Some time ago, several of our clients sent us this article from the New York Times. It is one that has become timeless and I thought I would share it with you. The article discusses how we as humans are able to take educated guesses about the future and how wrong we often are. We have a tendency to “pat ourselves on the back” for making a smart decision and cite “unpredictable” as the fault in our more useless decisions. I suggest you take a few minutes and look at the article; it starts off by discussing tests used in the Israeli Army to determine which individuals are officer material and ties those results to the nature of investing and perhaps the fallacy of the stock picker.
Too often, laymen as well as professionals allow their system of values and their emotions to interfere with decisions that should be based upon strictly quantitative factors. Behavioral economics studies this phenomenon and may help us to understand stories that we have heard from time to time of how chimps throwing darts can pick stocks better than professionals.
For a moment, let’s consider what happens when a stock is traded. One person sells a stock because they think it will lose relative value in the future and another person buys the same stock for the opposite reason. The reality that I see in my work is that while one set of brilliant money managers are buying, another set of brilliant money managers are selling, and on the same set of facts. Amazing!
I was brought up and educated in a world that taught us the concept that if one was simply smarter than the next, that person would excel in the stock market. Data and research on the subject now demonstrate (I believe conclusively), that this is just not the case. As a result of personal experience over the years with great money managers, I have come to the realization that the active selection of stocks and bonds simply do not typically help a portfolio’s return. While I am actually disappointed by this conclusion, we use this insight when we prepare our clients investment policies.