When Indian markets are surging, Zerodha CEO Nithin Kamath cites an interesting insight
PremiumMorgan Housel cautions the investors on how extreme events in one direction increase the odds of extreme events in the other
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When Indian equity markets are touching record highs almost on a daily basis, Zerodha co-founder and CEO Nithin Kamath shared Tuesday an insightful article that cites two little but interesting lessons about stock markets. Written by Morgan Housel, author of ‘The Psychology of Money’, the write-up shares how nature teaches us a few things about investing.
California wildfires and Japan Nikkei
The first part of the article cautions the investors on how extreme events in one direction increase the odds of extreme events in the other. The author cites examples of California wildfires. After a decade of long-term droughts in California, record rain in 2017 got everyone elated. But the happiness was short-lived, the wettest year in memory was followed by “the deadliest and most destructive wildfire season on record."
Why the record fire? “A wet year reduces fires while increasing vegetation growth, but then the increased vegetation dries out in subsequent dry years, thereby increasing the fire fuel," a US government report explained.
Housel equates the Califonia incident with the astonishing bull run of Japan Nikkei from 1950 to 1990. The Nikkei increased 400-fold within this period, an average annual return of more than 16%.
“The Nikkei index traded lower today than it was in 1990. In 2012 it traded 70% lower than it was at 22 years before," Housel writes.
“What’s happened over the last 30 years is the flip side of an extreme event in one direction leading to an extreme event in the other," he adds.
Magical returns
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The writer calls evolution the most astounding force in the universe. “Nothing else in science can blow your mind more than what evolution has accomplished," Housel says.
“The time, not the little changes, is what moves the needle. Take minuscule changes and compound them by 3.8 billion years and you get results that are indistinguishable from magic"
Extolling the power of compounding, Housel adds, “if you understand the math behind compounding you realize the most important question is not “How can I earn the highest returns?" It’s, “What are the best returns I can sustain for the longest period of time?"".
Housel says average returns for an above-average period of time leads to extreme returns. “That’s the second lesson: Less focus on change, more focus on the exponent," Housel concludes.
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