Success entails hard work, tenacity, integrity, self-awareness, and being an open-minded and independent thinker. There is no Holy Grail when it comes to being a successful investor. Garnering the investment experience–and learning from one’s and others’ investment mistakes–certainly help; getting an MBA or CFA typically do not, and in my experience, may detract from one’s long-term investment performance.
Reading books alone doesn’t help either, but they do speed up the learning process. Reading books provides a solid foundation for a successful investment/finance career. They are also key to leading a successful life, which should be the #1 priority of every human being. Having or staying in a broken marriage; or having no friends, is miserable and certainly do not lead to a successful investment career in the long-run. Without further ado…
1) The Art of Living and Being
The Tao Te Ching (Stephen Mitchell’s translation) by Chinese Philosopher Laozi, Letters from a Stoic by Seneca, and A New Earth by Eckhart Tolle are my all-time favorites. They are widely accessible and are great signposts for the attainment of higher self-awareness and enlightenment, as well as one’s higher purpose. These books shatter the illusion of the importance of everyday’s trivialities–allowing one to be present and to focus on the big-picture. Reading these books is an important step to being a successful investor for two reasons: 1) For most purported investors, reading these will guide them to a different career path–one they truly enjoy and where they possess innate talent; 2) A person that lives in the present has more energy to focus on one’s present tasks. Anxiety and worry only sabotages one’s life, and those around you. Yes, there is a practical application to these works. Some may even leave long-term relationships or switch careers after reading these, and they will be for the better. Reading these books also allow us to be more connected with our fellow human beings, what Carl Jung would describe as the “Collective Unconscious.” Being in tune with the psychology of the masses (their hopes, fears, and what they are invested in) allowed me to catch the final “exhaustion” tech rally in late 1999; and to have the good sense to sell and short the market during January to March 2000.
For our more scientific-minded or technical readers, I highly recommend String Theorist Brian Greene’s The Hidden Reality: Parallel Universes and the Deep Laws of the Cosmos. Similar to the above three books, The Hidden Reality strives to answer the age-old question: “What is Truth?” and conjures a reality that is alien to everyday experiences, as well as a world-view that has been solidly in place since the Age of Enlightenment. Newton’s Laws and our limited 3-D perception no longer provide an adequate explanation of how our universe and lives truly work. To this point, CERN’s next goal is to explore the existence of other dimensions after verifying the existence of the Higgs Boson earlier this year,
Why is this important? Because these books give you better perspective; and challenges the (arrogant) notion that we could model the economy or even value stocks (the notion of “value investing”–i.e. pretending that you understand a company’s valuation better than that of the market–is hubris) using classical models. By definition, stock returns cannot be modeled using classical models. Only simulations created by a quantum computer could achieve this. e.g. We know that a 300-qubit quantum computer can model the behavior of every atom in our universe; but if String Theory is correct, we will need an even more powerful quantum computer. Right now, we are not even close to having such a quantum computer, so we should stop pretending we have the right tools.
2) The Art of Leadership
A successful investor needs to build a successful institution. At the very least, such a successful investor needs to build a trustworthy network capable of supporting him or her in difficult times. Let’s say you have made great investment decisions in the past and have accumulated a large portfolio of securities. One day, you have a stroke. How do you make sure your portfolio will continue to make decent returns and support your standard of living in the future?
Or let’s say you were a great trader and have made a substantial portion of capital for a French-Jewish bank before and in the midst of WWII. The Nazis take over. You may have great investment or market timing skills. Hopefully, these timing skills translated to real life, and you were able to flee the Nazis in time. André Meyer, partner at Lazard, found himself in such a predicament. Utilizing his network, he was able to flee the Nazis just in time. Called “the most creative financial genius of our time in the investment banking world” by David Rockefeller, he eventually became co-head of Lazard’s American operations, and would lead Lazard to become the top U.S. M&A firm in the 1960s, and act as a close adviser to Jackie Onassis and LBJ.
Of course, one cannot lead or build a network of close confidants by reading books. But I have found that reading books on leadership have made me conscious of what I was doing correctly or otherwise. e.g. Few people in power roles have good listening skills. In today’s social media driven and globalized world (where cross-cultural investing and understanding are becoming more important), good listening skills are a must. A book I highly recommend for personal development is “Co-Active Coaching: Changing Business, Transforming Lives.” Co-authored by the founders of The Coaches Training Institute, the book digs into the essentials of effective communication, mentoring, and coaching skills. It calls for understanding, curiosity, and compassion for your clients and fellow human beings–traits that are essential for the 21st century leader. I used this book as my blueprint during my coaching classes at CTI, and it has paid off in both my business and personal relationships. Perhaps most importantly, reading the book also helped me discover my own unique leadership and communication styles. Other books I include in this category are the Jim Collins’ classics Built to Last and Good to Great. You can learn about what makes for a bad company or management, and vice versa–allowing you to avoid bad investments or find good shorting candidates. I hesitate to recommend more books in this category simply because the most effective way to learn leadership or business-building skills is to go and just do it.
And finally, some actual investment-related books!
3) Timeless Works on Investing
There is no book that is as timeless or better captures the individual and mass psychology of investing than Reminiscences of a Stock Operator. Rumored to be ghost-written in the early 1920s by Jesse Livermore, this book is the culmination of all of Livermore’s investing and trading wisdom since he began trading full-time at the age of 14. Filled with anecdotes and historical events (such as Livermore’s personal experience in the Northern Pacific Corner of 1901), this book comes alive and is at its most effective at capturing the action and psychology during important market events. You feel as if you were living and breathing these events–and making the same mistakes as those made by Livermore–while you’re reading it. Livermore’s signature trade was a massive short position ahead of the 1929 crash. He came out of the crash in November 1929 with $100 million in cash ($15 billion today on a US-nominal-GDP adjusted basis). I have read this book cover-to-cover at least a dozen times over the years.
Unfortunately, Livermore’s streak did not last. He protected his assets by putting some of it into trust funds; but he eventually filed for bankruptcy and committed suicide in 1940. The 1930s just wasn’t a good time to trade–either on the long or short side–there just wasn’t much activity or liquidity. Livermore did not build an institution (see 2) above), and on top of that, was likely bipolar. This leads us to the next book.
Co-authored by Bethany McLean and Peter Elkind, The Smartest Guys in the Room is an incisive biography of Enron and its collapse in 2001. The Smartest Guys in the Room is a textbook study of the failures of leadership and enterprise risk management, along with their sad consequences for both employees and society-at-large. The study of the rise and fall of Enron is almost an anti-thesis to the perfect case study in 2). Ironically, The Reminiscences of a Stock Operator was required reading on Enron’s trading floor.
Another required reading on the Enron trading floor was When Genius Failed: The Rise and Fall of Long-Term Capital Management. One story stuck in my mind during LTCM’s long string of losing days was a quote from Vinny Mattone, Meriwether’s long-time friend, who saw the markets as chaotic and unpredictable. Vinny Mattone was everything that LTCM’s professors were not. When he learned that LTCM’s portfolio was down by half, he flatly told Meriwether “You’re finished … When you’re down by half, people figure you can go down all the way. They’re going to push the market against you. They’re not going to roll your trades. You’re finished.”
LTCM was a study in the common occurrence of the self-fulfilling prophecy, which George Soros popularized as his Theory of Reflexivity in his book The Alchemy of Finance. Quoting Soros: “In his books [Karl] Popper [his tutor] argued that the empirical truth cannot be known with absolute certainty [see 1) above, namely the book The Hidden Reality and quantum mechanical behavior]. Even scientific laws can’t be verified beyond a shadow of a doubt: they can only be falsified by testing … Ideologies which claim to be in possession of the ultimate truth are making a false claim; therefore, they can be imposed on society only by force. This applies to Communism, Fascism and National Socialism alike.”
From an investment standpoint, the implication is significant: Fundamental valuations are constantly evolving and reflect the sentiment of the times, including technicals. That is why so-called fundamental analysts who are slaves to their valuation models always fail and under perform. Firstly, it is hubris to think you know more than the market. In my opinion, valuation models are only useful for scenario analyses. Secondly, as we mentioned in 1), classical models cannot, by definition, be reflective of the real world. Consider that only a 300-qubit quantum computer is capable of modeling all the atoms in our universe. Also consider that humankind only understands, at most, 5% of the universe–the latter of which excludes other potential dimensions. Thirdly, we know empirically that the momentum factor is the most predictive of all factors in terms of future stock returns. The valuation factor has failed for extended periods, including the 1930s, the late 1990s, and late 2007 to early 2009.
Soros’ Theory of Reflexivity dictates that prices affect fundamentals, and vice versa. When IndyMac fell below $3 a share in 2008, I (impolitely) told a friend who worked there that the firm was finished. He disagreed for obvious reasons, and stated that it was “undervalued.” But he did not understand that IndyMac’s cost of equity just went through the roof, and it had become impossible for the company to borrow or to raise equity (this was even before Hank Paulson put Fannie and Freddie into conservatorship). This is not dissimilar to J.C. Penney’s (JCP) situation today. As JCP’s stock price continues to fall, it becomes harder for the company to raise much-needed equity. At some point, JCP’s vendors will pull their financing, which is especially important ahead of the Thanksgiving and Christmas shopping season. I expect JCP to file for bankruptcy by Christmas 2014, unless U.S. real GDP growth comes in at 3.5%+ in 2014.
William O’Neil’s How to Make Money in Stocks synthesizes the common factors of the best-performing stocks over the last 110 years. Philip Fisher’s Common Stocks and Uncommon Profits and Other Writings (Philip Fisher has as much influence on Warren Buffett’s investing style as did Benjamin Graham) attempts (and achieves) the same feat on a more qualitative basis. Both investors can claim actual, real-world performance as evidence for the validity of their systems and writings. Unlike what business schools teach (such as the highly theoretical and unusable “Porter’s Five Forces”), these are real-world tools available to most investors.
A reading list on investing isn’t complete without biographies, some history, and of course, some technical reading…
4) Financial Biographies
These works are self-explanatory. Reading the biographies of great financiers allows one to find the common traits that lead to success; or other traits that may have been just right for the times they lived in. It is up to you to decide what they are and how they fit into our times, and your way of life. Such books include:
- Alexander Hamilton by Ron Chernow: Our first Treasury Secretary was a financial genius; and successfully (and rightly) argued why a national, central bank was needed–an argument that Thomas Jefferson could not understand nor fathom
- The House of Morgan
- John Maynard Keynes (abridged) by Robert Skidelsky
- Prophet of Innovation: Joseph Schumpeter and Creative Destruction
- Buffett: The Making of an American Capitalist by Roger Lowenstein
- The Partnership: The Making of Goldman Sachs
- The Last Tycoons: The Secret History of Lazard Freres & Co.
- The House of Rothschild, Volumes 1 & 2
5) Financial History
Those that do not know history are doomed to repeat it. It is through the meticulous study of the 1929 crash (where I holed myself in a library for ten straight weeks; this was in early 2000, before all the historical archives were available on the internet) that I became convinced the timing was ripe for a similar crash in technology stocks in early 2000 (note: I was >100% long in tech stocks as late as January 2000). I sent a series of three emails from February 14 to April 2, 2000 detailing my reasoning–email me for copies.
- Wall Street: A History
- Manias, Panics and Crashes: A History of Financial Crises
- Extraordinary Popular Delusions and the Madness of Crowds
- Origins of the Crash by Roger Lowenstein
- The Great Crash by John Kenneth Galbraith
- The Go-Go Years: The Drama and Crashing Finale of Wall Street’s Bullish 60s
- Panic of 1907
- A History of Interest Rates by Sidney Homer
- Ibbotson Annual Yearbook
6) Final Reads
This list would not be complete without a mention of the required curricula in our MBA finance classes, as well as the CFA, CAIA, FRM reading materials (all of which I had to go through, but which I enjoyed). Most are useless for real-world applications, but interesting anyway. They are required reading not for hazing purposes; but because other investors have read them and are using these tools. In a zero-sum world of investing where true alpha is nearly impossible in the long-run, one needs to know and understand what one’s fellow investors are doing. For example, some fundamental managers shorted value stocks during August 2007 knowing that their quant counterparts were heavily, leveraged long these same stocks and thus vulnerable to a mass exit. This strategy–which had nothing to do with valuation or excel modeling–paid off. Books that I highly recommend among these areas include:
- Capital Ideas: The Improbable Origins of Modern Wall Street by Peter Bernstein: This is an awesome chronicle of Modern Portfolio Theory, which is of course the equivalent of a professor’s wet dream (I personally find the CAPM to be mathematically elegant and beautiful but useless in real-world application)
- Investment Valuation by Damodaran
- The Handbook of Fixed Income Securities
- Exotic Options and Hybrids: A Guide to Structuring, Pricing, and Trading: This book is too advanced for MBA, CFA, and CAIA students; but is definitely useful for those studying the FRM certification or an MFE degree.
Please email me if you feel I have left any off the list. I’d be happy to post a mention of you as well as an updated list in the future.