Exploring One of the Greatest Investment Passages Ever Written

Here’s how to find amazing quotes and passages: find great writers, and then find the passages that they reference. Having followed this plan quite a lot, I’ve noticed that many of the best writers are J.M. Keynes junkies. The man was as quotable as they come. One great writer, George Goodman (aka “Adam Smith”), put the following passage (“one of the most acute passages ever”) towards the end of his great book The Money Game, with the descriptor, “That is the way it is, and no one has ever said it better.” Let’s explore this illuminating, timeless summary of the investing game.

It might have been supposed that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, would correct the vagaries of the ignorant individual left to himself. It happens, however, that the energies and skill of the professional investor and speculator are mainly occupied otherwise. For most of these persons are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public. They are concerned, not with what an investment is really worth to a man who buys it “for keeps,” but with what the market will value it at, under the influence of mass psychology, three months or a year hence. Moreover, this behavior is not the outcome of a wrong-headed propensity. For it is not sensible to pay 25 for an investment of which you believe the prospective yield to justify a value of 30, if you also believe that the market will value it at 20 three months hence. Thus the professional investor is forced to concern himself with the anticipation of impending changes, in the news or in the atmosphere, of the kind by which experience shows that the mass psychology of the market is most influenced … (thus) there is no such thing as liquidity of investment for the community as a whole. The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The actual, private object of the most skilled investment today is “to beat the gun,” as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow. This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years, does not even require gulls amongst the public to feed the maws of the professional; it can be played by the professionals amongst themselves. Nor is it necessary that anyone should keep his simple faith in the conventional basis of valuation having any genuine long-term validity. For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs—a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops. These games can be played with zest and enjoyment, though all the players know that it is the Old Maid which is circulating, or that when the music stops some of the players will find themselves unseated.

There is so much here. Some quick hits:

  • A study of psychology, game theory, and market incentive structures is probably the most valuable use of your time if you want to be an active investor. Every active investor should focus on two things: finding/building an investment strategy that consistently identifies different opportunities (I know, I know, everyone says they are a contrarian—but still), and finding limits to arbitrage. This is why I recently wondered if it is now smart to be dumb.
  • Time horizon is critical. Short time frame? Momentum works very well, until it occasionally crashes and burns. Medium horizon? Value works very well because the market overdoes it at extremes and, on average, corrects those mistakes slowly (as Jim Grant said, the key to successful investing is to have everyone agree with you…later). Long/Indefinite horizon? I have no idea.
  • Maybe buying and holding forever (“for keeps”) is best, and then quality matters greatly, but replicating the Buffett approach is extremely difficult and probably requires a hefty dose of luck—it’s either hard or impossible to consistently predict long term outcomes in a complex adaptive system like the stock market. Again, Keynes says it better than I can: “The outstanding fact is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made. Our knowledge of the factors which will govern the yield of an investment some years hence is usually very slight and often negligible. If we speak frankly, we have to admit that our basis of knowledge for estimating the yield ten years hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes to nothing; or even five years hence. In fact, those who seriously attempt to make any such estimate are often so much in the minority that their behaviour does not govern the market.”

I’ll follow Goodman’s lead and leave you with another Keynes passage, also from his book The General Theory of Employment, Interest, and Money:

If the reader interjects that there must surely be large profits to be gained from the other players in the long run by a skilled individual who, unperturbed by the prevailing pastime, continues to purchase investments on the best genuine long-term expectations he can frame, he must be answered, first of all, that there are, indeed, such serious-minded individuals and that it makes a vast difference to an investment market whether or not they predominate in their influence over the game-players. But we must also add that there are several factors which jeopardise the predominance of such individuals in modern investment markets. Investment based on genuine long-term expectation is so difficult to-day as to be scarcely practicable. He who attempts it must surely lead much more laborious days and run greater risks than he who tries to guess better than the crowd how the crowd will behave; and, given equal intelligence, he may make more disastrous mistakes. There is no clear evidence from experience that the investment policy which is socially advantageous coincides with that which is most profitable. It needs more intelligence to defeat the forces of time and our ignorance of the future than to beat the gun.

God damn was he good.