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April 21, 2014

Andrew Silow-Carroll: Passoverkill? Suggestions to make next year's seders even more culturally sensitive

Sara Israelsen Hartley: Seeking the Divine: An ancient connection in a new context

Christine M. Flowers: Priest's execution in Syria should be call to action

Courtnie Erickson: How to help kids accept the poor decisions of others

Lizette Borreli: A Glass Of Milk A Day Keeps Knee Arthritis At Bay

Lizette Borreli: 5 Health Conditions Your Breath Knows Before You Do

The Kosher Gourmet by Betty Rosbottom Coconut Walnut Bars' golden brown morsels are a beautifully balanced delectable delight

April 18, 2014

Rabbi Yonason Goldson: Clarifying one of the greatest philosophical conundrums in theology

Caroline B. Glick: The disappearance of US will

Megan Wallgren: 10 things I've learned from my teenagers

Lizette Borreli: Green Tea Boosts Brain Power, May Help Treat Dementia

John Ericson: Trying hard to be 'positive' but never succeeding? Blame Your Brain

The Kosher Gourmet by Julie Rothman Almondy, flourless torta del re (Italian king's cake), has royal roots, is simple to make, . . . but devour it because it's simply delicious

April 14, 2014

Rabbi Dr Naftali Brawer: Passover frees us from the tyranny of time

Greg Crosby: Passing Over Religion

Eric Schulzke: First degree: How America really recovered from a murder epidemic

Georgia Lee: When love is not enough: Teaching your kids about the realities of adult relationships

Cameron Huddleston: Freebies for Your Lawn and Garden

Gordon Pape: How you can tell if your financial adviser is setting you up for potential ruin

Dana Dovey: Up to 500,000 people die each year from hepatitis C-related liver disease. New Treatment Has Over 90% Success Rate

Justin Caba: Eating Watermelon Can Help Control High Blood Pressure

The Kosher Gourmet by Joshua E. London and Lou Marmon Don't dare pass over these Pesach picks for Manischewitz!

April 11, 2014

Rabbi Hillel Goldberg: Silence is much more than golden

Caroline B. Glick: Forgetting freedom at Passover

Susan Swann: How to value a child for who he is, not just what he does

Cameron Huddleston: 7 Financial Tasks You Should Tackle Right Now

Sandra Block and Lisa Gerstner: How to Profit From Your Passion

Susan Scutti: A Simple Blood Test Might Soon Diagnose Cancer

Chris Weller: Have A Slow Metabolism? Let Science Speed It Up For You

The Kosher Gourmet by Diane Rossen Worthington Whitefish Terrine: A French take on gefilte fish

April 9, 2014

Jonathan Tobin: Why Did Kerry Lie About Israeli Blame?

Samuel G. Freedman: A resolution 70 years later for a father's unsettling legacy of ashes from Dachau

Jessica Ivins: A resolution 70 years later for a father's unsettling legacy of ashes from Dachau

Kim Giles: Asking for help is not weakness

Kathy Kristof and Barbara Hoch Marcus: 7 Great Growth Israeli Stocks

Matthew Mientka: How Beans, Peas, And Chickpeas Cleanse Bad Cholesterol and Lowers Risk of Heart Disease

Sabrina Bachai: 5 At-Home Treatments For Headaches

The Kosher Gourmet by Daniel Neman Have yourself a matzo ball: The secrets bubby never told you and recipes she could have never imagined

April 8, 2014

Lori Nawyn: At Your Wit's End and Back: Finding Peace

Susan B. Garland and Rachel L. Sheedy: Strategies Married Couples Can Use to Boost Benefits

David Muhlbaum: Smart Tax Deductions Non-Itemizers Can Claim

Jill Weisenberger, M.S., R.D.N., C.D.E : Before You Lose Your Mental Edge

Dana Dovey: Coffee Drinkers Rejoice! Your Cup Of Joe Can Prevent Death From Liver Disease

Chris Weller: Electric 'Thinking Cap' Puts Your Brain Power Into High Gear

The Kosher Gourmet by Marlene Parrish A gift of hazelnuts keeps giving --- for a variety of nutty recipes: Entree, side, soup, dessert

April 4, 2014

Rabbi David Gutterman: The Word for Nothing Means Everything

Charles Krauthammer: Kerry's folly, Chapter 3

Amy Peterson: A life of love: How to build lasting relationships with your children

John Ericson: Older Women: Save Your Heart, Prevent Stroke Don't Drink Diet

John Ericson: Why 50 million Americans will still have spring allergies after taking meds

Cameron Huddleston: Best and Worst Buys of April 2014

Stacy Rapacon: Great Mutual Funds for Young Investors

Sarah Boesveld: Teacher keeps promise to mail thousands of former students letters written by their past selves

The Kosher Gourmet by Sharon Thompson Anyone can make a salad, you say. But can they make a great salad? (SECRETS, TESTED TECHNIQUES + 4 RECIPES, INCLUDING DRESSINGS)

April 2, 2014

Paul Greenberg: Death and joy in the spring

Dan Barry: Should South Carolina Jews be forced to maintain this chimney built by Germans serving the Nazis?

Mayra Bitsko: Save me! An alien took over my child's personality

Frank Clayton: Get happy: 20 scientifically proven happiness activities

Susan Scutti: It's Genetic! Obesity and the 'Carb Breakdown' Gene

Lecia Bushak: Why Hand Sanitizer May Actually Harm Your Health

Stacy Rapacon: Great Funds You Can Own for $500 or Less

Cameron Huddleston: 7 Ways to Save on Home Decor

The Kosher Gourmet by Steve Petusevsky Exploring ingredients as edible-stuffed containers (TWO RECIPES + TIPS & TECHINQUES)

Jewish World Review

When smart investors do stupid things

By Morgan Housel






JewishWorldReview.com | In his 2003 memoir, former Treasury Secretary Robert Rubin wrote:

"There is one type of financial risk, the risk of remote contingencies -- which, if they occur, can be devastating -- that market participants of all kinds almost always systematically underestimate. The list of firms and individuals who have gone broke by failing to focus on remote risks is a long one."

This is smart, but depressingly ironic. While writing the book, Rubin was chairman of the executive committee at Citigroup. Five years later, while still under Rubin's watch, the bank added its name to the list of firms that went broke (or close to it) by failing to focus on remote risks.

I remembered this story this weekend when reading a blog post from economist Noah Smith, one of the sharper commentators out there. Smith was discussing hedge fund returns (or lack thereof), and wrote:

"To evaluate hedge funds -- or any investment -- you need to look not only at the return, but at the risk. If hedge funds have higher return-to-risk ratios (such as Sharpe ratios) than a passive stock-bond portfolio, then they are a better investment. Why? Because in that case you can borrow money and invest it in hedge funds, and your leverage will increase the returns (and the risk) of the hedge fund investment."

Pardon me, but I disagree.

The problem here is the definition of "risk." As defined in finance textbooks, including the Sharpe ratio Smith mentions, risk is volatility.

But volatility is a strange way to think about risk. Time and time again, investments utterly implode after periods of silky-smooth calmness.

Take Rubin's Citigroup. Before it blew up, it has a long record of stable, consistent profits. Or consider AIG. Before it blew its top in 2008, the insurer enjoyed two decades of smooth, predictable, volatility-free profits.

In each case, equating volatility with risk would have sweet-talked you into a dangerous sense of complacency. The narrative, which is common among large companies, probably went like this: AIG earns stable profits year after year. That makes it a safe, low-risk investment. Maybe even safe enough to leverage up on.

And then ... boom! Investors lost almost everything overnight.

To be fair, Smith was talking about hedge fund returns, not corporate profits. But there's a classic example of hedge fund investors getting duped to death by focusing on volatility as a measure of risk.

The hedge fund Long-Term Capital Management is now infamous for being the largest hedge fund failure of all time. In 1998, during a period when seemingly no investor could lose money, the geniuses at LTCM -- including two Nobel laureates -- lost everything. They literally went bankrupt during a period when Barbra Streisand was a successful day trader.


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But before LTCM's blowup, the fund was known for one thing: low volatility. A 1996 article in Institutional Investor describes it like this: "Before August, when returns dipped 0.24 percent, LTCM had not had a down month since February 1995, and only six down months in total."

And the fund's Sharpe ratio was an amazing 4.35, meaning it was earning big returns with low volatility. "If a fund manager can sustain a Sharpe ratio of 1, he is doing well," the magazine wrote. "But a Sharpe ratio of more than 4 is off the charts."

The article closes by asking, "how long can they produce those kinds of returns before suffering some spectacular crash?"

We now know the answer: about a year.

LTCM was a glaring reminder that past volatility is a terrible measure of future risk. Yet we still obsess over volatility, convinced that it tells us how safe an investment is.

Nassim Taleb describes using volatility as a measure of risk as the "turkey problem." He writes in his book "Antifragile":

"A turkey is fed for a thousand days by a butcher; every day confirms to its staff of analysts that butchers love turkeys 'with increased statistical confidence.' The butcher will keep feeding the turkey until a few days before Thanksgiving. Then comes that day when it is really not a very good idea to be a turkey."

So if volatility isn't a good measure of risk, what is?

I like the Berkshire Hathaway credo:

Warren Buffett: "Risk comes from not knowing what you're doing."

Charlie Munger: "Risk to us is 1) the risk of permanent loss of capital, or 2) the risk of inadequate return."

Buffett's definition of risk is most applicable to individual investors. If you don't know what you're doing, you are rolling the dice at best. Add in fees, and you will almost certainly lose.

Munger's definition is more relevant to institutional investors. For pension funds, the biggest risk is not suffering a down month or a bad quarter; it's that, over a 20- to 50-year period, they won't earn high enough returns to cover their obligations.

But for both groups, past volatility tells you very little about future risk. "Using volatility as a measure of risk is nuts," Munger says.

(Morgan Housel has no position in any stocks mentioned. The Motley Fool recommends American International Group and Berkshire Hathaway. The Motley Fool owns shares of American International Group, Berkshire Hathaway and Citigroup.)

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Morgan Housel, a columnist at The Motley Fool, is a two-time winner, Best in Business award, Society of American Business Editors and Writers and Best in Business 2012, Columbia Journalism Review.


Previously:


The deep downside of home ownership The biggest retirement myth ever told

He's rich, smart and old: Listen to him

Admit it: No one has any idea what's going on

Gold collapse: The start of something big?

BAD NEWS: EVERYONE IS RIGHT!

Twitter: The carnival barker of investing

Warning: Don't waste your capital being fooled by profit prophets

25 important things to remember as an investor

New paradigm for both drivers and car companies

Biases that make you a bad investor

Nine financial rules you should never forget

Gaining from financial destruction

How to read financial news

Housing: Partying like it's 1925

A rebuttal to student loan horror stories

CONGRATULATIONS: We just saved half a trillion dollars

End this crazy tax: It will boost the economy

Medicare: A dangerously good deal

Economic future looks bright

The Biggest Threat to Your Portfolio (It's Not What You Think)

Bond Market Bull Run dead at 30



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