The Great Myths of Investing

GreatMythsAs the great Mark Twain (may have) said, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” That’s particularly true in the investment world because we know, to a mathematical certainty, that avoiding errors provides more bang for the buck than making correct calls and generating outperformance. Fixing what we “know for sure that just ain’t so” provides a remarkable opportunity for investment success.

On the other hand, it simply doesn’t make a lot of sense to spend enormous amounts of time and energy looking for a strategy or a manager that might (but probably won’t) outperform by just a little bit. As the great Spanish artist Pablo Picasso put it, “Every act of creation is first of all an act of destruction.” What we want to do is to find the next great investor, the terrific new strategy, the market sectors that are about to heat up or the next Apple. But what we should do is eliminate the things that make it so hard for us to get ahead. Accordingly, I will highlight some of the great myths of investing — ideas that lots of people, alleged experts even, claim to be true and act as as though are true “that just ain’t so.”

There are lots of myths at work in our lives, of course, falsehoods that are often believed and which are used to further a favored narrative. But George Washington didn’t really cut down a cherry tree and wax eloquent about not telling a lie as a consequence. Isaac Newton didn’t come up with his theory of gravity because an apple fell on his head. Columbus didn’t discover that the earth was round (that had been established centuries before). Ben Franklin didn’t fly a kite in a storm and discover electricity. And Einstein never flunked math. If any of these are news to you, I’m sorry to have had to break it to you.

Such myths persist because they “work” in some way. Their story elements — ease of recall, readily adaptability, explanatory power — make them useful and even important.  But utility and truth are hardly the same things and neither are utility and helpfulness.

So here is my list of the top ten great myths of investing. Since they aren’t true and are indeed damaging, if you can eliminate them from your mind and your investment process, your results will necessarily improve. Continue reading

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A Commitment to Truth

InvestmentBeliefssm2 (2)It seems to me, after a good deal of thought, reflection and research, that we have so much difficulty dealing with behavioral and cognitive bias in large measure because we build our belief structures precisely backwards. There’s nothing revelatory in that conclusion, obviously, because it is exactly what confirmation bias is all about. We like to think that we make (at least relatively) objective decisions based upon the best available evidence. But the truth is that we are ideological through-and-through and thus tend to make our “decisions” first — based upon our pre-conceived notions — and then backfill to add some supportive reasoning (which need not be very good to be seen as convincing).

I have been working on an infographic to try to illustrate the issue* and have come up with the following.

Commitment Hierarchy

The goal should be to build from the ground up — beginning with facts, working to conclusions and so on. Beliefs are interpretations of one’s conclusions about the facts. If more fervently held, they rise to the level of conviction and perhaps to the highest pyramid level, whereby one makes a major commitment to a particular cause, approach or ideology. These commitments are the things by which we tend to be defined.  Continue reading

Five Stinkin’ Feet

Investment Belief #5: Process Should Be Prioritized Over Outcomes InvestmentBeliefssm2 (2)

My first baseball memory is from October 16, 1962, the day after my sixth birthday, by which time I was already hooked on what was then the National Pastime. In those days, all World Series games were played during the day. So I hurried home from school on that Tuesday afternoon to turn on the (black-and-white) television and catch what I could of the seventh and deciding game of a great Series at the then-new Candlestick Park in San Francisco between the Giants and the New York Yankees.

Game seven matched New York’s 23-game winner, Ralph Terry (who in 1960 had given up perhaps the most famous home run in World Series history to lose the climatic seventh game), against San Francisco’s 24-game-winner, Jack Sanford. Sanford had pitched a three-hit shutout against Terry in game two, winning 2-0, while Terry had returned the favor in game five, defeating Sanford in a 5-3, complete game win. Game seven was brilliantly pitched on both sides. While Terry carried a perfect game into the sixth inning (broken up by Sanford) and a two-hit shutout into the ninth, Sanford was almost as good. The Yankees pushed their only run across in the fifth on singles by Bill “Moose” Skowron and Clete Boyer, a walk to Terry and a double-play grounder by Tony Kubek.

1962 WS ProgramsWhen Terry took the mound for the bottom of the ninth, clutching to that 1-0 lead (the idea of a “closer” had not been concocted yet), he faced pinch-hitter Matty Alou, who drag-bunted his way aboard. His brother Felipe Alou and Chuck Hiller struck out, bringing the great future Hall-of-Famer Willie Mays to the plate, who had led the National League in batting, runs and homers that year, as the Giants’ sought desperately to stay alive. Mays doubled to right, but Roger Maris (who had famously hit 61 homers the year before and who was a better fielder than is commonly assumed) cut the ball off at the line. His quick throw to Bobby Richardson and Richardson’s relay home forced Alou to hold at third base.

With first base open, Giants cleanup hitter and future Hall-of-Famer Willie McCovey stepped into the batter’s box while another future Hall-of-Famer, Orlando Cepeda, waited on deck. Yankees Manager Ralph Houk decided to let the right-handed Terry pitch to the left-handed-hitting McCovey, who had tripled in his previous at-bat and homered off Terry in game two, even though Cepeda was a right-handed hitter. With the count at one-and-one, McCovey got an inside fastball and rifled a blistering shot toward right field but low and just a step to Richardson’s left. The second baseman, who Terry had thought was out of position, snagged it and the Series was over. McCovey would later say that it was among the hardest balls he ever hit.

“It was an instant thing, a bam-bam type of play,” recalled Tom Haller, who caught the game for the Giants. “A bunch of us jumped up like, ‘There it is,’ then sat down because it was over.

“It was one of those split-second things. ‘Yeah! No!’ ”

Hall-of-Famer Yogi Berra, who has pretty much seen it all, said, “When McCovey hit the ball, it lifted me right out of my shoes. I never saw a last game of a World Series more exciting.”

Had McCovey’s frozen rope been hit just a bit higher or just a bit to either side, the Giants would have been crowned champions. As recounted by Henry Schulman in the San Francisco Chronicle, it was a matter of “[f]ive stinkin’ feet.”

Tremendous skill was exhibited by the players on that October afternoon over half a century ago. But the game – and ultimately the World Series championship – was decided by a bit of luck: that “five stinkin’ feet.” Continue reading

That’s So Random

Investment Belief #4: Randomness must be actively accounted for as part of the investing equation

InvestmentBeliefssm2 (2)For at least the course of my lifetime, we Americans – all of whom are said to be “created equal” – have held to a straightforward construct of the American Dream, where it’s always morning in America. In its telling, we are a people of unlimited power, promise and potential. The keys to our success are not status, wealth or connections, but rather ability, ambition, and drive. Anybody can become whatever he or she wants. Life is thus a ladder, there to be climbed by anybody willing to step up.

James Truslow Adams coined this evocative phrase in his 1931 book, The Epic of America. His American Dream is “that dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement. It is…a dream…in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position.”

Over the last few decades, a darker vision has grown up. Many of those who claim to have “done their part” by going to school, gaining new skills or working hard do not perceive themselves to have received reward commensurate with their efforts and abilities, leading to great disappointment and some remarkable income inequality. Indeed, since at least the dawning of the 21st Century, this Dream has turned more nightmarish and been deemed outside the reach of many. Investments haven’t seemed to live up to their earlier promise either, with two major financial crises since 2000 terrifying an entire generation of potential investors. It’s as if (in the words of the critic Andy Greenwald), by some cruel trick, we have come to realize too late that someone or something has tipped the ladder of success sideways, the rungs casting shadows tall as prison bars.

As a consequence, political activists of all stripes actively point blame and propose solutions. But on a personal level, we are all prone to self-serving bias – our tendency to attribute our successes to or own effort and skill but to attribute less desirable outcomes to bad luck. In point of fact, and irrespective of the political conclusions one draws from the current state of the American Dream, luck (and, if you have a spiritual bent, grace) plays an enormous role in our lives – both good and bad – just as luck plays an enormous role in many specific endeavors, from investing to poker to coin-flipping to winning a Nobel Prize. We don’t like to think that much of what happens (and happens to us) is the result of luck – i.e., randomness. We hate the idea of so much that is so important being outside of our control. But how we feel about a given proposition tells us precisely nothing about whether or not it is true and there is no disputing the facts. The random is an important factor in our lives, and, despite how counterintuitive and contradictory it may sound, we need to plan accordingly. Continue reading

We Are Less Than Rational

Investment Belief #3: We aren’t nearly as rational as we assume

InvestmentBeliefssm2 (2)Traditional economic theory insists that we humans are rational actors making rational decisions amidst uncertainty in order to maximize our marginal utility. Sometimes we even try to believe it.  But we aren’t nearly as rational as we tend to assume. We frequently delude ourselves and are readily manipulated – a fact that the advertising industry is eager to exploit.1

Watch Mad Men‘s Don Draper (Jon Hamm) use the emotional power of words to sell a couple of Kodak executives on himself and his firm while turning what they perceive to be a technological achievement (the “wheel”) into something much richer and more compelling – the “carousel.”

Those Kodak guys will hire Draper, of course, but their decision-making will hardly be rational. Homo economicus is thus a myth. But, of course, we already knew that. Even young and inexperienced investors can recognize that after just a brief exposure to the real world markets. The “rational man” is as non-existent as the Loch Ness Monster, Bigfoot and (perhaps) moderate Republicans.  Yet the idea that we’re essentially rational creatures is a very seductive myth, especially as and when we relate the concept to ourselves (few lose money preying on another’s ego). We love to think that we’re rational actors carefully examining and weighing the available evidence in order to reach the best possible conclusions.

Oh that it were so. If we aren’t really careful, we will remain deluded that we see things as they really are. The truth is that we see things the way we really are. I frequently note that investing successfully is very difficult. And so it is. But the reasons why that is so go well beyond the technical aspects of investing. Sometimes it is retaining honesty, lucidity and simplicity – seeing what is really there – that is what’s so hard. Continue reading

Get Real

Investment Belief #2: Smart Investing is Reality-Based

InvestmentBeliefssm2 (2)Anytime is a good time to talk baseball. I’ve done it pretty much my whole life. If you’re watching a game, its pace is perfectly conducive to discussing (arguing about) players, managers, strategy, tactics, the standings, the pennant races, the quality of ballpark peanuts, and pretty much anything else. In the off-season, the “hot stove league” allows for myriad possible conversations (arguments) about how to make one’s favorite team better. And now that spring training camps have opened, baseball talk about the upcoming season and its prospects has officially begun again in earnest.  The coming of Spring means the return of hope — maybe this will finally be the year (Go Padres!) — which of course means talking (arguing) about it.

Our neighborhood quarrels about the National Pastime when I was a kid were incessant and invigorating, and didn’t have to include the vagaries of team revenues and revenue-sharing, player contracts, free agency and the luxury tax, as they do now. We could focus on more important stuff. Who should be the new catcher? Who should we trade for? Do we have any hot phenoms? Who’s the best player? The best pitcher? The best hitter? The best third baseman? Who belongs in the Hall of Fame? Which team will win at all this year? How do the new baseball cards look? Is the new Strat-O-Matic edition out yet?

Early on, my arguments were rudimentary and, truth be told, plenty stupid. They were ideological (the players on my team were always better than those on your team), authority-laden (“The guy in the paper says…”), narrative-driven (“Remember that time…”), overly influenced by the recent (“Did you see what Jim Northrup did last night?”) and loaded with confirmation bias.

Quickly I came to realize that it’s really hard to change an entrenched opinion, and not just because I was arguing with dopes. Slowly it became clear that if I wanted to have at least a chance of winning my arguments, I needed to argue for a position that was reality-based. I needed to bring facts, data and just-plain solid evidence to the table if I wanted to make a reasonable claim to being right, much less of convincing anyone. Arguments and beliefs that are not reality-based are bound to fail, and to fail sooner rather than later.

Continue reading

Investing Successfully is Really Hard

InvestmentBeliefssm2 (2)Investment Belief #1: Investing Successfully is Really Hard

Investing successfully is really hard. Investors are necessarily exposed to so much uncertainty, so much randomness and so many variables that it simply isn’t reasonable to expect to succeed routinely. In fact, it’s surprisingly easy based upon the available data to wonder if it’s reasonable to expect to succeed at all. Continue reading

What Do You Believe In?

InvestmentBeliefssm2 (2)
We readily recognize that facts are not the same things as truth. Facts are true by definition (or they wouldn’t be facts), but they require analysis, understanding and interpretation to become useful and actionable, to become truth. Logically, we should decide what the facts are as objectively as we can and then interpret the facts to come to a consistent set of beliefs about them. But that’s not how it usually works. We try to jam the facts into our pre-conceived notions and commitments or simply miscomprehend reality such that we accept a view, no matter how implausible, that sees a different set of alleged facts, “facts” that are used (again) to support what we already believe. Since we quite readily see poor thinking in others but fail to see it in ourselves (on account of bias blindness) and live in a highly polarized society wherein commonly accepted facts are increasingly rare, beliefs (at least the beliefs of people who disagree with us) are not generally held in high regard.

I see at least two primary although not necessarily contradictory narratives concerning the nature and utility of belief in the modern world. On the one hand, we see people (always other people) who are hell-bent on claiming that belief (usually manifested ideologically) can and does trump all, that it can deny facts and evidence. This narrative plays out in religion, politics (right and left), sports and even investing — everywhere that ideology exists (which is essentially everywhere) — for we are ideological through-and-through. It is also well represented within popular culture. Continue reading