Yes and Not Yes

I just finished reading Mobs, Messiahs, and Markets by William Bonner and Lila Rajiva. The authors are pretty staunch libertarians, which means they like gold, dislike fiat currencies, dislike George W. nearly as much as they dislike Stalin, rail against the so-called “wisdom of crowds”, etc., etc.

Despite these divergent views, I liked the book because it was very well-written. The authors opined on a multitude of topics in definitively witty manner. There were a bunch of great metaphors used to highlight the absurdity of human nature and the ease with which man can compound public spectacles and make a fool out of himself.

Two examples…

About investment newsletter business, the authors write, “If you really want to appreciate the media, though, you have to get close enough to see how things work—like a prairie dog peering into a hay bailor—but not so close that you get caught up in it yourself. The newsletter business is perfect; it is a part of the media, but no one would mistake it for the most respectable part.”

On conflicting desires: “Watching a fat man with the keen eye of a zoologist observing a species of dumb animal, you would come to the conclusion that losing weight is not his primary concern. He also desires other things—such as Krispy Kreme donuts and Aunt Jemima’s pancakes. The two desires, he knows as well as you do are incompatible. It is his preferences you see in his waste size, not his desire for weight loss.”

So, getting to main topic of this post, which is the uselessness of experts and efforts to predict the future as it relates to investing. Physiologically, the human brain was not designed for the complex world in which we live today. The authors write, “In order to think, people are forced to start simplifying and eliminating a lot of the detail. They have to abstract…theorize…generalize.” Though the heuristics of our brains are extremely useful in helping simplify a complex world to a point where we can understand it, I feel that simplification does not necessarily lead to good results or accurate predictions.

Because modern society “forces human beings to interact in groups far larger than their brains can handle effectively”, individuals will seek out the experts in hopes of gaining some sort of guidance in their lives. But the experts seem to be no good. The authors cite the work of political psychologist Philip Tetlock, who conducted a 20-year study of 287 political experts whom he asked a range of questions: “Would there be a nonviolent end to apartheid in South Africa? Would the United States go to war in the Persian Gulf? Would Canada disintegrate?”

Tetlock found that these experts were terrible in their predictions. Even more amazingly, “specializing” in a field of knowledge tended to make for worse predictions. The moral of the story here is that there is that the law of diminishing returns applies to knowledge and learning. The authors write, “Too much knowledge can actually trip you up, because it gets enlisted on behalf of your favorite hunches—or fears—instead of being evaluated objectively.” Lay persons are just as good as the experts at making predictions.

So, in relation to investing, one cannot and should not hope to achieve perfect or near-perfect knowledge of a company or potential investment. Time spent trying to gain near-perfect konwledge is inevitably a waste and would have been better spent in evaluating several other companies that you feel might be presenting a bargain. Furthermore, I am even more convinced that attempts at predicting the future are clearly a waste of time and a needless source of worry.

Last week I finished reading Benjamin Graham’s Intelligent Investor. Though the first edition was published in 1949, the investor of average intelligence is still capable of understanding the language and general concepts contained in the book. I am still excited and a little giddy at having read the whole thing, especially with the pleasure and benefit of having an outstanding mentor to help me along the way.

Thinking back at how I first started investing my spare money, I can only shake my head. I wasn’t entirely wrong, but I also could have done much better in choosing how and when to invest. The one smart thing I did was to put most of my money into an index fund. The one dumb thing I did was to put my money into some of the growth stocks about which Graham provided much warning and evidence against such a proposition. I invested in these two or three individual stocks without any consideration of whether I was purchasing a stock at a bargain price, at fair value, or if I was paying a premium for the growth (which I was).

Of course, one stock did very well up until it started to miss analysts’ unrealistic expectations. The other stock just didn’t do well to begin with - I got in at the top! I lacked an understanding of two very important things. One is that the investor should use the fluctuations to take advantage grossly mispriced stocks. Never allow the daily market fluctuations to guide your investment decisions. Second, one ought to invest in stocks that possess a margin of safety. In other words, as Seth Klarman says, “Buying at a discount creates a margin of safety for the investor–room for imprecision, error, bas luck or the vicissitudes of volatile markets and economies.”

These two concepts are key to making successful, long-term investments.