Financial Wisdom from The Princess Bride

Now, a clever man would put the poison into his own goblet, because he would know that only a great fool would reach for what he was given. I am not a great fool, so I can clearly not choose the wine in front of you. But you must have known I was not a great fool, you would have counted on it, so I can clearly not choose the wine in front of me.

~ Vizzini, from the movie The Princess Bride

The Princess Bride DVD

As I was writing about biflation and the various investment approaches we might take this week, I couldn’t help but think about how difficult these choices are. For every good argument for a certain course of action, there is an equally valid reason why the opposite might be true. I can make a very reasonable argument why neither stocks nor bonds are attractive right now. The Reformed Broker did so a few weeks ago with more wit and clarity than I could hope to achieve. The post was entitled Stock Are from Mars, Bonds Are from Venus and it’s a great read.

Every time I hear the stocks vs. bonds debate, I can’t help but feel that both sides are missing something important. It reminds me of a scene from the movie The Princess Bride. For this reason, I chose that scene to provide the foundation for today’s Friday Food for Thought. In the scene, a self-proclaimed genius examines every angle of a decision based on his assumptions about human nature, resorts to a schoolyard trick, and fatally overlooks an outlier in the end.

Pour the Wine. The Battle of Wits Has Begun . . .

For those of you who are not familiar with Rob Reiner’s The Princess Bride, it‘s a movie that was based on a novel by William Goldman. In it, there is a scene where the hero, Westley, is trying to free the princess from Vizzini, the villain. Westley proposes a battle of the wits for the princess. He pours two glasses of wine, claims to poison one with iocane powder, and asks Vizzini, who fancies himself a genius, to choose which glass is poisoned.

Today’s opening quote goes through some of the dizzying logic Vizzini undertakes to make his decision. In the end, he distracts Westley in order to switch glasses with him. He then chooses his own glass and they both drink. Westley reveals that both were poisoned, but that he had spent years developing an immunity to iocane powder. Vizzini falls over dead, and Westley wins.

8 Financial Lessons from Vizzini

There are a few financial lessons we can take from this scene:

  • Look for the Third Way: If neither of two options is attractive, you’re allowed choose neither. Instead, look for a better option and be ready to wait until the right one comes along.
  • People in Masks Cannot Be Trusted: This is a quote from Fezzik the giant, another character in the movie. There is always elevated risk when people with vested interests and hidden agendas make the rules.
  • Never Put More at Risk Than You Can Afford to Lose: Vizzini wagered his life, so that’s pretty extreme, but the lesson holds for money at risk as well. Always understand exactly how much you have at risk.
  • Make Contingency Plans: Vizzini accepted Westley’s challenge without even considering changing the rules or offering an alternative. He never considered what would happen if he were wrong.
  • Anything Can Happen: Sometimes we just have to admit that we cannot anticipate every risk and make the best choices we can with the information we have. (“Get used to disappointment” is another great line from the movie.)
  • Conventional Wisdom Isn’t Always That Wise: Vizzini accuses Westley of falling “victim to one of the classic blunders . . . Never go against a Sicilian when death is on the line!” Vizzini drops dead as he is laughing at Westley. I’m sure all of you can come up with some interesting financial parallels. If you’re stuck, you might try starting with the old “subprime is contained” mantra.
  • Overconfidence Can Kill You: Your mother was right: It really is better to be safe than sorry. Be on the lookout for outliers no matter how confident you are in your investment thesis.
  • Intelligence & Logic Do Not Guarantee Success: This is particularly true in the financial management realm. I have heard many anecdotes about financial planners whose personal finances are a mess and of highly intelligent professionals and academics who know a great deal about the stock market and economics, but can’t seem to manage a positive return in their own portfolios.
  • Cheaters Never Prosper – at Least Not Forever: I guess we have seen a few cheaters leave with pay packages containing more money than most of us can hope to save in a lifetime. Vizzini thought, for a brief moment, that he had outsmarted Westley by tricking him. Justice was served swiftly. The cases of Madoff and others show that justice is sometimes a little slow. Better late than never.

Outliers, Caveats and Iocane Powder

Prior to the financial crisis of 2008, many analysts, investors, politicians, and central bankers exhibited a lot of the complacent attitudes outlined above. Investors and consumers were told not to worry about skyrocketing housing prices or emerging problems with derivatives related to mortgages or the fact that millions of people had bought homes that they were never going to be able to afford. Instead, many blustered on about historic stock market returns, about how housing prices hadn’t fallen since the Great Depression, and about the sheer lunacy of the idea that a large U.S. financial institution could fail.

These faulty assumptions, and many many more, were the iocane powder that poisoned our economy. Of course, we know that the stock market has not been a great investment for over a decade now – unless you’ve traded it very well. U.S. housing prices did fall; they did so quite precipitously, and they continue to fall over a year after the recession supposedly ended. As for large U.S. financial institutions, let’s take attendance: Bear Stearns, Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, Washington Mutual, Wachovia, Countrywide Financial, and AIG have all either gone bankrupt, merged with other banks, or remain under taxpayer protection to this day.

Iocane is a fictional poison that is colourless, odourless, and dissolves instantly in liquid. If we continue the financial metaphor, perhaps it has some sensitivity to gold. Maybe the gold price is telling us that there are pockets of trouble gathering, like iocane powder, in our economic system. Where will they turn up? Will it be more trouble in Europe, Chinese bubbles popping, a U.S. dollar currency crisis, or something we haven’t yet considered?

Do you see increasing risks in the system, or do you think gold is sending a false signal?

Written by Kim Petch

18 Responses to Financial Wisdom from The Princess Bride

  1. Tony Boeckh’s book, The Great Reflation, is a pretty good read on investing during these uncertain times. He urges tactical rebalancing based on monetary conditions and other variables.

    • Glad to inject a lighter note on a Friday. Maybe I’ll get that movie out and watch it tonight. I think we have it on VHS! πŸ˜‰

  2. Every time I hear the stocks vs. bonds debate, I can’t help but feel that both sides are missing something important.

    I think your instinct here is a good one, Two Cents. I do not at all buy this idea that the choice is between stocks and bonds, the two asset classes that just happen to bring in the biggest commissions for The Stock-Selling Industry (how conVENient, Church Lady would say).

    I believe in achieving effective diversification. That means that my two asset classes need to complement each other. I go for stocks for growth; whenever stocks are priced reasonably, I want most of my money in stocks. When stocks are insanely overpriced (as they have been for pretty much the entire time-period from 1996 forward) I don’t want to go with another relatively high-risk asset class, which in all likelihood is ALSO overpriced for the same reasons stocks are. I want to go with a super-safe asset class — TIPS, IBonds, or certificates of deposit (CDs).

    The common objection to the super-safe asset classes is that the returns on them are not high enough. Patience, grasshopper! It’s a mistake to look only at the direct return these asset classes provide. After the next crash, stocks will be providing amazing returns (probably 15 percent real or more per year). If you can earn a zero return while stock prices are making their way down to mouth-wateringly great levels, you will be earning 15 percent real on a larger stack of money. So in a long-term sense you are earning a huge return on those assets.

    I don’t see a place for bonds at all. When stocks are priced reasonably, stocks offer more growth. When stocks are priced insanely, you don’t want to be fooling around with stocks OR bonds, in my assessment. The same emotional factors that make stocks a bad bet undermine all other markets (except possibly the markets for the super-safe asset classes, where the investor emotion tends to be least in evidence — people don’t get in these asset classes to make a killing and the financial industry directs little in the way of marketing efforts to them).


    • I can see by your Church Lady reference that you must be somewhere close to my age. I loved those SNL skits!

      I read an article today (can’t recall where) that investing in 30 year treasuries in 1981 would have yielded returns much higher than equities. If I’m not mistaken, however, the great bull run in bonds began in 1981. It’s still going strong, but you would have to think we are closer to the end than the beginning, so I am not in bonds either.

      You make an interesting case for sticking with the safety (and low returns) of cash in order to reap much higher returns once stocks hit their trough valuations.

  3. The quote reminds me of the concept of “leveling” in Poker: When playing against advanced players, you often have to think about “What does he think I have?” and “What does he think I put him on?”, and “What does he think I think he puts me on?”, etc… it can get to the point where some players have to wear tinfoil hats if they want to keep their sanity!

    I also don’t see a place for bonds right now, but nothing is safe. I believe that the Fed will do as much as they dare to inflate, and that is not so great for cash. It also results in illusory stock market gains that make people happy (Dow up another 300 pts!), yet they fail to notice that the US dollar index dropped by a point at the same time.

    • And to add, no country seems to want a strong currency, including Canada. Mark Carney has indicated that he will intervene should the dollar become too strong, so a falling US dollar means a race by every other country to depreciate their currency to match…

      • I think this whole “race to the bottom” in the currency markets could end up being a big story in 2011, just as sovereign debt was the story of 2010.

        I like your Poker analogy. I actually don’t really know much about Poker at all, but I’m glad to add the term “levelling” to my vocabulary, as that’s how I feel most of the time when I’m trying to figure out what to do with our savings.

        It also reminds me of those spy movies where you think a character is on “good” side, but he is actually on the other. Then in the end you find out he really was on the “good” side all along. It’s a bit too much for me, and that’s pretty much how I feel about the markets right now. πŸ˜‰

  4. Well written… In a nutshell, gold is reacting to a falling US dollar. Lately, the greatest correlation between gold prices and the markets has been the price of the US dollar. They both serve as “safe” havens to sink money… so when one goes down, the other seems to go up. Interestingly, this relationship has become stronger in recent months.

    • It seems everything is working in gold’s favour right now, including seasonality. I’m curious about whether you invest in gold or not, and whether you prefer gold companies, ETFs, or the metal itself?

      • I tend to stay clear of commodities. However, gold typically is more stable and has longer trends; therefore, I do look for the trends and purchase them accordingly. One of my recent Trade Alerts (Semafo SMF.TO) profited me over 40%. I am also in Keegan right now, which has returned over 50% so far. Basically, the trend (especially with gold) is your friend… and they tend to last a little longer.

  5. Great post! I haven’t watched that movie in ages–perhaps I will have to sit down with a financial mindset now πŸ˜‰

    Hope you don’t mind I linked to your post!

    • I’m generally not a movie maven, but this in one of a few that I really like. It’s sort of like cinematic comfort food for me. Thanks for the link!

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