Why “variolation” might be a cure for speculation

The front page headline in the Wall Street Journal this morning was predictable: TerraUSD Crash Led to Vanished Savings, Shattered DreamsThe implosion of TerraUSD, a supposed “stable coin”, was certain to inflict a great deal of pain on individuals who bought into the fantasy that it is possible to own a “safe” asset pegged to the dollar that yielded nearly 20%. Unfortunately, this was always an illusion. 

TerraUSD was not backed by U.S. dollars, but by an algorithm tied to the Luna cryptocurrency. It didn’t work as planned:

“Here is how it was supposed to work: If TerraUSD fell below $1, traders could buy the coin and convert it into $1 of Luna, earning arbitrage profits. That would dry up supply of TerraUSD and push its price back to $1. But the mechanism only worked if traders saw value in Luna. When TerraUSD started wobbling this month, Luna went into free fall.”

When the music stopped, TerraUSD went into a free fall and is now “worth” 3 cents.

Source: WSJ

The article goes on to describe the steep losses taken by ordinary individuals, some of whom have lost the majority of their life savings. You have to wonder how people could have fallen into the trap of thinking that it was possible to earn double digit yields on an asset devoid of risk of loss. 

My reaction to these types of articles is always the same. I cannot believe how people fall into what seem to be “obvious” speculative traps. However, we should keep in mind that many of these people are not stupid. One of the individuals profiled in the article is a surgeon. The irony is that it is often highly educated people who fall into speculative traps in financial markets. 

I think that there is something hard-wired in our psychology that often leads to speculation, especially among people who have achieved a great deal in other fields. A surgeon, for example, cannot fake his skills. Incompetence would quickly reveal itself and result in an exit from the field of medicine. The same is not true in the field of investing, but many people don’t realize that. 

The financial “experts” on television are usually empty suits, and even those who appear to have skill might just be lucky. It takes a decade or more to demonstrate real skill in the investing arena. If you are a surgeon, you might assume that an investment expert is just like you, except in another field, and then listen to some very bad advice.


This brings me to the point where I’m obligated to share a personal story about speculation. In February 2001, I purchased 100 shares of Level 3 Communications for $2,870, including a $20 commission. 

A year earlier, I made my first investment in Berkshire Hathaway which had done very well, especially compared to market averages. During that year, I started to participate on the Berkshire Hathaway Yahoo! group where a number of Berkshire shareholders wrote about investing in Level 3. The Berkshire connection was that Walter Scott Jr. was Chairman of Level 3. Many very smart Berkshire shareholders decided to invest in Level 3. I simply followed them into the stock even though I had no understanding of the business and did almost no due diligence.

In November 2001, I sold my shares of Level 3 Communications for $327, again paying a $20 commission. The total loss was $2,543, or 89%. I thought I was investing, but I was really blindly speculating, and I paid for it with nearly a total loss. I read about the idea on a message board, but the fault was mine, and mine alone.

There was no excuse for speculating in Level 3 Communications. Aside from my finance degree, I had spent years studying Benjamin Graham and Warren Buffett and my investment in Berkshire Hathaway the prior year was a legitimate investment made after much due diligence and effort.

Intellectually, I should have been immune to speculation, but clearly I was not.


Long before the development of safe vaccines for dreaded diseases like smallpox, a risky procedure known as variolation was used to provide some protection. Although the methods varied by region and changed over time, the general idea was to purposely expose a person to smallpox in a controlled way that would hopefully result in a mild case of the disease and provide durable immunity in future outbreaks.

Although some people died after the variolation procedure, there is no doubt that it saved many lives. We might cringe at the idea of purposely infecting ourselves with a deadly disease in order to gain immunity today, but it was useful in its time.

If reading Benjamin Graham and Warren Buffett’s writings represents vaccination against speculation, then perhaps having a small “mad money” account at an early age used for speculation could be a form of variolation. If we cannot learn the perils of speculation vicariously through the experience and wisdom of others, maybe we need to learn by direct experience.

The key thing, however, is to learn our lesson through experience that burns but doesn’t kill us. It is one thing to learn not to speculate by losing a couple thousand dollars, and quite another for a surgeon in his 40s to lose 90% of his life savings speculating in cryptocurrencies. 

My experience in Level 3 Communications has offered durable protection against speculation over the past two decades. Although I have certainly made investing mistakes, I have not outright speculated since 2001, and I have no desire to do so. Witnessing other people get rich (usually temporarily) through speculation does not tempt me to join them.

I know that the $2,500 loss in 2001 easily represents $15,000 today given that I also owned Berkshire Hathaway at the time and could have invested that sum in Berkshire instead of speculating. Losing $2,500 in 2001 burned but didn’t change my life, and while having $15,000 more today would be nice, it also wouldn’t change my life.

For most people, I doubt that reading books or making pretend trades in a test account will cure the urge to speculate. However, actually losing money that is meaningful but not ruinous might represent a cure. It is best to learn this lesson at a young age with small sums at stake.

PS: This is a longer version of a Twitter thread I posted last week, before I decided to stop using the platform.

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