Big Mistakes

by Michael Batnick

  Although his investments delivered him constant stress, they provided the world with some brilliant language:

  “There are two times in a man's life when he should not speculate, when he can't afford it, and when he can.”

  “A banker is a fellow who lends you his umbrella when the sun is shining and wants it back the minute it begins to rain.”

  “That would have been foresight, whereas hindsight is my specialty.”

  “I was seldom able to see an opportunity until it had ceased to be one.”

  Ernest Hemingway once said, “All modern American literature comes from one book by Mark Twain called Huckleberry Finn.” Twain began this project in 1876, but it would be nearly a decade until he'd finish it. This book, which he thought would take two months to write, took a back seat to more important things, like his search for riches.

  Mark Twain compiled a list of failed investments longer than a pharmacy receipt. He tried his hand at gold mining, both with a shovel and with stock certificates. Jaded by the experience he said, “A mine is a hole in the ground with a liar standing next to it.”

  Twain was particularly smitten with inventors. He put money into the New York Vaporizing Co., which was going to improve steam engines, except of course it didn't. Not only did it fail to accomplish its objective, but he provided an endless stream of funds to the inventor, $35 weekly. Twain recalled, “He visited me every few days to report progress and I early noticed by his breath and gait that he was spending 36 dollars a week on whisky, and I could never figure out where he got the other dollar.”5

  Twain invested in Plasmon, a milk powder extract, a steam pulley and a start‐up insurance company called the Hartford Accident Insurance Company. He became so fed up with these money‐losing ventures that he wrote to a fellow author, “If your books tell how to exterminate inventors send me nine editions.”

  He also lost plenty of money the old‐fashioned way, by buying stocks and selling at the wrong time. One of many examples was the Oregon Transcontinental Railroad, which he purchased at $78 a share and sold at $12. Of this experience, he said, “I don't wish to ever look at a stock report again.”6

  These experiences led him to not only errors of commission but errors of omission, which perhaps burned an even deeper hole of resentment into his soul. He wasted $42,000 on an engraving process called a kaolotype that was supposed to revolutionize illustrations (it didn't), and then decided to pass on Alexander Graham Bell's telephone. A friend of Twain's, General Joseph Roswell Hawley, owned the Hartford Courant newspaper and met with Bell. Hawley invited Twain to come to the Courant office to hear Bell's pitch to potential investors. As Twain described it, Bell “believed there was great fortune in store for it and wanted me to take some stock. I declined. I said I didn't want anything more to do with wildcat speculation. Then he offered the stock to me at twenty‐five. I said I didn't want it at any price.”7

  When he returned from a European vacation, he saw an old clerk in town who had invested the little money he had with Bell, and became a very wealthy man. Twain came back and said, “It is strange the way the ignorant and inexperienced so often and so undeservedly succeed when the informed and the experienced fail.”8 If this strikes you as sour grapes, that's exactly what this is. Mark Twain may have had experience with investing, but it was only with a multitude of failed investments. And to say he was informed would have taken giant liberties with the English language.

  Twain didn't just invest in others; he had plenty of his own ideas: an elastic strap for holding up pants, a scrapbook with preglued pages, and a portable calendar. Samuel Charles Webster, his niece's husband, once wrote, “He tried to be an Edison as well as a Shakespeare and a few other great men besides.”9

  Twain gambled when he had very little money, and it didn't end once he acquired a great deal of it. The money he had to speculate on some of the bigger failures came from the success he found at Webster & Company, a publishing house which he started in 1885.

  Grant's memoirs was the first deal they made, and it was a massive success, breaking records with 600,000 volumes issued. Grant's family received $400,000, $12 million in today's dollars, because of an overly generous deal.10 Industry royalty standards were 10% of the cover price, but Twain offered him 70% of net profits, after printing expenses and everything. Despite the lousy business deal with the former president, Webster & Company got off to a very good start. Like most things in his life, this too would end badly and what would grind his company's success, and his life, to a screeching halt, was a loss that Twain refused to take. He kept throwing good money after bad, and it inflicted far more damage than all his other losses combined.

  James Paige received a patent on his typesetter in 1874, and he envisioned the 18,000‐piece machine replacing a similar human‐operated apparatus. He met Mark Twain in 1880 and convinced him – although it's likely not much convincing was needed – to invest in what was another horribly crafted contract. Twain was entitled to profits only if he paid for all expenses until the completion of the machine, and later, to make matters worse, he promised to pay Paige $7,000 a year until the machine turned a profit. Twain was blinded by his own hubris; he called Paige “the Shakespeare of mechanical invention.”

  As time went on and money went out, Twain said of Paige: “He could persuade a fish to come out and take a walk with him. When he is present I always believe him: I can't help it. When he is gone away all the belief evaporates. He is a most daring and majestic liar.”11 Toward the end of the nineteenth century, the country experienced its worst economic depression up until that time. During the panic of 1893, 500 banks failed and 15,000 were sent to the graveyard. Twain and Webster & Company wouldn't be spared.

  No matter how many times Twain told himself that he was done with Paige and his excuses, he just couldn't look in the mirror and admit he was wrong. Imagine pouring everything you have, financially, mentally, and emotionally, into an investment and admitting defeat. It is excruciating. Few things are harder to do in life and especially in investing than to admit you were wrong. With the help of a friend, Henry “Hell Hound” Rogers, a mega‐rich partner in John Rockefeller's Standard Oil, they took control of the typesetter business from Paige. On life support, Clemens went to look for new investors and found two in Bram Stoker, who would later go on to write Dracula, and the famous actor Henry Irving.12

  When the typesetter failed at the Chicago Herald, there would be no more chances. Henry Rogers was a serious businessman and, unlike Twain, had no problem cutting his losses. It wasn't as easy for Twain, however, who was traveling in France when he heard of the machine's unraveling. He wrote Rogers an overly morose letter that indicated he felt connected to the machine almost as though it were a person.

  On December 21, 1894, the Paige Compositor Manufacturing Company was laid to rest. In the end, only an outsider had the ability to cut Twain's losses. Without Rogers, it's entirely possible that Twain would have taken this bottomless money pit to his grave. The total loss for the typesetter is estimated to be close to $5 million in today's dollars. Twain's compulsion to keep the typesetter afloat drained his financial resources and was a major reason why Webster & Company couldn't survive the depression. Twain wrote, “I am terribly tired of business. I am by nature unfitted for it and I want to get out of it.”

  The panic had reduced his stock and bond portfolio from $100,000 to virtually nothing at all. On April 18, 1894, out of options and out of money, Webster & Company declared bankruptcy.

  Helen Keller said, “Sometimes it seemed as if he let loose all the artillery of Heaven against an intruding mouse.” So you can imagine how Twain felt when the newspapers started to attack him. His spectacular failings in the market produced a series of brilliantly crafted words – “October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.”A newspaper took this line and replaced “to speculate in stoc
ks” with “for an author to go into business.”He was getting it from all sides. The San Francisco Call wrote “Mark Twain's failure was his own fault and yet he plans to lecture the world about it.” Twain was hypersensitive of public opinion. He once said, “The public is the only critic whose judgment is worth anything at all.”Bombarded with criticism, Twain responded the only way he knew how, with his pen and a canvas:

  It has been reported that I sacrificed, for the benefit of the creditors, the property of the publishing whose financial backer I was, and that I am now lecturing for my own benefit. This is an error. I intend the lectures, as well as the property, for the creditors. The law recognizes no mortgage on a man's brain, and a merchant who has given up all he has may take advantage of the rules of insolvency and start free again for himself; but I am not a business man; and honor is a harder master than the law. It cannot compromise for less than a hundred cents on the dollar, and its debts never outlaw.13

  At the ripe age of 59, he set out to repay his debts to each and every one of his 101 creditors who made a claim in his bankruptcy filings. In order to get out of the hole, he traveled around the globe doing a standup comedy tour.

  He went across the United States, to Australia, New Zealand, India, South Africa, and Europe. By 1898, he was out of debt, and more than ready for new financial adventures.

  Twain erased his debts, but he never lost his speculative gene. He said to his friend Rogers, who made him a great deal of money in the stock market, “Don't leave me out; I want to be in, with the other capitalists.”

  Risk and reward go together like copy and paste; there cannot be one without the other. But sometimes we receive the rewards and other time we experience only the risk. When risk arrives at our brokerage account, which it inevitably does from time to time, don't bury your head in the sand, acknowledge it. The most important thing when speculating is that you keep your losses manageable. Paper cuts sting, but they heal. Shotgun wounds on the other hand, those are tough to come back from.

  The best way to avoid the catastrophic losses is to decide before you invest how much you're willing to lose, either in percentage or dollar terms. This way, your decisions will be driven by logic rather than fear—or some other emotional attachment to a position.

  Just a few years removed from his bankruptcy, Twain invested $16,000, with high hopes as always, in the American Mechanical Cashier Company. After eight months with no results, after promise after promise and a feeling of déjà vu, he walked away. Lesson learned.

  Notes

  1. Quoted in Meena Krishnametty, “David Einhorn Told You to Buy GM,” MarketWatch.com, December 20, 2012.

  2. J. P. Morgan, “The Agony and the Ecstasy,” Eye on the Market: Special Edition, September 2014.

  3. Richard Zacks, Chasing the Last Laugh (New York: Doubleday, 2016).

  4. Peter Krass, Ignorance, Confidence, and Filthy Rich Friends (Hoboken, NJ: Wiley, 2007).

  5. Zacks, Chasing the Last Laugh, 3.

  6. Ibid., 14.

  7. Quoted in Elston Electric Company, “Mark Twain and the Telephone,” OldTelephones.com, May 29, 2012.

  8. Ibid.

  9. Krass, Ignorance, Confidence, and Filthy Rich Friends, 91.

  10. Zacks, Chasing the Last Laugh, 6.

  11. Krass, Ignorance, Confidence, and Filthy Rich Friends, 197.

  12. Ibid., 201.

  13. Quoted in Zacks, Chasing the Last Laugh, 67–70.

  CHAPTER 4

  John Meriwether

  Genius's Limits

  Investment success accrues not so much to the brilliant as to the disciplined.

  —William Bernstein

  Isaac Newton advanced science and thinking like few others ever have. With an IQ of 190, and the ability to calculate to the 55th decimal by hand, his intellect towered above Charles Darwin and Stephen Hawking. But powerful as his brain was, it was unable to save him from falling prey to our most basic human instincts, namely, greed and envy.

  In 1720, as shares of the South Sea Company began to rise and hysteria swept the streets of London, Newton found himself in a precarious situation. He bought and sold the stock, earning a 100% return on his investment. Except shares of the South Sea Company rose eightfold in under six months, and they did not stop going higher just because he decided to collect his profits. Unable to cope with the feelings of regret, Newton jumped back into the stock with three times the amount of his original purchase. He reentered as shares approached their apex and instead of doubling his money, he would lose nearly all of it. When the bubble burst, it took just four weeks for prices to plummet 75%.

  This left Newton despondent, and it is said that he could not stand to hear the words “South Sea” for the rest of his life. He got an expensive lesson in just how far intelligence goes when attempting to turn money into even more money. When asked about the direction of the markets, Newton replied, “I can calculate the motions of the heavenly bodies, but not the madness of the people.” Isaac Newton actually was one of the smartest people to ever walk the earth, and not even he was able to resist the sight of other people getting rich without him.

  One of the problems many investors face is that we all feel we have a little Isaac Newton in us. We all feel we're above average. In a classic 1977 study, “Not Can, But Will College Teaching Be Improved,” 94% of professors rated themselves above their peer group average.1 If traders and investors were asked the same question, I would guess that the results would be very similar. You don't have to be Albert Einstein to realize this math doesn't add up. As Charlie Munger once said, “The iron rule of life is that only 20% of people can be in the top fifth.”

  To be in Mensa, the largest and oldest high IQ society in the world, members must score in the top 2% of any standardized intelligence test. This means that there are between four and five million brilliant adults living in the United States alone that would qualify for this prestigious society. When you go to your computer screen to buy or sell a stock, there are a lot of these super humans waiting to take the other side of your trade. Therefore, a high IQ guarantees you nothing! This is one of the hardest things for newer investors to come to grips with, that markets don't compensate you just for being smart. Raw brainpower is only one prerequisite to even give yourself a chance of having a positive investment experience. Being smart alone does not determine investment results because markets are not linear. Most formulas eventually fail, if they ever even work at all.

  The chances of pulling a nine of spades out of a deck of cards is 1 in 52, but there is no way to calculate the odds of a recession given x, y, and z. With risk assets, one plus two doesn't always equal three, and the graveyard of investors is rife with people who thought they could model their way to above average investing results.

  Intelligence in investing is not absolute; it's relative. In other words, it doesn't just matter how smart you are, it matters how smart your competition is. Charlie Ellis brilliantly brought this idea to the forefront in a 1975 article, “The Loser's Game.” He wrote “Gifted, determined, ambitious professionals have come into investment management in such large numbers during the past 30 years that it may no longer be feasible for any of them to profit from the errors of all the others sufficiently often and by sufficient magnitude to beat market averages.”2 Not only have ambitious professionals come into investment management, they've also brought with them a whole lot of computer power. These machines have permanently changed the investing landscape. A lot of what used to be considered brilliant is now considered to be standard.

  In the 1950s, individuals dominated trading. Now institutions – with nearly unlimited resources – make up 90% of daily trading volume. There are 325,000 Bloomberg terminals and 120,000 Chartered Financial Analysts. Technology and the explosion of information have leveled the playing field.

  With any activity that involves both skill and luck, as investing clearly does, as skill and intelligence improve, luck or chance plays an increasing role in the outcome. Michael Maubouss
in has written about this idea many times, and he calls it the paradox of skill. The takeaway is that there is a lot of skilled market participants; so, intelligence alone is not enough. Other skills are required. Genius and its limitations are exemplified in no better way than by studying John Meriwether and his band of Einsteins at Long‐Term Capital Management.

  John Meriwether founded Long‐Term Capital Management in 1994 and before that he enjoyed a legendary two‐decade career as head of the fixed‐income arbitrage group and vice chairman at Salomon Brothers. At Salomon, he surrounded himself with some of the brightest minds in the industry.

  Michael Lewis, who began his career at Salomon Brothers, wrote in the New York Times, “Meriwether was like a gifted editor or a brilliant director: he had a nose for unusual people and the ability to persuade them to run with their talents…Meriwether had taken it upon himself to set up a sort of underground railroad that ran from the finest graduate finance and math programs directly onto the Salomon trading floor. Robert Merton, the economist who himself would later become a consultant to Salomon Brothers and, later still, a partner at Long‐Term Capital, complained that Meriwether was stealing an entire generation of academic talent.”3

  This generation of academic talent included Eric Rosenfeld, an MIT‐trained, Harvard Business School assistant professor, and Victor J. Haghani, who received a master's degree in finance from the London School of Economics. Also on his team were Gregory Hawkins, who got a PhD in financial economics from MIT, and Lawrence Hilibrand, who earned two degrees from MIT. In addition to these rock stars, Long‐Term also employed David Mullins, former vice chairman of the US Federal Reserve Board. Meriwether's goal was to outsmart everyone, and this advantage persisted for a long time.