The Zurich Axioms (Harriman Definitive Edition): The rules of risk and reward used by generations of Swiss bankers

The Zurich Axioms

The rules of risk and reward used by generations of Swiss bankers

Max Gunther

Foreword by James P. O’Shaughnessy

Contents

Foreword By James P. O’Shaughnessy

Introduction: What the Axioms are and how they came to be

The First Major Axiom: On Risk

Minor Axiom I: Always play for meaningful stakes.

Minor Axiom II: Resist the allure of diversification.

The Second Major Axiom: On Greed

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

The Third Major Axiom: On Hope

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

The Fourth Major Axiom: On Forecasts

The Fifth Major Axiom: On Patterns

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 Sixth Major Axiom: On Mobility

Minor Axiom IX: Do not become trapped in a souring venture because of sentiments like loyalty and nostalgia.

Minor Axiom X: Never hesitate to abandon a venture if something more attractive comes into view.

The Seventh Major Axiom: On Intuition

Minor Axiom XI: Never confuse a hunch with a hope.

The Eighth Major Axiom: On Religion and the Occult

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 is kept in its place.

The Ninth Major Axiom: On Optimism and Pessimism

The Tenth Major Axiom: On Consensus

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

The Eleventh Major Axiom: On Stubbornness

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

The Twelfth Major Axiom: On Planning

Minor Axiom XVI: Shun long-term investments.

Publishing Details

Foreword by James P. O’Shaughnessy

I’ve always been fascinated by markets and why and how they work. Over the years this has driven me to read countless books and papers – and, these days, blog posts – that take a serious (and sometimes not-so-serious) look at how markets operate and how to develop a process that helps us become better investors. Along the way, I’ve come to understand that good investment habits are broadly applicable to almost every aspect of leading a successful life.

I’ve always believed that, to get the most out of learning, it’s best to be truly open-minded – willing to replace a treasured belief if the evidence contradicts it and to avoid becoming prematurely certain about, well, anything. We are plagued by many behavioral biases that wreak havoc with our investment results. An ability to become aware of them, and then take action to mitigate them, is invaluable.

I was an early buyer of Max Gunther’s The Zurich Axioms: Investment Secrets of the Swiss Bankers (the subtitle of the original edition). This book was first published in 1985 – when I was 25. Interestingly, at that time, the term ‘Swiss banker’ was synonymous with savvy and success.

The very first pages were a revelation to me: Gunther bluntly said that to use any of the rules of the book effectively, you had to be willing to bet. Before then, I hadn’t explicitly equated investing with betting, yet a liberal definition of the term ‘bet’ certainly includes making a wager (of various durations) on any uncertain outcome. The author rather pugnaciously speculated that many – even most – people want to win without betting. He assailed the risk-averse and ‘nose to the grindstone’ conservatism of that era.

I agree with him. To succeed with your investments, you not only have to embrace uncertainty and doubt, you need to see them as the essential facts of investing in particular – and life in general. I’ve always thought that one of our most limiting factors as human beings is that we are deterministic thinkers trying to succeed in a probabilistic world. Life – and investing – doesn’t work that way. So right out of the gate, the author puts that on the table – if you take no risk, you get no reward.

Sounds simple, but it is devilishly complicated. Sometimes things that appear safest, such as T-Bills are, in the long-run, the riskiest; whereas other investments, such as stocks, appear very risky in the short term but become less so over time.

The first axiom Max Gunther shares states that If you’re not worried, you are not risking enough. But then the author cleverly extends the idea beyond investing – if you’re afraid of risk, you’ll never fall in love; you’ll never have life-changing experiences and you’ll likely lead a sad, dull life. By extension, if you want to do well investing, accept worry and uncertainty.

His fourth axiom concerns forecasts and how you should distrust anyone who claims to know the future, however dimly. He quotes economist Dr. Theodore Levitt: You make twenty-five predictions and the ones that come true are the ones you talk about. Thirty-five years on, we have ten times the predictions and a lot fewer honest prognosticators. It’s part of our nature to desire knowledge of the future because it helps us maintain our illusion of control. That’s why, despite the evidence that you’d most likely do as well flipping a coin as paying attention to predictions, we can’t help ourselves. We continue to take predictions seriously. We continue to be disappointed.

I think the better approach is to look at the long sweep of market cycles and let the empirical data guide our actions and investments. Virtually every risk-based equity market has had vastly higher returns than the alternatives. Not every market and not every time, but the historical odds are clear – if you want to do well over time, you must place a bet and put capital at risk.

His ninth major axiom, on Optimism and Pessimism, offers good counsel – be optimistic, yes, but never invest on optimism alone. I call myself a pragmatic optimist, meaning that my general outlook is optimistic but that doesn’t stop me from thinking about what could go wrong and what actions I will take if it does. I think of this as situational awareness. You’ll almost always be better off if you have a process in place for when things don’t go your way. Why? Because when things aren’t going your way, you’re highly likely to get emotional, and when the emotional part of your mind takes over, it blots out all your former well-thought-out plans and puts the lizard brain in full control.

Gunther’s book is ultimately a series of axioms that provide a good starting outline of a process that leads to success. You needn’t embrace all of Gunther’s advice (or mine for that matter) to succeed, but your chances of succeeding will soar if you develop and follow a process rather than basing decisions on outcomes.

Markets change minute by minute. Human nature has remained the same over the last several millennia. This presents the opportunity for you to arbitrage human nature by building a process that does its absolute best at shielding you from your own worst instincts. As the cartoon character Pogo famously said we’ve met the enemy and it’s us. Understanding this will put you ahead of the majority of investors. Develop a plan, and stick to it. It’s that simple.

Though Gunther’s final axiom sounds counterintuitive, it makes a lot of sense when given thought: Long-range plans engender the dangerous belief that the future is under control … don’t take your own or other people’s seriously. Different people will interpret this axiom differently. As I interpret it, lots of unexpected and unplanned things will arise in life, and you’ll handle them much better if you haven’t married your process and plans to rigid goals or milestones. If you’ve developed an elaborate long-term plan that has you becoming a millionaire by age 40 and that doesn’t happen, you might be tempted to think that your process has failed. You might then be tempted to give it up and chase all sorts of other – probably much riskier – enterprises to reach your goal.

But that’s not how any of this works. A flexible plan, with contingencies, is a much sturdier framework on which to build your long-term process. Does this mean that nothing is certain – so why bother with plans and processes? Not at all. It means that life offers many specifically novel roadblocks, and a plan that focuses on overcoming roadblocks in general will work much better for you over time. Not getting caught in highly specific goals but rather focusing more intently on a flexible process that can move with events is the key.

Taken as a whole, Gunther’s axioms advocate an awareness of risks. They warn against falling into the same traps that have ensnared generations of investors – who rely on hunches and stories rather than empirically generated odds and flexible processes. They warn against irrational optimism and a reluctance to learn from mistakes. Successful investors unbind themselves from the moment, letting the past, present and future make up their now. They learn from the mistakes of others, are aware of their own deficiencies, and devise strategies to mitigate them. As Damon Runyon said: The race is not always to the swift nor the battle to the strong, but that’s the way to bet.

James P. O’Shaughnessy

Author, What Works on Wall Street

Greenwich, Connecticut, USA

Introduction: What the Axioms are and how they came to be

Consider the puzzle of Switzerland. This ancestral home of mine is a rocky little place about half the size of Maine. It has not one inch of seacoast. It is one of the most mineral-poor lands on earth. It possesses not a drop of oil to call its own, barely a bucket of coal. As for farming, its climate and topography are inhospitable to just about everything.

It has stayed out of European wars for 300 years; chiefly because, in all that time, there has never been an invader who really wanted it.

Yet the Swiss are among the most affluent people in the world. In per capita income they rank with the Americans; West Germans; and Japanese. Their currency is among the world’s soundest.

How do the Swiss do it?

They do it by being the world’s cleverest investors, speculators, and gamblers.

This book is about betting to win.

Perhaps that makes it sound like a book for everybody. It is not. Everybody wants to win, of course. But not everybody wants to bet, and therein lies a difference of the greatest magnitude.

Many people, probably most, want to win without betting. That is an entirely understandable wish. There is nothing reprehensible about it. Indeed, many of our hoariest old Work Ethic teachings urge it upon us. We are told that risk-taking is foolish. A prudent man or woman places no bets beyond those that are required by the unalterable basic terms of human existence. The well-lived life is a nose-to-the-grindstone life, perhaps somewhat dull but safe. A bird in the hand…

Well, everybody understands the trade-offs. If you have a philosophical bias against betting, you will find little that is useful to you in this book – unless, of course, it changes your mind.

But if you do not mind taking reasonable risks – or better, if you enjoy risk, as the Swiss do – then this book is for you. The Zurich Axioms are all about risk and its management. If you study the Axioms with the diligence they deserve, they can enable you to win more of your bets than you ever thought possible.

Let’s not mince words. They can make you rich.

The book is about betting in its broadest sense. You will find the stock market mentioned frequently because that is where most of my experience has been, but the book is not limited to that great supermarket of dreams. The Axioms apply as well to speculation in commodities, precious metals, art or antiques; to gambles in real estate; to the thrust and parry of daily business; to casino and table gambling. The Axioms apply, in short, to any situation in which you put money at risk in order to get more money.

All of life is a gamble, as every adult knows. Many people, probably most, are unhappy with this fact and spend their lives figuring out how to place as few bets as possible. Others, however, take the opposite route, and among these are the Swiss.

Not all Swiss men and women display this trait, of course, but large numbers do – enough, certainly, to allow for generalisations about the Swiss national character. 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.

The Swiss, amid their mountains, look around at the world and find it full of risk. They know it is possible to cut one’s personal risks to a minimum – but they also know that if you do that, you abandon all hope of becoming anything but a face in the crowd.

To make any kind of gain in life – a gain of wealth, personal stature, whatever you define as ‘gain’ – you must place some of your material and/or emotional capital at risk. You must make a commitment of money, time, love, something. That is the law of the universe. Except by blind chance, it cannot be circumvented. No creature on earth is excused from obedience to this pitiless law. To become a butterfly, a caterpillar must grow fat; and to grow fat, it must venture out where birds are. There are no appeals. It is the law.

The Swiss, observing all this, conclude that the sensible way to conduct one’s life is not to shun risk but to expose oneself to it deliberately. To join the game; to bet. But not in the caterpillar’s mindless way. To bet, instead, with care and thought. To bet in such a way that large gains are more likely than large losses. To bet and win.

Can this be done? Indeed. There is a formula for doing it. Or perhaps ‘formula’ is the wrong word, since it suggests mechanical actions and a lack of choice. A better word might be ‘philosophy’. This formula or philosophy consists of twelve profound and mysterious rules of risk-taking called the Zurich Axioms.

Be warned: the Axioms are somewhat startling when you first encounter them. They are not the kind of investment advice most counselors hand out. Indeed, they contradict some of the most cherished clichés of the investment-advice business.

The most successful Swiss speculators pay scant attention to conventional investment advice. They have a better way.

The term ‘Zurich Axioms’ was coined by a club of Swiss stock and commodity plungers who collected around Wall Street after the Second World War. My father was one of the founding members. It wasn’t a formal club. There were no by-laws, dues, or membership lists. It was simply a group of men and women who liked each other, wanted to get rich, and shared the belief that nobody ever got rich on a salary. They met irregularly at Oscar’s Delmonico and other Wall Street watering places. The meetings continued all through the 1950s, 1960s, and 1970s.

They talked about many things, but mainly about risk. The work of codifying the Zurich Axioms got started when I asked my father a question he couldn’t answer.

My father was a Swiss banker, Zurich-born and bred. The given names on his birth certificate were Franz Heinrich, but in America everybody called him Frank Henry. When he died a few years ago his obituaries made much of the fact that he had headed the New York branch of the Schweizerbankverein – Zurich’s financial colossus, the Swiss Bank Corporation. That job was important to him, but he once told me that what he really wanted engraved on his tombstone was this sentence: He gambled and won.

Frank Henry and I started to talk about speculation while I was in high school. He would look at my report