humans, we seem unable to learn from our mistakes very well.

I have never heard of an entity that could make money in all kinds of markets consistently, year in and year out. Yet we continue to believe that there will be one. It is, like much else in finance, a myth that will not die. I have never heard of a financial manager who promised to be able to defeat the markets anytime he chose and who, in fact, was able to do so. Even Mr. Buffett says repeatedly that he will have losing years and losing stretches of years. (Wow, is he right this year.)

By the same token, I belong to a number of country and town clubs. In all of my years at them, I have never gotten an investing tip that made money. In fact, as far as I can recall, I have never gotten a tip from any source that made me money, except for my former agent’s wife mentioning Berkshire Hathaway, Mr. Buffett’s company, 30 years ago.

The same goes on a much larger scale for the debacle of subprime mortgages. In essence, it is a much larger version of the Drexel Burnham Lambert junk-bond debacle of the 1980s. Back then, investors were charmed by the idea that the lower-ranked the bond, the more money it would make. It seemed like a great idea: there’s this little corner of the market that the big boys turn up their noses at. But in this little corner, huge money is made. It’s almost like the myth that you get great bargains in poor parts of town.

In fact, the Drexel episode should have taught us to be wary, indeed, of poorly rated debt. But it didn’t. The new version of the myth was so alluring that it drew in not just billions of dollars from lenders and mortgage bond buyers, but much more in derivatives linked to the myth.

Then there was the myth of the hedge funds. One great advantage of being 64 is that I can remember the early hedge funds of the 1960s. They, too, were supposed to turn water into wine, but they fell hard in the stock market meltdown that also laid low the Nifty Fifty — another 1960’s idea that 50 carefully selected stocks could long beat the indexes.

I can still recall visiting an early hedge fund pioneer. He had a small stereo playing rock music in his office as he tried to make millions. That’s how cool he was. I don’t know where he is now and I don’t want to know.

AND there are many other myths I could talk about, myths that we believed in and that tricked us and hurt us. But I will tell you about the main myth that’s hurting investors right now. It is well expressed by my hero, Bob Dylan, who warns against being “ nothing more than something they invest in” in the immortal song, “It’s Alright Ma (I’m Only Bleeding).”

We are more than our investments. We are more than the year-to-year or day-by-day changes in our net worth. We are what we do for charity. We are how we treat our family and friends. We are how we treat our dogs and cats. We are what we do for our community and our nation. If you had $100 million or $100,000 a year ago and now you have a lot less, you are still the same person. You are not a balance sheet, at least not one denominated in money, as was explained to me recently.

Losing and making money are not moral issues so long as you are being honest. You may have a lot less money as this year ends than you did two years ago. But you are just as good or bad a person as you were then. It is a myth that money determines who you are, and if you have gotten over that myth by now, then 2008 will have been a very good year.

http://www.nytimes.com/2008/12/28/business/28every.html?_r=1&em

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Old 12-29-2008, 12:28 PM
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Originally Posted by al76slc View Post

I protested that a perfect hedge would not allow making any money, because money made on the one side would be lost on the other. They assured me that this genius had found a way to spot market inefficiencies and, indeed, to make money off a perfect hedge.

http://www.nytimes.com/2008/12/28/business/28every.html?_r=1&em
This is a great article. I particularly like the above sentiment.

It makes the case that I'm always making about the value of index funds. Everybody wants to beat the market, but the fact that is over the long term, almost nobody does. As measured over 15 year intervals, something like only 4% of all mutual funds beat the S&P 500 index.

While I'm on my soap box, Ben Stein's piece leads me to want to make to basic points about the markets and investing:

1. Investing is a zero sum game.
Investors as a whole make up the market, so as a group, investors can do no better than the market itself. If one investor outperforms the market, another one must underperform it by a like amount.

2. Financial markets are efficient.
Information is so readily available, especially about large U.S. companies, that it’s tough for any fund manager to sustain a performance edge over the long term. Some markets are less efficient (international and U.S. small capitalization companies), but they tend to have higher costs, which diminish their returns.
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Old 12-29-2008, 01:01 PM
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Originally Posted by suginami View Post
While I'm on my soap box, Ben Stein's piece leads me to want to make to basic points about the markets and investing:

1. Investing is a zero sum game.
Investors as a whole make up the market, so as a group, investors can do no better than the market itself. If one investor outperforms the market, another one must underperform it by a like amount.

2. Financial markets are efficient.
Information is so readily available, especially about large U.S. companies, that it’s tough for any fund manager to sustain a performance edge over the long term. Some markets are less efficient (international and U.S. small capitalization companies), but they tend to have higher costs, which diminish their returns.
If I may add a 3rd point to Paul's excellent comments:

3. You will NOT beat the real professionals.

I used to shudder when someone would tell me they've taken up daytrading and do it a couple of hours a day.

Having worked as a bond trader for a major investment bank, I thought back to when I would sit for hours glued to a handful of green screens (that's what they were then). Periodically, over the intercom system, we would get intelligence from our researchers, economists and market analysts. plus get comments from our customers who were seeing stuff at ground level. With all that, maybe we were correct 51% of the time.

If the daytraders thought they could outsmart us - I'm sorry, but all their money just added new money into the system, which was drawn out by the professionals.


Not saying that it is fair. It's just the way it is.
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Old 12-29-2008, 01:09 PM
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Originally Posted by al76slc View Post
[I] ABOUT two years ago, a little delegation from a major investment bank arrived at my home in Beverly Hills. These nice young people were from the bank’s “wealth management division.” I told them straight away that I didn’t have anywhere near enough wealth to make their trip worth their time, but they smilingly insisted that we could help each other.

They told me that if I invested a certain sum with them, they would make sure that a large chunk of it was managed by a money manager of stupendous acumen. This genius, so they said, never lost money. He did better in up markets than in down markets, but even in down markets he did well. They said he used a strategy of buying stocks and hedging with options.

I protested that a perfect hedge would not allow making any money, because money made on the one side would be lost on the other. They assured me that this genius had found a way to spot market inefficiencies and, indeed, to make money off a perfect hedge.
"When a man with money meets a man with experience, the man with experience leaves with money and the man with money leaves with experience."

Been that way since the beginning of time.
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Old 12-29-2008, 01:13 PM
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Cliff notes:

If it sounds too good to be true, it probably is.

A lot of losers outside the casino have "winning systems" that ensures them results

Rule of Acquisition #48: The bigger the smile, the sharper the knife.
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Old 12-29-2008, 01:14 PM
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Originally Posted by al76slc View Post
Losing and making money are not moral issues so long as you are being honest. You may have a lot less money as this year ends than you did two years ago. But you are just as good or bad a person as you were then.
Rule of acquisition #109: Dignity and an empty sack is worth the sack.
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Old 12-29-2008, 01:19 PM
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Originally Posted by aklim View Post
Cliff notes:


A lot of losers outside the casino have "winning systems" that ensures them results
What about the group from MIT? They did pretty well, IIRC.........till they got ID'd and were banned.
(I'll concede you can't win if you can't play.)


http://en.wikipedia.org/wiki/MIT_Blackjack_Team

The MIT Blackjack Team continued to play throughout the 1980s, growing to as many as 30 players in 1984 with a capitalization of as much as $350,000. Having played and run successful teams since 1977, Kaplan reached a point in late 1984 where he could not show his face in any casino without being followed around by the casino personnel in search of his team members. As a consequence he decided to fall back on his growing real estate investment and development company, his "day job" since 1980, and stopped managing the team. He continued on for another year or so as an occasional player and investor in the team, now being run by Massar, Chang and Bill Rubin, a player who joined the team in 1984.

The team played successfully from 1985 through 1988 but interest in the team waned in the late 1980s as casino conditions, player exhaustion, and other factors caused the group to lose players and finally stop playing in early 1990.[citation needed]

The MIT Blackjack Team played through at least 22 banks in the time period from late 1979 through 1989. At least 70 people played on the team in some capacity (either as counters, Big Players, or in various supporting roles) over that time span.
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Old 12-29-2008, 01:47 PM
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What about the group from MIT? They did pretty well,
Perhaps so but for every MIT team you have, how many losers do you see? We went to Vegas one time and they had a "craps" lesson. The dealer was the teacher and he began with "This lesson will IMPROVE your odds at winning. It will NOT guarantee a win. Look outside and see if you believe that Vegas was built from the winners."
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Old 12-29-2008, 01:59 PM
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For a 300 year old perspective,to show there is nothing new under the sun you all should read about John Law and the Mississippi Scheme.
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Old 12-29-2008, 03:54 PM
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Originally Posted by suginami View Post
1. Investing is a zero sum game.
Investors as a whole make up the market, so as a group, investors can do no better than the market itself. If one investor outperforms the market, another one must underperform it by a like amount.
I know what you're trying to say, but something is fishy in the way that this is worded.

If it was really a zero-sum game, there could be no wins without an equal loss. What you are saying is that of the gains, these are distributed unequally among the players. But that means that it is not a zero-sum game, as there really is value added somewhere along the line.
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Old 12-29-2008, 08:51 PM
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I know what you're trying to say, but something is fishy in the way that this is worded.

If it was really a zero-sum game, there could be no wins without an equal loss. What you are saying is that of the gains, these are distributed unequally among the players. But that means that it is not a zero-sum game, as there really is value added somewhere along the line.
The market as a whole is a zero sum game, but yes, it is not spread evenly. There are winners and losers individually, and the gains and losses are spread unequally, but the sum total of all trades (trades that resulted in a loss or gain) results in the value of the market.

It's really hard to phrase well.

How about this:
The gross return of all traders in a market must equal the market return. If the market goes up 10%, in other words, the gross return of all traders must also be 10% (assuming they all remain fully invested and don't keep some percentage of their portfolio in cash, which is another "market").
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Old 12-29-2008, 09:08 PM
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For a 300 year old perspective,to show there is nothing new under the sun you all should read about John Law and the Mississippi Scheme.
Just read about that last week in Paul Strathern's History of Economic Genius. There are a lot of lessons in that book which put the present economic crisis in perspective. But it's expecting a lot for Americans to learn from the French. (although I think Law was a Scot).
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Old 12-29-2008, 09:19 PM
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Originally Posted by suginami View Post
The market as a whole is a zero sum game, but yes, it is not spread evenly. There are winners and losers individually, and the gains and losses are spread unequally, but the sum total of all trades (trades that resulted in a loss or gain) results in the value of the market.

It's really hard to phrase well.

How about this:
The gross return of all traders in a market must equal the market return. If the market goes up 10%, in other words, the gross return of all traders must also be 10% (assuming they all remain fully invested and don't keep some percentage of their portfolio in cash, which is another "market").
It's not a zero-sum game. If it were then the economy would not grow.

A growing economy means there can be more winners than losers. A shrinking economy means there can be more losers than winners.

B
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Old 12-29-2008, 10:06 PM
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It's not a zero-sum game. If it were then the economy would not grow.

A growing economy means there can be more winners than losers. A shrinking economy means there can be more losers than winners.

B
This is a good point. I think we can save the original idea, however, if we modify it to say that excess return, meaning returns above the market return, is a zero sum game. You could also go further and say it is a negative sum game after fees and taxes.
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Old 12-29-2008, 10:10 PM
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Just remember and don't forget...

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Rule of acquisition #109: Dignity and an empty sack is worth the sack.
Ben Stein got his start in life as Nixon's speech writer.

Look it up, it's true

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