Experience teaches many lessons.
As an investor, I’ve learned many lessons over the years. One of the more important lessons is to be leery of repetition.
If I hear a word, phrase, or a concept repeated often to explain a myriad of phenomena, I immediately question the worth of the commentary, as well as the validity of the commentator’s underlying thesis.
Repetition of the familiar is often a mental short cut. It allows the commentator to explain a cause-and-effect relationship, even though he might be unsure of the relationship (or he might simply be attempting to fill space).
Below are five commonly invoked buzz words or phrases investors would be better off ignoring. They simply fail to impart any insight, yet their use is ubiquitous.
1. Fear. This word is most often used upon the bursting of an asset-price bubble. Investors are fearful, so that’s why we are in a recession. Unfortunately, fear is wrongly used as a synonym for uncertainty.
An investor is more often uncertain, not fearful. And he is usually uncertain, and rightfully so, after the bursting of an asset-price bubble because he is unsure of government’s response to the bursting. And he is uncertain how other market participants will react to the government’s response. Therefore, it is uncertainty keeping him out of the market, not fear.
2. Greed. The word “greed” is often associated with fear. It was greed that led to an asset-price bubble.
But asset-price bubbles form not because of greed, but because of investors acting on outside incentives. The federal government’s push to increase home ownership is an obvious example. Investors acting on incentives, even if the incentives are misguided, doesn’t mean the investors are greedy.
Greed is also incorrectly used to denote ambition. The two are not the same. Ambition means working to get what you want. Greed is an attempt to get something for nothing. Most investors and analysts are ambitious, not greedy.
3. Probabilities and Statistics. An analyst who says “there is a 40% chance of the economy falling into recession” is proffering nonsense. Economies and investments are not a gamble like the roll of a fair die, where you know there is a 16.7% chance of hitting any number.
Economies and investments deal mostly in uncertainty, not risk. Uncertainty can’t be quantified, because uncertainty deals with unquantifiable human action. Risk – like the chance of a house burning down within a five-mile square radius – is quantifiable because it is not influenced by deliberate human action.
Ignore prognostications like “Apple has a 70% chance of hitting $700 within the next three months.” There is simply no way of knowing, unless the source of the prediction is revealed, such as “according to current options prices.”
4. Market Efficiency. Market efficiency should only refer to ease and cost of exchange between individuals. Instead, market efficiency is used to reflect fully and realistically all that is known about a company.
If markets are truly efficient, as some academics believe, then there would be no Warren Buffett. It is impossible to know the amount of information embedded in a stock price.
5. Markets Acting. Any reference to a market doing anything is wrong from the start. Markets can’t act; they can’t do anything. A market isn’t a place; it’s a process of exchange.
When a commentator says something like “the market sold off today,” he is talking about the activity of many individual investors and then ascribing that to “a market.” To refer to the market doing anything on its own is to talk of the market as if it were an acting entity, which it isn’t.
Markets reflect the actions of individuals; the markets themselves do nothing. The distinction is worth remembering, because there is rarely only one reason for why the market ended the day up or down. All individual investors don’t act on the same information.
I don’t mention these mental short cuts to point fingers. I’ve been guilty of invoking them myself on occasion. The key is to become aware of the habit, and not be fooled into thinking a cliché is an insight.
Experience teaches many lessons.