The economic world is not like the natural world at all. The "laws" of economics aren’t really laws at all, not in the same way that the laws of physics are. The economic world is populated with human beings, whose behaviour is highly random and unpredictable, and therefore it is unreasonable to expect that any investor can systematically predict the future.
Investing is not a science
At a recent Q&A at the Wharton School of Business (his alma mater), value investor Howard Marks (Trades, Portfolio) responded to a question from a student asking him to systematise his investing process.
According to Marks, the most important thing for investors is to understand the nature of the game. He doesn’t believe there is a "secret formula" that you can rigidly follow in order to make money:
“I hesitate to describe what we do as even a process. We have a process, but it’s all conjecture. John Kenneth Galbraith said that “There’s nothing dependable to be learned about making money. If there were, the study would be intense, and everybody with a positive IQ would be rich”. Everybody wants to make money, and if there were a sure-fire, mechanical process for doing so, then it would become widespread in its use, and then of course it would stop working, because we make money by out-thinking others.”
Having a sense for what you know as well as what you don’t know is also important for investors. People who try to control everything in their lives and who cannot accept that some things are going to be chaotic and random are probably not going to be successful investors. I believe this is especially true of many highly intelligent scientists and engineers, who may want to think of the world of finance as having the same kind of mathematical relationships as the world of nature.
An especially illustrative example of this is Sir Isaac Newton, who, despite being one of the most brilliant minds of any generation, lost £20,000 (more than £4.1 million in today’s money) in the South Sea Bubble of 1720. This led him to reportedly remarking that he could “calculate the motions of the heavenly bodies, but not the madness of the people.” Interestingly, Newton initially sold his shares in the South Sea Company a few months before the crash when he felt that the market was getting out of hand, only to jump back into the stock at a much higher price later on - a classic demonstration that greed can overwhelm even those investors who have exercised discipline in the past.
In a similar vein, Marks contrasted investors with dentists. If you go to dental school and learn how to fill cavities, then you will be able to reliably repeat the same process with more or less the same result each time. Investors don’t have the luxury of simply sticking to a formulaic process - they need to embrace uncertainty and understand that every opportunity is unique.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Morgan Stanley Is Betting on a Swift Recovery
- Seth Klarman: What Is a Margin of Safety?
- The Value Investor's Handbook: Defining Your Investment Goals
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
