The key to fool-proof investing is truly internalizing the implications of the following unsettling fact.
Most people are fools when it comes to evaluating their own talent in many of their own skills. (Including, as we’ll see in a moment, investing.)
Unfortunately, chances are, that includes us.
Studies show that 95% of people believe they are “above-average” drivers.
Other studies found that 94% of college faculty believe they produce “above average” work, and 90% of them believe they are “above average” teachers.
87% of MBA students have rated themselves “above average” in academic talent
These biases are called the “Lake Wobegon effect,” named after storyteller Garrison Keillor’s fictional town of Lake Wobegon, “where all the women are strong, all the men are good-looking, and all the children are above average.”
The effect operates in almost every field in which we humans rate ourselves on positive traits.
In fact, one study showed that 84% of people believe they are “above average” in rating their own detection of their own biases.
In other words, 85% of people felt they were “above average” in rating whether they were “above-average” or not!
And most people who invest actively, believe they are above average in investing.
What this means is that, when you and I think we are better than the crowd we’re competing in, including in the crowded field of investing, the chances are, we are wrong.
It seems like depressing news, right? (BTW, depressed people are the one group who consistently rate themselves more realistically. Though not pleasant, depression takes off the rose-colored glasses.)
Fortunately, as I shared in my last post, “What Socrates Knows About Investing That You Don’t…” the old wise man shows us a non-depressing way out.
“I know that I know nothing,” he is often paraphrased as saying.
The key of fool-proof investing is: know the areas where you are a fool (i.e., where you overestimate your knowledge and talents compared to those you’re competing against in that realm), and know the areas where you are less likely to be a fool.
Know the areas you’re likely to have a true (not falsely-overestimated) competitive advantage.
You should especially heed this advice if you are considering any form of active investing in market assets such as stocks, bonds, real estate, or crypto.
When you are investing in any market asset, you are betting against multi-billion-dollar hedge funds who have access to near-insider information about individual companies, executives, the economy, the government and the markets–information that we retail investors likely don’t even know exists, and wouldn’t have a prayer’s chance of getting our hands on before the trades are already made.
Furthermore, they are literally employing PhDs in quantum physics to run statistical analyses on proprietary big data sets to determine the best milliseconds to buy and sell, because each fraction of a second could mean millions gained or lost, given the size of their trades, as the market fluctuates.
They are hiring AI experts to create programs to scan millions of gigabytes of obscure big-data troves we don’t have access to, looking for clues. These funds are employing AI programs that allow them to scan immediately-breaking news stories on the web for relevant news. They’re now even creating AI *speech recognition programs* to scan and evaluate video/TV/radio news as well– and then execute trades on this news automatically.
As we explored in the previous “Socrates” post– do you really believe you know more about stocks and bonds than these people you’re betting against?
Any time you buy an asset, the person selling it is betting against you. Likely, that “person” is a massive financial institution that has decided to sell, based on their data and analyses.
If you do believe you know more about the future value of that asset than they do, why are you confident in that belief? What better knowledge/theories do you believe you have, vs the competition?
Now, you’ve probably heard arguments that ultimately very few of these big active fund managers end up beating the market, on a risk-adjusted basis–any more than they would if they went and put the same money on the roulette table in Vegas. (The house always wins.)
It turns out, about 95% of fund managers underperform the market over a period of 15 years or more. When it comes to evaluating their stock picking, even fancy fund managers with Harvard MBAs live in Lake Wobegon. These hotshots all think they’re “above average” when they’re not (who could imagine!)
So, in response, the personal investment advisors and mutual fund managers and personal finance book authors–the entire personal finance industry–advance a countervailing theory. One that’s more catered to the hopes and egos of retail investors such as ourselves (their target market). It goes like this:
“You can’t beat the market over the long haul, and neither can anyone else. But, despite inevitable ups and downs, the stock market has always gone up in the long run, so scrimp-and-save towards your IRAs and 401(k), invest in low-fee index funds, ride out the waves, and they’ll continue to go up in the long run.” This is called “buy-and-hold” or “passive investing.”
It sounds so easy and hopeful! Why wouldn’t I want to just sit back and watch myself get rich passively over 40 years? Why wouldn’t I put my *entire life savings* in the hands of such sensible and obvious advice?
The problem is, there’s a fundamental flaw at the heart of this advice.
Almost everyone who gives this “buy-and-hold,” “passive investing” advice–i.e., the entire personal finance industry–misunderstands this one crucial point.
A mistake so huge it renders their advice worthless.
In fact, it renders their advice worse than worthless. It makes it outright dangerous for the future of your financial health.
Once you understand this point, you’ll know where you should be focusing your attention in your investing for your future.
Which brings me to the next letter in this series:
“The Dirty Secret of the BS Investment Business”
To get instant access to this letter, sign up for my free series on investing via this link.
Cheers,
–Michael
