Recognizing Reality
“Recognizing reality, when it’s really awful, and taking appropriate action, just involves, often, just the most elementary good sense.” —Charlie Munger (2022)
Stock markets had another volatile week. The S&P 500 fell 3.35%, and the Nasdaq dropped 5.65%. The selling of technology stocks occurred at the mega-cap level, as the likes of Amazon, Apple, and Alphabet all fell by 10% or more on the week. It also happened in some of the hottest stocks of 2020 and 2021. For example, companies such as Carvana, DraftKings, and Twilio all fell between 27% and 39% on Friday alone.
Investing is hard. There are almost always two sides to every story, and they often both sound believable and probable and worth putting some money behind.
What many investors have forgotten is that business is also hard. Just because a company says it will upend and transform an industry, and gain a dominant market share, doesn't mean it will. Just because a company says it’s burning cash while making profitable long-term investments doesn’t mean those investments will actually be profitable. It usually takes more to conquer the competitive forces of capitalism than an elegant pitchman and a shiny PowerPoint presentation.
Whether it’s investing or gambling or whatever, people are often too confident in their ability to predict the future. The reality is that the future will surprise, and even the best investors tend to be wrong 1/2 to 1/3 of the time. It's best to realize these odds before placing your bets so that you can manage risk appropriately and then be diligent about Scrambling Out of Mistakes when things don’t go as planned.
Concentration and leverage within investment portfolios amplify the good and the bad. That’s a reality. Diversification, if done correctly, and the absence of leverage make it harder to beat the market. But it also makes it harder to significantly underperform the market and experience the kind of losses that take one out of the game.
Bear markets tend to reward skill and humility—and punish overconfidence. As Charlie Munger said in a quote we’ve used before but which continues to be one worth thinking about over and over in today’s market:
“You have to strike the right balance between competency or knowledge on the one hand and gumption on the other. Too much competency and no gumption is no good. And if you don’t know your circle of competence, then too much gumption will get you killed. But the more you know the limits to your knowledge, the more valuable gumption is.”
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