Spotlight: Understanding the Risk-Taking Cycle

History has a way of repeating with greater shocks in the financial markets and it shows up in the risk-taking cycle that investors go through.

I tend to collect the best quotes I read on various subjects in print or on the Internet in a document. As I was glancing through that document a few days back, searching for inspiration for my future posts, I found a few on the subject of history and how it repeats itself so often, especially in the financial world.

The philosopher Santayana stressed the penalty for failing to attach sufficient importance to history –

Those who cannot remember the past are condemned to repeat it.

Then, humourist and author Mark Twain talked about the
relevance of the past thus –

History doesn’t repeat itself, but it does rhyme.

And then, economist John Kenneth Galbraith described the shabby way investors treat history and those who consider it important as –

Contributing to…euphoria are two further factors little noted in our time or in past times. The first is the extreme brevity of the financial memory. In consequence, financial disaster is quickly forgotten. In further consequence, when the same or closely similar circumstances occur again, sometimes in only a few years, they are hailed by a new, often youthful, and always supremely self-confident generation as a brilliantly innovative discovery in the financial and larger economic world. There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.

Warren Buffett said –

What we learn from history is that people don’t learn from history.

And here’s Charlie Munger’s version –

There is no better teacher than history in determining the future…

String together these three pearls of wisdom and you get a pretty accurate picture of investment reality. Past patterns tend to recur. If you ignore that fact, you’re likely
to fall prey to those patterns rather than benefit from them. But when markets get euphoric, the lessons of the past are readily dismissed. Investors start to say and believe in the “this time it’s different” theory, and completely forget the pain that such theorizing and subsequent actions had caused people in the past.

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