12 Axioms of Risk Reward followed by generations of Swiss Bankers

The Calm Investor | Zurich Axioms

How is it that Switzerland, a tiny country, poor in natural resources and arable land, has one of the highest per capita incomes and standards of living in the world?

This is the enticing premise with which Max Gunther opens his book The Zurich Axioms: The rules of risk and reward used by generations of Swiss bankers

“The Swiss did not become the world’s bankers by sitting in dark rooms chewing their fingernails. They did it by facing risk head-on and figuring out how to manage it.”

And therefore, the author says, there is a lot to learn about how to think about risk and reward from them. He goes on to distill the principles behind how the Swiss approach risk, to offer as a set of rules (12 Major and 16 Minor axioms) to be used for decision-making in investing, and even life, in general.

What’s good about the book:

His portrayal of his dad, a banker on Wall Street, along with other real-life characters whose experiences distill into the axioms promises an almost mystery/thriller feel to the beginning of the book. About 10% of the way into the book though, I was rolling my eyes at the obvious nature of some of the axioms. But then I took a step back to think, “what if I’d come across this book when finishing school or even beginning college?”

There is value in it for someone just stepping out of the cocoon of student-life into the business of living life, and to be thinking about how to make key decisions, not just about money, but about what kind of field of study to pursue, skills to acquire or jobs to apply for. For the seasoned investor, it can serve to highlight some unproductive behaviour that could help future returns.

“They are rich in secondary and tertiary layers of meaning, some coldly pragmatic, some verging on the mystical. They are not just a philosophy of speculation; they are guideposts for successful living.”

That it’s a quick read also helps.

What’s not-so-good:

The book introduces itself as

The Axioms apply, in short, to any situation in which you put money at risk in order to get more money.” 

The interchangeable manner in which the word “speculation” or “bet” is used along with “investment” throughout the book means they can be misconstrued and mis-applied liberally. The book says it is about “betting in it’s broadest sense”. One of the axioms literally says all endeavours are speculative, which offends the calm investor in me but gets a nod of acceptance from the “in the long run we’re all dead” philosopher in me.

I have summarised the axioms laid out in the book with the ‘TCI take’ on what I think carries well and doesn’t into the real world of decision-making and investing. Read on and decide for yourself?

The 12 Zurich Axioms’ – A cheat sheet

Major Axiom #1: On Risk. Worry is not a sickness but a sign of health. If you are not worried, you are not risking enough.

Minor Axiom I: Always play for meaningful stakes
Minor Axiom II: Resist the allure of diversification

“Most people grasp at security as though it were the most important thing in the world. Security does seem to have a lot going for it. It gives you that cozy immersed feeling, like being in a warm bed on a winter night. It engenders a sense of tranquility.”

“But any good Swiss speculator will tell you that if your main goal in life is to escape worry, you are going to stay poor.”

“In the normal course of speculative play, you must start out with a willingness to be hurt, if only slightly. Bet amounts that worry you, if only a little.”

The author says there are three problems with diversification:

  • it forces you to violate minor axiom 1
  • your gains and losses can and will cancel out
  • you try and keep too many balls in the air

TCI take: Most of us are likely too timid to start investing, tend to be be non-committal and need a bit of push to get started. This means something of a “leap of faith”, along with some amount of worry about how things will turn out. So, this actually makes sense.

But a lack of diversification, might be a problem. Your learning as an investor is proportional to the number of different “use cases” you can get exposed to early in your tenure; the “hot tech growth stock”, “the dull dividend-paying PSU”, “the out of favour pharma stock”. Each one teaches you about your temperament and what’s likely to work for you.

Major Axiom #2: On Greed. Always take your profit too soon

Minor Axiom III: Decide in advance what gain you want from a venture, and when you get it, get out

TCI take: Had it not been for the disastrous accompanying minor axiom, we could interpret this axiom to be careful of market euphoria and why rising markets are tricky. But the advice to get out when a pre-decided target is met just seems plain wrong and will result in sub-standard investment performance. Some of my biggest investing mistakes have had me exit stocks too early, so following that axiom is a definite no-no.

Major Axiom #3: On Hope. When the ship starts to sink, don’t pray. Jump.

Minor Axiom IV: Accept small losses cheerfully as a fact of life. Expect to experience several while awaiting a large gain.

TCI take: Think of this as setting stop-losses (something I never do) and cutting losers early (something I’m trying get disciplined about). For individual investments, there is certainly a case for overcoming loss aversion and cutting the cord on the ones with worsening prospects after you’ve bought them. The scenario where this won’t work well is when the fall is swift and universal (like in Oct 2008), getting out might be like trying to stampede towards the emergency exits.

Major Axiom #4: On Forecasts. Human behaviour cannot be predicted. Distrust anyone who claims to know the future, however dimly.

TCI take: Yes! It does not take much to rubbish the repeatedly off-target forecasts of the “smart money” managers. If the ivy league, analyst-rich, spreadsheet modelling environs of UBS, Credit Suisse, Goldman Sachs can’t get it right more than occasionally, then why wouldn’t you junk any and all forecasts?

Major Axiom #5: On Patterns. Chaos is not dangerous unless it begins to look orderly.

Minor Axiom V: Beware the historian’s trap
Minor Axiom VI: Beware the chartist’s illusion
Minor Axiom VII: Beware the correlation and causality delusions
Minor Axiom VIII: Beware the gambler’s fallacy
“The truth is that the world of money is a world of patternless disorder, utter chaos. Patterns seem to appear in it from time to time, as do patterns in a cloudy sky or in the froth at the edge of the ocean. But they are ephemeral. They are not a sound basic on which to base one’s plans.”

TCI take: Probably the most insightful point in this book. It’s when we think there is a predictable pattern that we are really at risk. I even did an exercise to try and predict how the NIFTY will move based on historical data. I still go back to it from time to time, out of curiosity, never to make decisions.

Major Axiom #6: On Mobility. Avoid putting down roots. They impede motion.

Minor Axiom IX: Do not become trapped in a souring venture because of sentiments like loyalty and nostalgia
Minot Axiom X: Never hesitate to abandon a venture if something more attractive comes into view

“Never get attached to things, only to people. Getting attached to things decreases your mobility, the capacity to move fast when the need arises. Once you get yourself rooted, your efficiency as a speculator goes down markedly.”

TCI Take: This is one goes deeper than just buying and selling equities. While it seems heretical at first glance, it’s useful advice, to be able to stay disconnected from outcomes and familiar patterns and be open to being surprised and to be adventurous in your decision-making.

Major Axiom #7: On Intuition. A hunch can be trusted if it can be explained.

Minor Axiom XI: Never confuse a hunch with a hope

“If you are hit by a strong hunch telling you to make a certain move with your money, the Axiom urges you to put it to a test. Trust it only if you can explain it – that is, only if you can identify within your mind a stored body of information out of which that hunch might reasonably be supposed to have arisen. If you have no such library of data, disregard the hunch.”

TCI Take: A nudge to do second-order thinking than just react to the environmental stimulus. If you think GST rollout in India brightens prospects for companies, think about why and who specifically will it benefit, and what is the probability that benefit will occur. And finally, has it already been priced into stock prices?

Major Axiom #8: On Religion and the Occult. It is unlikely that God’s plan for the universe includes making you rich.

Minor Axiom XII: If astrology worked, all astrologers would be rich
Minor Axiom XIII: A superstition need not be exorcised. It can be enjoyed, provided it can be kept in its place

TCI Take: Like Charlie Munger would say “I have nothing to add”

Major Axiom #9: On Optimism and Pessimism. Optimism means expecting the best, but confidence means knowing how you will handle the worst.

TCI Take: Another way of saying, hope for the best but prepare for the worst. If the worst will likely wipe you out, then rethink whether the upside is worth it.

Major Axiom #10: On Consensus. Disregard the majority opinion. It is probably wrong.

Minor Axiom XIV: Never follow speculative fads. Often, the best time to buy something is when nobody else wants it.

TCI Take: A fundamental principle of value investing. To resist the urge to do something just because everybody’s doing it

Major Axiom #11: On Stubbornness. If it doesn’t pay off the first time, forget it.

Minor Axiom XV: Never try to save a bad investment by averaging down

TCI Take: I struggled with reading this one and decided it’s not for me. Yes, some of my worst investing mistakes have involved averaging down in businesses with worsening prospects. The change I have made is to assess whether the decline is due to broad market sentiment or specific to the stock. If the reality for the company has not changed, then buy more cheaper!

Major Axiom #12: On Planning. Long-range plans engender the dangerous belief that the future is under control.

Minor Axiom XVI: Shun long-term investments

TCI Take: Agree with the futility of plans. But General Eisenhower’s quote comes to mind “Plans are useless, but planning is essential”

There you have it. The Zurich Axioms

Which ones do you agree with and practice? Which ones do you not?

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