Josh Brown cites a Ben Carlson piece this morning arguing that there’s no point in understanding why certain things happen in the financial markets. Basically, the world is really complex, too complex to predict so you shouldn’t bother trying. This has become a very popular refrain in the last few years and I honestly don’t understand why. After all, if you put together a portfolio then you’re making predictions about the future whether you know it or not. The person who buys the S&P 500 Index Fund isn’t relying on a different prediction (stock market bull market) than the mutual fund manager who buys 200 large cap stocks in the XYZ Large Cap Blend Fund yet somehow our industry has convinced itself that the indexer doesn’t “actively” predict the future while the second one is “actively” predicting the future. That doesn’t make any sense to me. Anyhow….
There’s a much more important reason why it’s really helpful to understand why the world works in certain ways – it helps you avoid all the uncertainty and emotionally biased decisions that often come along with it. And yes, this can mean deciphering very silly daily events like Greece in order to help put things in the proper perspective so we don’t overreact. As you likely know, I work from a fairly operational foundation. That is, I try to understand the world for what it is rather than just embracing the orthodox views as fact. This has helped me overcome a great deal of emotional uncertainty over the years. For instance:
- I didn’t buy into the “QE is money printing which leads to hyperinflation” nonsense because I actually understood how QE works at an operational level.
- I didn’t buy into the “USA is insolvent” myth that was so prevalent during the debt ceiling discussions because I understood how a government operates differently from a household.
- I didn’t buy into the “crowding out” myth that led many people to believe that government stimulus would cause rising interest rates because I understand endogenous money.
- I didn’t buy into the “stock bull market is a fraud” myth that was so prevalent thanks to misleading charts about QE.
I could go on and on there. I’ve spilled a lot of ink discussing the various myths in finance and economics. And I’ve helped countless people avoid emotional decisions by explaining to them, operationally, why certain things were likely to play out certain ways. I certainly don’t pretend to have a crystal ball, but understanding the world at an operational level has vastly sharpened my bull shit detector and helped me avoid making emotional decisions.
Successful investing is about understanding your surroundings so you can make high probability decisions. And this often involves avoiding the risks that increase the odds of a poor outcome (whether it’s paying high fees, paying high taxes, being overly active, etc). We’re playing a losers game here. In the aggregate, we all generate the post-tax and post-fee return of the financial markets. That arithmetic is irrefutable. So, like so many losing games, winning isn’t about “beating the market” and outsmarting the other players. It’s about avoiding the big mistakes. And the best way to avoid big mistakes and falling for your own personal emotional biases, is by formulating a better understanding of the world so you don’t overreact to every little zig and zag in the financial markets.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.