Consequences are more important than probabilities

7 minute read


Survival is the only road to riches in investing

Peter Bernstein interview by Jason Zweig

Peter Bernstein was a famous author and asset manager who died in 2009. He’s best known for “Against The Gods: The Remarkable Story of Risk”, a book on the history of risk which has sold >500k copies.

Jason Zweig, the famous finance journalist, interviewed him a long time ago back in 2004. As with most good interviews, some of the advice is timeless, and perhaps even more applicable in this time of crisis. Highlights below [1], which I’ve separated into three main themes of:

  1. Recognition of ignorance
  2. Survival is the only road to riches
  3. Paradigm shifts

Understanding what you don’t know

Q: Do you think the investing public has gotten smarter?

A: A lot of investors feel it isn’t hard, they just don’t know how. Because the more you think this is easy, the more you persuade yourself that you can take the heat. And then, the sooner the oven gets hot, the more shocked you are and the worse you get burned.

Anyone who’s known me for a while knows that I never give investment advice, and am reluctant to discuss investment ideas with people who have not worked in an investment firm [2]. Investing or speculating is easy for anyone to get into, and the quick wins during a bull market quickly result in overconfidence. Professional investors are more aware that we don’t know what we don’t know. Retail investors usually haven’t reached that stage yet and it’s difficult to convince them otherwise..

After 50 years in the investment business I still haven’t got it all clear. And that’s okay, because I understand that I haven’t got it figured out. In a hundred years, I won’t have it all figured out.

Anyone that has figured it all out in investing is either trying to sell you something or deluded. Either way, avoid them.

The riskiest moment is when you’re right. That’s when you’re in the most trouble, because you tend to overstay the good decisions. […] As incredible as it sounds, that makes you comfortable with not being diversified. So, in many ways, it’s better not to be so right. That’s what diversification is for. It’s an explicit recognition of ignorance.

There are two separate points here. The first is the hubris that comes with getting things right repeatedly. When that happens for too long, we believe that nothing can go wrong. Until it does.

The second is the benefit of diversification, not just in risk/return, but also in mindset. Of course you’d have made more money being all in on Amazon since the IPO. Could you have withstood all the peak to trough moments, just like one we’re having now though? Diversifying is acknowleding that we aren’t that smart. And really, none of us are.

The exact mix of your asset allocation doesn’t even matter that much, as Meb Faber shows here, as long as you’re diversifying.

Q: Over the course of your career, what are the most important things you’d say you had to unlearn?

A: You have to understand that being wrong is part of the process. And I try to shut up, you know, at cocktail parties. […] There’s always somebody around who looks very smart. I’ve learned that the people who are the most smart aren’t going to make it.

You just have to be prepared to be wrong and to understand that your ego had better not depend on being proven right. Being wrong is part of the process. It’s really why the market fluctuates.

But make sure that your being wrong doesn’t kill you.

To win, you must first survive

Q: How can investors avoid being shocked, or at least reduce the risk of overreacting to a surprise?

A: In general, survival is the only road to riches […] You should try to maximize return only if losses would not threaten your survival and if you have a compelling future need for the extra gains you might earn.

I understand that everyone wants to speculate on something, be that crypto, real estate, or your friend’s video dating service. I’m not saying to avoid these, and don’t think Peter is either. Whatever you do though, make sure that the amount you’re putting in won’t threaten your livelihood. Ideally it’s an amount you’re comfortable losing entirely. Don’t risk something you don’t have for something you don’t need

Pascal’s Wager doesn’t mean that you have to be convinced beyond doubt that you are right. But you have to think about the consequences of what you’re doing and establish that you can survive them if you’re wrong. Consequences are more important than probabilities.

For those unaware of Pascal’s Wager, I’ve linked more in a footnote [3]. As Peter notes, none of your expected values will matter when you’re facing an existential risk. No amount of money is worth playing Russian Roulette. [4]

If you’re investing for the long term (30 years or more), you don’t need to play to win. You just need to avoid getting taken out of the game.

Narratives about the world can change rapidly

Q: Your first job was working in the research department of the Fed in 1941. What did you learn there?

A: Two things. One, being a good boss or teacher is a tremendous thing, a great thing. […] The second thing is that what you think is true one day is not necessarily true the next.

Tyler Cowen has mentioned before the outsize impact a mentor can have by nudging someone to do something or think differently. If you’re in such a position, I’d encourage you to push your mentees more.

The second point is apt for today’s times. We all felt fine… until one day we didn’t. Humans will be humans.

Q: What are the important lessons about risk from your book Against the Gods?

A: First, in 1703 the mathematician Gottfried von Leibniz told the scientist Jacob Bernoulli that nature does work in patterns, but “only for the most part.” The other part — the unpredictable part — tends to be where things matter the most. That’s where the action often is.

We’re clearly in the unpredictable part now. As others have put it, this is where reputations are made, and where the narrative is going to be shaped for the next decade. Don’t do something you’ll regret, and also don’t miss out on doing something you’d rue later.

Markets are shaped by what I call “memory banks.” Experience shapes memory; memory shapes our view of the future.

If you invested in stocks in the ’70s, your portfolio would have been essentially flat for 10 years. And if you invested at the peak of the ‘29 depression, you were screwed for >20 years. Even now, I don’t think many of us can conceive of that happening to us. And that’s precisely why it’s so dangerous.

People who started investing after the 09 crisis have never experienced something like this before. This period of time will be formative for all their future investment decisions. Decades from now you’ll hear people say “Oh that time in the 20s when I experienced the corona crisis I did this”

Q: Why has the low saving rate in this country not caused the problems most experts predicted? How worried should we be that no one saves anything anymore? Or are we not correctly measuring our savings?

A: Savings figures are very difficult to interpret. Nevertheless, I am deeply concerned over this problem, because spending beyond income means borrowing, and all of economic history proves that too much borrowing is the core of economic disasters and chaos.

I’m in agreement that high debt loads eventually lead to a problem due to inability to service the interest costs. I’m less in agreement on whether the US has a savings issue because of consumer spending, after reading what Pettis had to write on capital flows.

We’ve covered three things today:

  1. Becoming aware of the extent of your ignorance
  2. Making sure that you don’t exit the game unintentionally
  3. Realising that mindsets and narratives can shift overnight

There’s no sure thing in investing [4], and being aware of pitfalls both on an individual and societal level will help us last for the long term.


  1. Sometimes I might paraphrase the article in order to make the text flow better, just fyi
  2. In case it still isn’t clear, none of this article is investment advice. If I ever do give investment advice in an email, I’ve been kidnapped and held against my will. Send help.
  3. A full explanation can be found here. A simplistic summary is that it postulates that a rational person should believe in a god since there’s limited downside to believing, and unlimited downside to not believing.
  4. We’ve been all focused on doom and gloom, but this applies to the upside as well. If you can find bets that have high upside and no or low cost, take as many as possible
  5. Well, almost. Diversification is kinda a sure thing

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