On Bad Investments and Marathons

This week, The New York Times launched Upshot , described as “a plainspoken guide to the news” and in essence, similar to two other explanatory new sites that have recently launched (Vox.com and FiveThirtyEight.com). My favorite piece so far on Upshot is Justin Wolfers’s “What Good Marathons and Bad Investments Have in Common” (because it combines two of my interests: finance and running):

In the usual analysis, economists suggest it’s worth putting in effort as long as the marginal benefit from doing so exceeds the corresponding marginal cost of that effort. The fact that so many people think it worth the effort to run a 2:59 or 3:59 marathon rather than a 3:01 or 4:01 suggests that achieving goals brings a psychological benefit, and that missing them yields the costly sting of failure.

But in other domains, this discontinuity between meeting a goal and being forced to confront a loss can lead to bad economic decisions. Because losses are psychologically painful, we sometimes strain too hard to avoid them.

For instance, when you sell your house, your goal may be to get at least what you paid for it. But this simple goal has led to disastrous decisions for those who bought homes in Florida or Nevada during the housing bubble. Too many homeowners set their selling prices with an eye on recouping past investments rather than on current market conditions, and as a result, their homes didn’t sell, deepening their financial distress.

Well worth the read in entirety.

The 2014 Annual Shareholder Letter from Warren Buffett

Fortune Magazine has a sneak peek into the annual shareholder letter than Warren Buffett will soon share with the Berkshire Hathaway shareholders. He shares two personal stories from his life and how the investment decisions have paid off over time. He echoes his wisdom in the following points:

  • You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick “no.”

  • Focus on the future productivity of the asset you are considering. If you don’t feel comfortable making a rough estimate of the asset’s future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn’t necessary; you only need to understand the actions you undertake.

  • If you instead focus on the prospective price change of a contemplated purchase, you are speculating. There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so. Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game. And the fact that a given asset has appreciated in the recent past is never a reason to buy it.

  • With my two small investments, I thought only of what the properties would produce and cared not at all about their daily valuations. Games are won by players who focus on the playing field — not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.

  • Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important. (When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle’s scathing comment: “You don’t know how easy this game is until you get into that broadcasting booth.”)

Read the rest here.

Marc Andreessen on the Future of Bitcoin

Marc Andreessen, writing in The New York Times, has a very good piece titled “Why Bitcoin Matters” explaining Bitcoin and its potential. You have to remember that Mr. Andreessen has skin in the game (to quote Nassim Taleb), because he will do very well if Bitcoin succeeds. However, it is still worth the read.

What’s the future of Bitcoin?

Bitcoin is a classic network effect, a positive feedback loop. The more people who use Bitcoin, the more valuable Bitcoin is for everyone who uses it, and the higher the incentive for the next user to start using the technology. Bitcoin shares this network effect property with the telephone system, the web, and popular Internet services like eBay and Facebook.

In fact, Bitcoin is a four-sided network effect. There are four constituencies that participate in expanding the value of Bitcoin as a consequence of their own self-interested participation. Those constituencies are (1) consumers who pay with Bitcoin, (2) merchants who accept Bitcoin, (3) “miners” who run the computers that process and validate all the transactions and enable the distributed trust network to exist, and (4) developers and entrepreneurs who are building new products and services with and on top of Bitcoin.

All four sides of the network effect are playing a valuable part in expanding the value of the overall system, but the fourth is particularly important.

All over Silicon Valley and around the world, many thousands of programmers are using Bitcoin as a building block for a kaleidoscope of new product and service ideas that were not possible before. And at our venture capital firm, Andreessen Horowitz, we are seeing a rapidly increasing number of outstanding entrepreneurs – not a few with highly respected track records in the financial industry – building companies on top of Bitcoin.

For this reason alone, new challengers to Bitcoin face a hard uphill battle. If something is to displace Bitcoin now, it will have to have sizable improvements and it will have to happen quickly. Otherwise, this network effect will carry Bitcoin to dominance.

One immediately obvious and enormous area for Bitcoin-based innovation is international remittance. Every day, hundreds of millions of low-income people go to work in hard jobs in foreign countries to make money to send back to their families in their home countries – over $400 billion in total annually, according to the World Bank. Every day, banks and payment companies extract mind-boggling fees, up to 10 percent and sometimes even higher, to send this money.

Switching to Bitcoin, which charges no or very low fees, for these remittance payments will therefore raise the quality of life of migrant workers and their families significantly. In fact, it is hard to think of any one thing that would have a faster and more positive effect on so many people in the world’s poorest countries.

Moreover, Bitcoin generally can be a powerful force to bring a much larger number of people around the world into the modern economic system. Only about 20 countries around the world have what we would consider to be fully modern banking and payment systems; the other roughly 175 have a long way to go. As a result, many people in many countries are excluded from products and services that we in the West take for granted. Even Netflix, a completely virtual service, is only available in about 40 countries. Bitcoin, as a global payment system anyone can use from anywhere at any time, can be a powerful catalyst to extend the benefits of the modern economic system to virtually everyone on the planet.

And even here in the United States, a long-recognized problem is the extremely high fees that the “unbanked” — people without conventional bank accounts – pay for even basic financial services. Bitcoin can be used to go straight at that problem, by making it easy to offer extremely low-fee services to people outside of the traditional financial system.

A third fascinating use case for Bitcoin is micropayments, or ultrasmall payments. Micropayments have never been feasible, despite 20 years of attempts, because it is not cost effective to run small payments (think $1 and below, down to pennies or fractions of a penny) through the existing credit/debit and banking systems. The fee structure of those systems makes that nonviable.

All of a sudden, with Bitcoin, that’s trivially easy. Bitcoins have the nifty property of infinite divisibility: currently down to eight decimal places after the dot, but more in the future. So you can specify an arbitrarily small amount of money, like a thousandth of a penny, and send it to anyone in the world for free or near-free.

I think this is the most interesting/compelling use of Bitcoin to me:

Think about content monetization, for example. One reason media businesses such as newspapers struggle to charge for content is because they need to charge either all (pay the entire subscription fee for all the content) or nothing (which then results in all those terrible banner ads everywhere on the web). All of a sudden, with Bitcoin, there is an economically viable way to charge arbitrarily small amounts of money per article, or per section, or per hour, or per video play, or per archive access, or per news alert.

For example, I don’t want to pay the monthly subscription to The New York Times, because while I read a lot on the site, I don’t see the benefit of paying for a subscription when I can get to the articles for free via social media channels. But if the cost was something small, say $0.05 per article, then I would be more inclined to browse from the homepage directly.

The Human Element in Quantification

I enjoyed Felix Salmon’s piece in Wired titled “Why Quants Don’t Know Everything.” The premise of the piece is that while what quants do is important, the human element cannot be ignored.

The reason the quants win is that they’re almost always right—at least at first. They find numerical patterns or invent ingenious algorithms that increase profits or solve problems in ways that no amount of subjective experience can match. But what happens after the quants win is not always the data-driven paradise that they and their boosters expected. The more a field is run by a system, the more that system creates incentives for everyone (employees, customers, competitors) to change their behavior in perverse ways—providing more of whatever the system is designed to measure and produce, whether that actually creates any value or not. It’s a problem that can’t be solved until the quants learn a little bit from the old-fashioned ways of thinking they’ve displaced.

Felix discusses the four stages in the rise of the quants: 1) pre-disruption, 2) disruption, 3) overshoot, and 4) synthesis, described below:

It’s increasingly clear that for smart organizations, living by numbers alone simply won’t work. That’s why they arrive at stage four: synthesis—the practice of marrying quantitative insights with old-fashioned subjective experience. Nate Silver himself has written thoughtfully about examples of this in his book, The Signal and the Noise. He cites baseball, which in the post-Moneyball era adopted a “fusion approach” that leans on both statistics and scouting. Silver credits it with delivering the Boston Red Sox’s first World Series title in 86 years. Or consider weather forecasting: The National Weather Service employs meteorologists who, understanding the dynamics of weather systems, can improve forecasts by as much as 25 percent compared with computers alone. A similar synthesis holds in eco­nomic forecasting: Adding human judgment to statistical methods makes results roughly 15 percent more accurate. And it’s even true in chess: While the best computers can now easily beat the best humans, they can in turn be beaten by humans aided by computers.

Very interesting throughout, and highly recommended.

NANEX: Nightmare on Elm Street for HFT Traders

A thoughtful headline and a very good article about the small firm NANEX in this week’s Bloomberg piece:

Staring at four computer monitors, Eric Scott Hunsader, the founder of market-data provider Nanex LLC, looks for hints of illicit trading hidden in psychedelic images of triangles dancing with dots that represent quotes to buy and sell U.S. stocks broken down by the millisecond.

Charts of trading produced by Hunsader’s eight-person firm have captivated everyone from regulators to art gallery owners. One stunt involved a computerized piano piece mimicking quotes for an exchange-traded fund. He infuriates some traders, who say Nanex draws unwarranted conclusions and spreads conspiracy theories.

To Hunsader, the images created from market feeds are evidence of high-frequency trading firms exploiting market rules to turn a profit in a lawless environment. Though others in the industry see his reports and charts as propaganda, Nanex’s interpretations are helping to drive the public debate about the fundamental fairness of the modern stock market.

I’ve blogged about the importance of NANEX’s post on the blog in the past, particularly this excellent post titled “Einstein and The Great Fed Robbery.”

Why care about NANEX is doing? Because:

To illustrate computerized trading to the general public, Nanex has turned trading data into animated videos, with triangles and dots representing tens of thousands of orders dashing between exchanges. One video he posted on YouTube showed a 50-millisecond period in which quotes for Nokia Oyj dashed around the market at a rate of 22,000 per second. The video, published on Oct. 9, has been viewed more than 6,400 times.

He programmed a computer to play piano notes corresponding to different bids and offers for a popular exchange-traded fund, resulting in a manic staccato composition even when slowed down. It was meant to highlight what Hunsader says is the absurdity of modern computerized trading.

Worth reading the entire piece here.

Sergey Kolesnikov and Igor Rybakov: Russia’s Roofing Billionaires

Often you hear of the Russian “new rich” who’ve accumulated wealth through corruption or usurping some power. So it was refreshing to read this Bloomberg piece on Sergey Kolesnikov and Igor Rybakov, who built a multi-billion dollar roofing business in Russia. What’s amazing is that they were actually enrolled at the Moscow Institute of Physics and Technology, one of Russia’s top research universities, and worked in roofing as a side business/project.

The roofing degree paid off. Closely held Technonicol, the company they founded while in college, is now the country’s largest roofing-supply company, with a network of 700 distribution outlets across the country, 180 of them wholly-owned. The business had revenue of 59.4 billion rubles ($1.9 billion) in 2012, up 25 percent from the prior year, according to financial statements provided by Kolesnikov.

The company is valued at $2.8 billion, according to data compiled by Bloomberg, making the equal partners two of the youngest billionaires in Russia. Neither has appeared on an international wealth ranking.

“I always liked to solve puzzles, and to me business is a kind of puzzle,” Kolesnikov said. “Neither of us ever thought about earning money of such scale.”

The billionaires, both 41, had a well-timed entry into the market, catching the start of a wave of private homeownership and government upgrades to Soviet-era housing. The number of newly built private homes in Russia almost doubled to 205,000 from 2002 to 2012, according to data from the Federal State Statistics Service, and new apartment units increased more than two times during the past decade to 838,000.

Here’s how they got their business off the ground:

In 1995, four years after the fall of the Soviet Union, Kolesnikov and Rybakov used $40,000 in savings and debt to buy their first plant, a roofing factory complex constructed in 1918 in Vyborg, a city 75 miles northwest of St. Petersburg. They spent $15 million modernizing the facility, and have since built 36 more plants — 30 in Russia, three in Ukraine, and one in Belarus, Lithuania and the Czech Republic.

Important to note their casual culture:

Kolesnikov adheres to western and Japanese management philosophies and quotes management consultant William Edwards Deming, whose statistical theories are credited with inspiring the economic growth surge in Japan after World War II. When Kolesnikov visits Technonicol’s plants, he hands out copies of “The Toyota Way,” a book about the Tokyo-based carmaker’s principles for continuous improvement and respect for workers.

Rybakov, who declined to be interviewed for this story, uses a YouTube channel to post videos of his family on yachting and skiing excursions.

The company maintains an informal corporate culture. It publishes an annual swimsuit calendar featuring female workers. To celebrate the company’s 20th anniversary last December, the billionaires hired a heavy-metal band to record a rock song and created a music video starring Technonicol employees singing in the studio after a day of answering phones and eyeing the clock before grabbing their coats and dashing from the office…

Great story.

On the Wealth Disparity in Russia

The Wall Street Journal highlights the incredible wealth disparity in Russia:

In the days of the Soviet Union, the country boasted that all its citizens shared the wealth equally, but a new report has found that a mere 20 years after the end of Communism, wealth disparity has soared with 35% of the country’s entire wealth now in the hands of just 110 people.

This is a wild statistic:

The study discovered that in Russia there is one billionaire for every $11 billion in household wealth. In the rest of the world, there is one for every $170 billion.

And so is this comparison with the United States:

Overall, 93.7% of Russia’s adult population has less than $10,000 in wealth, according to the report; 5.6% has between $10,000 and $100,000; 0.6% has between $100,000 and $1 million; and 0.1% — or about 84,000 people — has over $1 million. In the U.S., according to the report, 30.7% of the adult population has less than $10,000; 33% has between $10,000 and $100,000; 30.7% has between $100,000 and $1 million; and 5.5% — or 1.3 million people — has over $1 million.

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(hat tip: Annie Lowrey)