We have all heard the expression - “keep it simple”. However, how often do we put this concept into practice? At times it can be very overwhelming and complex when evaluating the markets or a potential investment. As a complex adaptive system, the markets have an almost infinite number of inputs. Interpreting all these inputs and trying to incorporate them into some cohesive game plan may lead us in the wrong direction. Market direction is determined from data points, emotions, and perspective. Although it done on a daily basis, I’m constantly amazed (and mystified) as to how an expert can analyze market trends past, present and future. So introducing a concept that proposes a basic approach may seem completely inappropriate when dealing such a complex problem. Yet it is the truly effective way to achieve better investment results.
Our process for analyzing potential investments should have a basic and simple approach. One that is realistic and repeatable in all market conditions. Now I’m not implying that the investing process is a simple one – the current market conditions remind us that this is far from the truth. The investment process may be one of life’s most challenging endeavors. It tests our capabilities because it goes beyond interpretation and into the fuzzy subjective world of emotions. Many, if not all, high level graduate business programs will lay out advanced academic theory and modeling as part of their curriculum. Yet they cannot effectively provide the most important part – how to deal with our own psychological shortfalls. In investment, we are battling the markets and ourselves. As a way to confront this issue, I am suggesting that our approach to analysis be consistent with some basic tenets. This provides us with a sense of discipline or a rudder if you will.
A very interesting study was performed a while back that tested our human decision making process and information feedback loop. A group of participants was divided into two groups. Each group was given the same exercises to complete with the understanding that they would be graded on results. The difference between the groups, however, was that the first group was given a simple set of instructions and straightforward feedback, while the second group was provided with complex procedures and feedback. As you might imagine the first group consistently outperformed the second. Furthermore, the first group continued to improve throughout the process while the second stagnated. These results seem interesting and informative on their own. But here’s the truly amazing part….before the participants received the results, group one participants (outperformance group) were given the option of changing their original answers using the complex set of procedures. Group one routinely chose the more complex system for reasoning – believing that system must be superior. And you guessed it…their results worsened to the levels of group two. This seems impossible to believe. They had an effective system producing strong results, yet chose to deviate only because their approach
This has obvious implications for us as investors. Our approach needs to be basic and adaptable. The more complicated process will eventually fall apart. In very difficult market conditions such as these, our basic tenets and rules will provide the foundation of a solid approach.
