I recently re-read an article by the Mises Institute’s Doug French about studies of behavioral economics relating to investing, “Don’t Go With The Flow.” I wrote an article on it last May. His main thesis is that we humans aren’t well equipped to invest in things like the stock market. He goes over some common behavioral flaws in our make-up (i.e., human nature) which lead to poor results with our investments. Things like hindsight bias, momentum investing, Groupthink (social conformity), the role of dopamine, and confirmation bias all impact our decision making process. It’s a good article.
Much of this is discussed in Nassim Taleb’s The Black Swan, one of my favorite books. He examines the epistemological foundations of investing through behavioral economics and fractal geometry, and concludes that all current investment models’ evaluation of risk are flawed. If you haven’t read it, I strongly urge you to do so.
Doug French also analyzes this in terms of Ludwig von Mises’s theories on epistemology and the causes of the business cycle. Austrian theory very convincingly rejects current investment models which which are based on the idea that people always make rational decisions. The Austrians recognize that people aren’t always rational and have created a theory to explain this.
My musings on these concepts gave me the idea that the current economic structure of our country is unfair to investors. My thesis is that the boom-bust business cycles created by the Fed have created a much more turbulent world which threatens our assets and places an unfair burden on ordinary people to find investments to protect themselves.
I am not being naive; I understand that the world is a risky place and investing is always risky. Citizens of less capitalistic countries have understood this concept for centuries as wars, inflation, depressions, and oppression rob their savings and turn people into fatalistic cynics. But I think we in the U.S. have entered into a new realm of almost perpetual boom and bust, inflation and deflation. I am not suggesting that the past was perfect: far from it. But we are far less “perfect” today than in the past.
I place the blame on these cycles solely on government. On the Fed because of their constant inflation and deflation of the money supply in an attempt to centrally plan the economy. On the federal government for gaming the system by creating rules to further distort market-based decisions in favor industries and projects they prefer. It forces investors to make guesses about what they will do next.
Investing is difficult enough for the professionals. Imagine the burden it puts on the average couple who have been lucky enough to save $50,000 or $100,000 for their retirement. Will we have inflation or deflation? Will stocks be a good investment or is it bonds? Will U.S. investments be good or should I go offshore? Is my stockbroker savvy or does he just follow what he’s told to do? Is that mutual fund going to stay on top or not. Value investing? Technical analysis? Long-short? Options? Should I buy gold? Should I just stick it under the mattress? Who are the experts? Who can I trust? It’s not the kind of world where buy-and-hold still works.
I don’t have any answers to this dilemma. This is an observation.
I will say that Austrian theory offers us a solution for the boom-bust business cycle. That would be to adopt a 100% gold-backed currency. We wouldn’t need the Fed then. We wouldn’t have inflation. Business cycles would even out. But that’s another topic. Please don’t send me letters and comments arguing this point. I have heard all the anti-gold arguments and this is not an article about the gold standard. It is about today and the inherent risks we have created.
What would you recommend to that couple today?
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I’d use the advice given to me – think long term, and choose vehicles that offer a steady-state of growth, relitive *security* (if there’s such a thing…), and needs a moderate/low level of maintence.
I have a Magellan fund, and its taken some hits, but been pretty stable for years. No need to tinker with it, and do some exotic voodoo with it – its ment for the long haul, and not the everyday whimsy/whatever adjustments.
Seeing how everything is walking a fine line these days, research, careful thought, and a focus for the long term would be the best advice.
I’ve been thinking about this lately as well. I’m at the point we’re I just don’t want to lose everything my wife and I have worked so hard for. I’ve taken the permanent portfolio approach, 25% in gold/silver, 25% in bonds, 25% in stocks, and 25% in cash. It’s not a perfect solution, but it seems the best way to preserve what I already have. I did my own mix, but there is a mutual fund that exists, PRPFX.
Great point on the fundamental uncertainty facing investors. One of the real problems we have is the destruction of trust, be it deliberate via obfuscation of risks or accidental. It boils down to investing in what you understand.
Without understanding, you are grasping at straws, and it is one of the great disservices that investment houses have done to the average investor, making it almost impossible to understand what it is you are investing in. It is going to be one of the most difficult challenges for the investment industry to turn this around. You’re doing your part: making sure that people understand that there are risks, and that the government is making things worse, not better. Amen to that.
I agree about investment houses.
Today very little investment is done via investment houses. Most of it is casino activity. Investment as economists use the term, not the bastardized version of the word used today, means generating new growth usually in something which creates new job opportunities. What we have today is simply shuffling around stocks and bonds on secondary markets, not investment. In your Magellan funds (Fred Z) you own no stock, you are only getting a portion of the proceeds. Unless you are in on an IPO you are not letting your money be used as investment, your simply someone elses greater fool and you’ll need to find one of your own someday.
I’ve had this same realization for a while. The problem with governments, fiat money, and central banks is not only inflation. It is also the wealth re-distribution (theft) favoring the first receivers of the printed money and the first receivers of information about where this fake liquidity will be directed (boom). A simple economic agent has to “invest” (expose his savings to risk) just to break even after inflation. He has to keep running just to stay in place. And he has to expose himself to competition with the ones who either direct the liquidity or know much sooner where it is likely to be directed. It’s a losing “game” against the fake money front-runners from the start.
Compare this to a free market for money (no legal tender, no capital gains taxes for commodities, etc.) where a saver can just keep his saved capital without exposing it to risk while its purchasing power increases due to falling prices caused by increasing productivity. Night and day.
The beneficiaries of the current system would never consider this change. Except when the market presents them with “an offer they can’t refuse” and the whole system collapses under its own weight.
Investing couldn’t be simpler, than it is today.
A) Look at the what you already buy/use, day-in and day-out, for goods and services.
. . . (The stuf you “NEED,” NOT the “WANT” stuf)
. . . food (Refrigerator, freezer, shelves)
. . . clothes (Closets), medicines (Bathroom). supplies, utilities, credit, etc.
B) Write down the names of the Companies.
C) Evaluate the companies management. Are they a Global Company?
. . . Have they been in business for 10 years and will they still be here in 10 years?
. . . Do they pay a Dividend, that grows every year and reinvests automatically?
Like a Garden, weed it, add funds to nourish it, watch it grow!
I like Ed’s answer. Common sense is uncommon. Get off the government’s case. Be real. The Greed on Wall Street and Main Street are very real factors in the Countrys dillema. I’m not going to comment on the abstracts. You already have and I don’t have the 200 IQ to do it.
Oh is it going to be different about the government when more “conservatives” come in power?
Incidentally, I feel the War on Terror has also terrified people and they are easier to manipulate. Fear is a powerful tool. I still am opptomistic and think things will get better.
Look at our export figures as of 11/15/2010.