Against the Gods Summary
Against the Gods: The Remarkable Story of Risk by Peter Bernstein is a book about man’s constant battle against the forces of fate. This is a fight that has existed for millennia, and in each epoch, influenced by the dominant ideology of the time, we have dealt with risk differently. Bernstein outlines the evolution of our different perceptions of risk by focusing on paradigm shifting ideas from mathematicians, biologists, and economists.
What makes modern society different from the past is the mastery of risk. With the help of countless mathematical tinkering from a group of thinkers with remarkable vision, humans are no longer passive victims of nature, or hostages of the whims of the gods. These thinkers, like Prometheus, have defied the gods and went in search of the light in the darkness, that converted the future into an opportunity, rather than an enemy.
These thinkers include Francis Galton, who introduced regression to the mean in 1875. He was Charles Darwin’s first cousin. This idea explains why ‘pride goeth before a fall’ and why clouds tend to have silver linings. Harry Markowitz demonstrated, in 1952, why putting all your eggs in one basket was a bad idea, and why diversification was the closest an investor could ever come to a free lunch. This revelation has revolutionized Wall Street and business, and its effects are still felt today.
We enter this battle because we think Lady Luck is on our side. Adam Smith explained the motivation: “The overweening conceit which the greater part of men have of their own abilities [and] their absurd presumption in their own good fortune.” Smith knew that risk taking propelled economic progress, but he feared what would happen when this propensity went too far.
The Discovery of Numbers
The Greeks refused to accept anything that was passed down to them by older societies. They didn’t care about samples, they wanted concepts that would apply everywhere, in every case. Greek mathematics is all about proof, such as Euclidean geometry.
The Stock Market
Markowitz thought that variance was the key method of measuring risk. Diversify your risk, and you minimize variance. If faced between a choice of investing in the S&P 500 or a 30-year Treasury bond, the investor should go with the latter because bonds have a lower standard deviation. But a higher return can compensate for greater volatility if the total stock return is sufficiently high.