Schwed’s Mockery

Where Are The Customers’ Yachts?

Fred Schwed, Jr

John Wiley & Sons, Inc 1955 edition

Fred Schwed Jr. was a professional trader who got out of the market after losing a bundle in the 1929 stock market crash.

Introduction by:

John Rothchild, Author, a Fool and his Money, Financial Columnist, Time Magazine 
It’s amazing how well Schwed’s book is hold up after fifty five years.  About the only things that’s changed on Wall Street is that computers have replaced pencils and graph paper.  Otherwise the basics are the same.  The investor’s need to believe somebody is matched by the financial advisor’s need to make a nice living.  If one of them has to be disappointed, it’s bound to be the former. 

Jason Zweig , Money Magazine, 2005 –

The individual investor is still situated at the very bottom of the food chain, a speck of plankton afloat in a sea of predators.

Schwed’s mockery, with the passage of time, has become indistinguishable from prophecy.

The people who took corporate financial reports on faith and never questioned the accounting principles of major companies like Enron or WorldCom would have known better if they had remember Schwed’s rule:  “Accounting is not even an art, but just a state of mind.”  His words are another reminder that if you are not a skeptic, you are not an investor.

Schwed’s is the only financial book, out of the hundreds I’ve read, that will provoke you, teach you and crack you up all at once.

Michael Lewis 1995 Author of Liar Poker –

What Schwed has done is capture fully – in deceptively simple language – the lunacy at the heart of the investment business: the widely held belief that there is someone out there who can tell you how to turn a little money into a lot, quickly

Excerpts from the book

Where are the customers’ yachts?

Once in the dear dead days beyond recall, an out-of-town visitor was being shown the wonders of the New York financial district.  When the party arrived at the Battery, one of his guides indicated some handsome ships riding at anchor.  He said, ”Look, those are the bankers’ and brokers’ yachts.” 

“Where are the customers’ yachts?” asked the naïve visitor

Schwed’s classic twin definition

Speculation is an effort, probably unsuccessful, to turn a little money into a lot.  Investing is an effort, which should be successful, to prevent a lot of money from becoming a little.

 But the ultimate dream

They (Wall Streeters) almost never shed: that there is a secret, meaningful and predictable, in the rise and fall of financial enterprises – that a “close study” of this and that will prove something; that it will tell the initiate when there will be a rally or give the speculator a better than even chance of making a killing ……. All these things are demonstrably unpredictable. …… But this cup of tea is too bitter for a Wall Streeter.

But soon the brokers ….. began adding the business of prophecy to the business of brokerage.

…..customers have an unfortunate habit of asking about the financial future. …..you may be assured that you will get a detail answer.  Rarely will it be the most difficult of all answers – “I don’t know.”

On the economic side there is no denying that the more financial predictions you make the more business you do and the more commissions you get. ….the usual thought process is far more innocent.  The broker influences the customer with his knowledge of the future, but only after he has convinced himself.  The worst that should be said of him is that he wants to convince himself badly and that he therefore succeeds in convincing himself – generally badly.

When the bull jumped over the moon

– refer to as “the era of wonderful nonsense”.  It was one of the great universal delusions of history, somewhat comparable to such magnificent errors as the world was flat or that all you had to do to heal anybody of anything was to bleed him.

…., if they bought on margin, they went to “the Cleaners,” ….

“What is the market doing?”

Usual reply to the inquiry, “What is the market doing?” The answers are “It is going up,” or “it is going down”.  ……This suggests not only that it has been going up, but that it will probably continue to on up, for a little time at least, because whatever impulse started it is still operating to some extent.  But it is not a fair thing to say of the stock market, which, not being a physical thing, is not subject to Newton’s laws of propulsion or inertia. Unfortunate most of us unconsciously credit this false analogy.  Thus we are not tempted to buy unless they are “going Up” or to sell unless they are “going down”.  But when the market is “going up” like fury, there is no reason to believe that the very next “tick” is more likely to be up than down. 

Chart reading

As a science, I should say that chart reading shares a pedestal with astrology; ….  That one can, by examining the line already drawn, make a useful guess at the line not yet drawn, must be predicated on the hypothesis that “history repeats itself.”  History does in a vague way repeat itself, but I does it slowly and ponderously, and with an infinite number of surprising variations.

All I was able to conclude from my informal studies was that chart reading is a complex way of arriving at a simple theorem, to wit:  when they gone up for a considerable time, they will continue to go up for a considerable time; and the same holds true for going down.

Margin trading

 In trying it, you must use real money.  Making “mind bets” won’t do.  Like all life’s rich emotional experiences, the full flavor of losing important money cannot be convey by literature. 

There are certain things that cannot be adequately explained to a virgin either by words or pictures. Nor can any description that I might offer here even approximate what it feels like to lose a real chunk of money that you used to own.

Stock for Retirement

“They told me to buy this stock for old age. It worked wonderfully.  Within a week I was an old man.”

Leverage

Some of the customers who went seeking slim margin requirements actually intended to act conservatively.  That is, they only intended to make a quick turn for a modest profit.  Also, they expected to limit themselves to a small loss, but his was more vague in their minds.  It is easy to take a small profit but taking a small loss is frequently just a good intention.  Eventually the customer finds himself throwing good money after bad, until there isn’t any good money left.

Rhinophobia – the stock addict

Customers who suffer from Rhinophobia always have as many securities as possible.  When they sell out stocks at a profit they hasten to fill the void in their accounts with other stocks.  The odd part is that they are frequently economical souls who do not believe in frittering away their money on food and drink and momentary pleasure.  If they play bridge of an evening for a quarter of a cent and lose $17, they are liable to go home in a pretty depressed state of mind.  Perhaps on the same day a slight weakness in the market reduced their equity by $500 but that doesn’t trouble them much; they still have their beloved stocks.  It is practically axiomatic for these men that every time the stock market goes bust, so do they.

To them, having a sizable cash balance in an account for any length of time is unbearable.  Suppose stocks should go way up?  They would be left high and dry with nothing but some dirty old money.

Active Wall Street Customer – the bored investor

Is frequently a man of capital …. Also wishes his capital to return him a goodly income …. Willing and eager to be a man of affairs.  So he becomes a stock customer ….he does not have to learn or half learn, the technical complexities of a business.  Almost anyone in a few weeks can learn how to put in orders, and limit them, and “stop” them, and all the fascinating patois that goes with it.  …….. staying home, away from any sort of an office, has, since the turn of the century, been the shrewd thing for a man of means to do.  But it was a dull life.  The man who chooses to take his money and churn it furiously, …… cannot in any way predict his fate, save for a single assurance.  So long as any of the money still clings to the sides of the churn, he will not be bored.

The Experts

The basic idea is familiar: the average individual is incapable of handling his own financial destiny ….. What is worse, he cannot, unless he is very rich, purchase the best financial advice.

So a lot of us who clearly are not magicians pool our money and hire a set of professional expert to do the guessing.  They may not be quite magicians but they have everything that should be necessary – experience, reputation, trained staffs, inside information, and unlimited resources for research.  Since the amount we pool together is often in the neighborhood of a hundred million dollars, we can afford to pay them fortunes for their ability.  Paying them fortunes will be a great bargain for us, provided only that they come across with the ability.

If the basic investment-trust idea is even half as sound as it appears to be …..The question may be put this way … if it was very important to you to win the class B championship at your country club and the rules permitted you to hire Gene Sarazen, at a reasonable fee, to make the shots for you, wouldn’t you be an egotistical fool to insist on playing the shots yourself?  This would be an airtight analogy, except for one thing.  Mr Sarazen is superior to you and me at playing golf, and he can demonstrate this superiority every time he steps onto the first tee.  But thus far in our history there has been little evidence that there exists a demonstrable skill in managing security portfolios.

The sad thing is that there can be no legislation against stupidity.  I should not care to entrust what I like to think of as “my funds” to a smart crook – or to an honest bonehead.  But if I were forced to choose, I would choose the crook.  With a writ of replevin and a policeman, I might be able to get back my money from the former, but all there would be for me from the latter would be a heartfelt, even a tearful, apology.

Diversification

 - this argument sounds a good deal more reasonable than it actually is.  A widely diversified portfolio …. All its “eggs” won’t go bad at once.  (This mechanism also prevents its value going up very fast.)  But this safety device doesn’t seem to work particularly well …….a dreadful fall …almost the entire diversified list of securities takes it right along with them.  High-grade bonds may hold up all right, and “cash on hand” certainly holds up splendidly but the trusts rarely have ….

 

The trouble with the best securities

… selecting the “best” securities … considered “best” change from period to period.  The pathetic fallacy is that what we thought to be the best are in truth only the most popular – the most active, the most talked of, the most boosted and consequently, the highest in price at that time.  It is very much a matter of fashion … …. Implacably, this universal habit of buying the popular securities works for bad results over a period of time.  It must tended to get the buyer in nearer the top than the middle.

A little wonderful advice

Like other great ideas, this one is simple:

When there is a stock-market boom, and every is scrambling for common stocks, take all your common stocks and sell them.  Take the proceeds and buy conservative bonds.  No doubt the stocks you sold will go higher.  Pay no attention to this – just wait for the depression which will come sooner or later.  When this depression – or panic – becomes a national catastrophe, sell out the bonds (perhaps at a loss) and buy back the stocks.  No doubt the stocks will go still lower.  Again pay no attention.  Wait for the next boom.  Continue to repeat this operation as long as you live and you’ll have the pleasure of dying rich.

A glance at financial history will show that there never was a generation for whom this advice would not have worked splendidly. …….It looks as easy as rolling off a log, but it isn’t.  The chief difficulties, of course, are psychological.  It requires buying bonds when bonds are generally unpopular and buying stocks when stocks are universally detested.

Market Crash – As many buyers as there were sellers

The public reads the papers and reading about the “large selling”, “new selling wave threw the market into utter chaos”, and “during the final hour equities were thrown overboard in huge lots, without regard for price or value.”, it get the impression that on the catastrophic day everyone sold and nobody bought.  Of course, there is just no truth in that at all.  If on that day the terrific “selling” amounted to seven million, three hundred, sixty-five thousand shares, the volume of the buying can also be calculated.  In this case it was 7,365,000 shares.

Schwed Jr, F. (1940). Where Are the Customers’ Yachts? By Fred Schwed Jr,. John Wiley & Sons,.