Seth Klarman wrote in the introduction to his 1991 investment classic, Margin of Safety, “If interplanetary visitors landed on Earth and examined the workings of our financial markets and the behavior of financial-market participants, they would no doubt question the intelligence of the planet’s inhabitants.” Similar observations about investor irrationality have been made many times before and since. Yet amazingly, the very same investor failings reappear across generations. It seems we humans can’t be reminded often enough of our own foolishness -- and so it is that some offbeat, lesser known investment classics on our summer reading list this year could help.
Where are the Customers’ Yachts? by Fred Schwed is worth a read because it is hilarious and because its depiction of Wall Street rings as true today as it must have in 1940, when the book first appeared. Schwed worked as a Wall Street stockbroker in the late 1920s after getting kicked out of Princeton, and he learned enough to be able to poke fun at brokers, bankers, and economists. It wasn’t that the Wall Street pros were bad or especially dishonest people in Schwed’s view. It was that they had the vanity to believe they could predict the future and make meaningful short-term investment recommendations when they couldn’t. For Schwed, Wall Street consisted of “thousands of erring humans, of varying degrees of good will, solemnly engaged in the business of predicting the unpredictable.” And of course, they were particularly adept at enriching themselves along the way: The title of Schwed’s book comes from a true story of a man admiring the biggest bankers and brokers’ boats and then asking an innocent question, “Where indeed were the customers’ yachts?”
The Art of Contrary Thinking, first printed in 1954. A reflective collection of essays by Humphrey Neill, it is best absorbed slowly.
Neill believed that the consensus opinions of the crowd were often wrong and made people complacent and prone to missing reversals in trends. The antidote for Neill was contrary thinking. By conscientiously assessing crowd opinions, gauging their strength, and entertaining opposite opinions, Neill believed that one could with practice avoid being ensnared by faulty predictions. Neill purposefully spent much of his life far away from Wall Street in Saxtons River, Vermont, where he read widely and published a newsletter called the Neill Letters of Contrary Opinion. His essays show one person’s highly individualistic approach to learning behavioral finance before it was even called behavioral finance.
Seth Klarman’s Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor from 1991 is probably the best known of the three books here but not often read. Long out of print, copies are rare and so coveted that they now sell for about $3,000. Why so valuable? One reason is Klarman’s tremendous success as an investor. Another is that his crystal clear writing makes the book well worth reading as a manual on the craft of value investing.
Klarman’s book is all about discipline, patience, and judgment. For him, there are no easy answers or formulas in investing -- only hard work that frankly many people are not prepared to do. The distinguishing feature of Klarman’s book is its emphasis on managing risk as much as return. To achieve the “margin of safety” referred to in the title, investors must buy assets at a discounted price one at a time, stay infinitely patient, be conservative in judgment, and always consider the worst case. Investing by theme, concept, or trend without regard to price simply will not work. And over and over again, Klarman reminds us that precision is impossible, that “Bad luck can befall you,” and that “mistakes happen.”