Today I release
A Puzzling Tale
and it falls under the category of Investing Tales. A Puzzling Tale deals with what is called “The Equity Premium Puzzle or EPP.” You’ll have to read the tale if you don’t know exactly what it is. Nevertheless it has baffled investment theorists for decades and to this day has no resolution. This tale speaks to the problem confronting every investor, namely, where do I put my money. How do investors make a trade-off between risk and reward? As we all know, the answer depends on your situation. Of particular importance to this tale is the concept of “The Long Run.” The Long Run is where your advisor, whether a SAD or a FAB, wants your attention focused. But in the words of John Maynard Keynes, one of my favorite economists, “In the long run we’re all dead.”
What I interpret Keynes meant by this apparently flippant statement is that you need to focus on the present. Averages are great as are statistics and probabilities but the Long Run is made up of a series of Short Runs. Every investor must understand the consequences of their portfolios today, not tomorrow. Remote possibilities or what are now commonly called Black Swan Events must be factored into portfolio composition today because when these unlikely events happen they happen to you and you suffer. As many of my readers know my father is a retired physician that brought an old world Cuban logic to the profession. One of the greatest lessons he imparted on me is the notion of probabilities. When asked by his patients on the probability of a successful outcome to a procedure he would always provide the medical response of 95% success rate or 98% success rate or whatever the case was for that procedure. However, he was quick to point out that if that particular patient was in the 5% or 2% failure rate, it represented 100% failure to them. Portfolios work the same way. When they fail, even if they fail only 1% of the time, they fail 100% for you. So, don’t get fooled by “The Long Run.” Stay in the present.