1. “Money is made by discounting the obvious and betting on the unexpected.” George Soros, like other great investors, is very focused on “expected value.” Expected value is equal to the weighted-average value for the distribution of possible outcomes (the payoff for a given outcome is multiplied by the probability that this outcome will occur). A bet which is unexpected by the crowd is only wise when the expected value of the bet is positive. Yes, Soros can make huge macro bets that others do not. No, his approach to investing is not fundamentally different from other great investors when it comes to process.
2. “The financial markets *generally* are unpredictable. So that one has to have different scenarios.” [emphasis added] Just because markets are *often* predictable does not means that they are *always* unpredictable. If an investor is patient and waits for the rare instance when he or she successfully spots a mispriced bet, they can beat the market and generate alpha.
3. “The hardest thing to judge is what level of risk is safe.” Risk is the possibility that you may suffer harm or loss. Three situations must be faced: (1) sometimes you know the nature of the risky event and the probability (as in a coin flip); (2) sometimes you know the nature of the event, but don’t know the probability (which is uncertainty as in the price of a given stock in 20 years); and (3) sometimes you don’t even know the nature of what future states might hurt you (as in a negative Black Swan). These decisions are made, says Soros, in an environment where: “there are myriads of feedback loops at work, some of which are positive, others negative. They interact with each other, producing the irregular price patterns that prevail most of the time; but on the rare occasions that bubbles develop to their full potential they tend to overshadow all other influences.” The best thing you can do to be “safe” given risk, uncertainty and ignorance is to have a “margin of safety.”
4. “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” It is “magnitude of correctness” that matters for an investor not “frequency of correctness.” This is the “Babe Ruth” effect at work (strike outs in baseball and in investing can be acceptable as long as you hit enough home runs).
5. “There is no point in being confident and having a small position.” If the odds are substantially in your favor on a given wager, bet big. Few investor bet bigger than Soros when he thinks he is right.
6. “I only go to work on the days that make sense to go to work. And I really do something on that day.” Staying busy trading mostly generates fees and mistakes. Being inactive can often be the very best thing an investor can do.
7. “If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.” If you are getting big dopamine hits from investing you are very likely engaged in gambling and not investing. It is best to “be the house” rather than the gambling customer. The best way to “be the house” is to bet only when the odds are substantially in your favor.
8. “Market prices are always wrong in the sense that they present a biased view of the future.” Soros is clearly not a believer in the efficient market hypothesis. This is not surprising since if markets were always efficient he would not be rich. Soros: “[My view is] diametrically opposed to the efficient market hypothesis and rational expectations. It is built on the twin pillars of fallibility and reflexivity.”
9. “Markets can influence the events that they anticipate.” This sentence is one attempt to put the theory of “reflexivity” into a a few words. Unfortunately, Soros is not a gifted communicator on this very complex topic. In his opinion, markets and the views of people about markets interact dynamically in their effect on each other. Soros: “There is a two-way reflexive connection between perception and reality which can give rise to initially self-reinforcing but eventually self-defeating boom-bust processes, or bubbles. Every bubble consists of a trend and a misconception that interact in a reflexive manner.”
10. “Equilibrium itself has rarely been observed in real life — market prices have a notorious habit of fluctuating.” Equilibrium is a bedrock assumption of most macroeconomists and Soros is of the view that equilibrium is a delusional fantasy. Equilibrium as an assumption makes the math beautiful but it does not jibe with reality. Soros has said: “Economic thinking needs to begin addressing real-world policy questions rather than simply creating more mathematical equations.” Soros does not adopt a rational agent thesis in formulating his views. For example, “When a long-term trend loses its momentum, short-term volatility tends to rise. It is easy to see why that should be so: the trend-following crowd is disoriented.” Soros also believes: “Boom-bust processes are asymmetric in shape: a long, gradually accelerating boom is followed by a short and sharp bust.”
11. “Economic history is a never-ending series of episodes based on falsehoods and lies, not truths.” The ability to create a narrative explanation of the past does not mean that the explanation is correct or the basis for a thesis which can predict the future. This human dysfunction is “hindsight bias” at work. Soros said recently: “Economic theory has to be rethought from the ground up, because the prevailing paradigm of the efficient-market hypothesis, rational-choice theory, has actually run into bankruptcy very similar to the bankruptcy of the global financial system after Lehman Brothers.”
12. “I’m only rich because I know when I’m wrong…. I basically have survived by recognizing my mistakes.” and “Once we realize that imperfect understanding is the human condition there is no shame in being wrong, only in failing to correct our mistakes.” This speaks for itself.
- A Dozen Things I’ve Learned About Investing From Peter Lynch
- A Dozen Things I’ve Learned About Investing from Howard Marks