Excellent points driven home by Mauboussin on Long term investing and Volatility during the 2008 crisis.
- Risk for a long term investor is permanent loss of capital while volatility is a reasonable measure of risk for short term investors.
- Investors overbet due to problem of induction (assuming future will be like past), leveraging and the short term focused incentives in the financial industry.
- Stress forces people to focus on here and now while they SHOULD be focused on the long term known as myopic loss aversion.
Mauboussin also briefly touches upon mean/variance efficiency (risk vs reward is linearly related), Kelly’s Criterion and portfolio sizing. Stay focused on long term investing, don’t overbet, retain a sound temperament and success is yours.
He has elaborated more on Kelly’s Criterion in another thought provoking paper (Size matters). Maximizing geometric mean should be the sole focus if you want to compound your wealth. This in turn requires an investor to participate in the markets for the long term as the returns can be volatile in the short term. Having an analytical edge is the key and appropriately sizing the bet is essential for market beating returns.
Incidentally, Consuelo Mack interviewed Michael Mauboussin last week on Wealthtrack – the podcast is available here.
