Investing as a business

Quite frequently we can see retail investors make big shots. For instance, WSJ just reports that a small currency investor in California turned $50K into "a number slight north to a 7-digit number" in one year. Such heroic stories won't disappear on media.

However, investing needs to be incorporated rather than staying retail.

Warren Buffet started his first investment business in 1957, called Buffet Partnership LLC. He was the general partner so that he could invest freely the $105.1K (he put in $100) at the start. The performance of the partnership was wonderful, resulting 30% annual returns in the next 13 years (not a single down year). By 1965 (he closed it in 1969), the assets under the partnership was $26M. Where did $26M come from? It came from extra funds he attracted. If no extra funds, $105.1K in 9 years (1957 to 1965) with 30% annual gain would be about $1.1M.

With $26M after 9 years, that equivalent to saying the partnership had been raising fund about $500K every year. That is much better than capital return solely because capital gain would never exceed $300K in the 9 years. Abundant funding combining Buffet's stock picking skills sent the partnership an excellent track record.

So the insight is: consider stellar returns are given, say 20% annually, investors got to establish themself as business owners, not retail investors. It is a huge waste to being retail investor. A viable business model to ensure return sustainability is very important. It is well known that a big ship can weather terrible turf better than a small boat.

On the other hand, retail capital should look for great return opportunities to join an entity so that returns can be more ensured.

Soros' Boom-Bust Model

Quoted from Soros:

The boom-bust drama unfolds in eight stages. It starts with a prevailing bias and a prevailing trend. In the case of the conglomerate boom, the prevailing bias was a preference for rapid earnings growth per share without much attention to how it was broght about; the prevailing trend was the ability of companies to generate high earnings growth per share by using their stock to acquire other companies selling at a lower multiple of earnings. In the initial stage (1) the trend is not yet recongnized. Then comes the period of accerlation (2), when the trend is recognized and reinforced by the prevailing bias. That is when the process approaches far-from-equillibrum territory. A period of testing (3) may intervene when prices suffer a setback. If the bias and trend survive the testing, both emerge stronger than ever, and far-from-equillibrum conditions, in which the normal rules no longer apply, become firmly established (4). Eventually there comes a moment of truth (5), when reality can no longer sustain the exaggerated expectations, followed by a twilight period (6), when people continue to play the game although they no longer believe in it. Eventually a cross point (7) is reached, when the trend turns down and the bias is reversed, which leads to a catastrophic downward acceleration (8), commonly known as the crash.

We now are between Stage (2) and (3) according to this model. There are many expressions on this cycle to be picked. But the message conveying is the same.

Another view on perfect information theory

In 1930s, there was a camp of economists considering that demand and supply could be analyzed independently. To the extreme, this thought was developed into the rational expectation theory. The reason of calling it "rational" is that it discount the irrational effects from participants. It somehow coincides with the perfect information theory.

Theory is theory. The rational expectation theory was disagreed by market participants. George Soros contended that the theory was a flaw even though the proponent of the theory was his mentor. He further developed two functions: cognitive and manipulating functions that representing the two sides of demands. Cognitive functions are to find out what the current states are and manipulating functions are to affect the states in participants' favor. The two functions are interacting all the time with great interference from participants' views. Participants can include regulators and market practioners. As there are no easy agreements on the interaction of these two functions, equillibrum can't be reached.

It means the perfect information theory is flawed.

What can be implied from this? Social science isn't as rigid as natural science, in which main goal is one-way process. On the other hand, social science has to deal with a two-way process. However, it is not easy to obtain full knowledge in such a two-way setup. Thus, scientists and scholars, in efforts to maintain that it is a science, tried to simplify the two-way problem with one-way assumption. That has caused many financial crises along the growth path of the financial markets and economical theories.