We live in a world brimming with information, data, and statistics. Despite this, the breadth of what you don’t know dwarfs what you do know.
If knowledge is power, understanding what you don’t know is wisdom.
HISTORY REPEATS ITSELF
Many investors cling to the belief (perhaps better described as misbelief), that the events of today are unprecedented. This is mostly false as the themes of history are repeated over time, just with different names and circumstances.
More than 92% of the people that have ever lived on planet earth are dead and gone. Your personal experiences are just a speck of dust within the arc of human history. The challenges and struggles that you experience today aren’t materially different from others throughout time.
Economic and financial market history illuminate current events and future probabilities. History provides context for information overload. Rather than focusing on precise circumstances, try looking instead at motivating behaviors, like fear and greed, that can provide a direct link to history.
If you obsess only about the data, you may miss the human element in its entirety.
GRAPPLING WITH UNCERTAINTY
Let’s face it, many things in life are simply unknowable. You don’t know what the weather will be tomorrow, because tomorrow is in the future. No one knows. Yet, investors want certainty and are attracted to forecasts and predictions that convey certitude. Just because some media “talking head” makes a prognostication about the market, doesn’t mean she’s right.
It’s important to realize that even very smart people can’t predict the future. In fact, as author Morgan Housel says, harnessing humility about forecasting the future is a “superpower” when it comes to investing.
Of course, it’s sometimes tempting to forecast future outcomes based on trends in the markets or economy today. However, extrapolating current events into the future can easily lead you down an errant path. For example, you might proffer that predicting whether or not there is a recession is significant for the direction of investment markets. However, the number of economic recessions in the U.S. since the end of WWII can be counted on two hands. That’s a very small sample size and doesn’t provide enough breadth to be reliable as a predictor of the future.
Financial markets are complex and the human emotions that drive the markets even more so. Try to remember that the probabilities, which reflect the likelihood of something, are always tighter than the possibilities.
I’ve noticed that many smart people struggle with the notion that markets can’t systematically be predicted. Instead, they sometimes create complicated stories about how they “know” the direction of the markets, ignoring the reality of randomness.
Analyzing reams of data about the economy or financial markets doesn’t constitute knowledge because it ignores the huge impact of human behavior. Financial choices involve emotions and these emotions aren’t easily quantified. Data is known; behavior is unknown.