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?