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The first part of an interview with Bill Gross by Barry Ritholtz is now available on Bloomberg. In 1971, Bill Gross cofound Pacific Investment Management Co. (PIMCO), a global investment firm which focuses mostly on bonds. By 2014, PIMCO’s Total Return Fund became the largest fund under management of Gross. Nicknamed “bond king”, he was later fired from PIMCO and joined Janus Capital Group Inc. (JNS) in September 2014.

Below are five lessons I learned from the interview.

  1. Gambler’s ruin: Even if the odds are in your favour, you should only invest a small portion of your portfolio, because you may experience a streak of bad luck. A rule of thumb is: one should invest at most 2 percent of your principle per trade. That means you have to be wrong 50 times before you run out of money, assuming that each lost is 100 percent.
  2. Stability leads to instability: Economist Dr. Hyman Minsky observed that long term macroeconomic stability, like maintaining inflation rate at 2 percent, tends to create instability inside the economy. We get accustomed to a particular trend or condition. When that trend fails, the ensued correction will be dramatic. It makes sense in term of human behaviour. If we believe that the next year will be the same as this year, we are more willing to borrow more (in finance speak, leverage) to spend/invest. When the condition changes, instability is generated by the need to change behaviour quickly. In the other words, instability is created when one part of economy moves to EXCESS. Subprime mortgage crisis illustrates this point. Prior to the GFC, households with poor credit overextended themselves with debt in order to buy houses under expectation that house prices would continue to rise. Eventually, the prices dropped dramatically. SEE ALSO Nassim Taleb’s The Black Swan.
  3. Investors’ common mistake: Not doing what Baron Rothschild said, “Buy when there’s blood in the streets.” That is, buy when there is extreme pessimism. More importantly, things cannot continue forever.
  4. It is ok to be wrong. It is not ok to stay wrong: Don’t fall in love with a trade. Have flexibility to admit that you are wrong and reverse the course.
  5. The Federal Reserve’s zero-interest-rate policy: Interest rate should be higher because it affects the real return on investment by lowering it. This discourages corporate leaders from making investments because the return is too low and the risk is too great. “Zero-interest-rate distorts capitalism to a significant degree.” For examples, companies engaged in stock buybacks instead of capital investment, or increasing dividends instead of hiring more employees. This means less investment into real economy.