Maths, losses, trust and ego
Posted by: Brian Dennehy
The markets change all the time but there is one big thing which doesn’t change, the people and their emotions. Once you accept this your investing success is assured.
The world is an extraordinarily complex place, made up of millions of people with complex emotions and motivations. If a single piece of information is revealed today in a newspaper you cannot in any useful way predict how millions of people will process the same piece of information.
One of the reasons why momentum investing works so well is because you are not trying to predict – this is what is built into our Dynamic Fund Ratings. You are simply moving the odds, the probabilities, strongly in your favour. As a matter of simple observation or calculation, a trend is in place and you are going to exploit it.
Very detailed testing of data over decades highlights firstly that this works, and secondly the period over which it works. This was not just our work, but the work and observations of many academics and practitioners stretching back to the 1930s.
It’s not sexy, it’s routine; you don’t need to be clever, but you do need to be disciplined.
Every day we are all challenged by change. Whether it is up close and personal in your office or your home, or in the media. Change is inevitable, the change can also cause uncertainty, and sometimes there is more uncertainty than at other times – how about now!
It is vital that these changes do not distract you from your investing process. Moreover, you have a deep acceptance of the fact that human behaviour does not change, and that what you see in the markets each day or year to year or decade to decade is nothing more or less than a huge multitude of humans behaving in particular ways. The predictable ways in which they behave in turn creates predictable trends, even though the motivations for that behaviour will vary hugely.
As momentum investors you do not predict, you just jump on board.
The markets are driven by investors with very different expectations, motivations and ambitions. This is why they act at different times and in different ways based on exactly the same piece of information. That is why large shifts in markets occur over many months and years, as the expectations of many investors gradually align – that’s why we get bull markets.
Ignore stories and seductive maths
Those of a literary nature will enjoy Tim Price’s guest blog today
on why we should ignore the media (and stories) and focus on the indisputable facts – the numbers. I would add we must focus on the numbers which matter.
Many people (and too many bright people) are seduced by elegant maths, or by those who proffer them.
“Too large a proportion of recent ‘mathematical ’economics are merely concoctions, as imprecise as the initial assumptions they rest on, which allow the author to lose sight of the complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols.”
A recent quote? No, that was Keynes in 1936.
In the context of investment funds, which is our focus, these “concoctions” have led many investors to adopt index trackers (or worse) and do themselves a huge injustice – you must avoid this trap.
Who do you trust?
One Gold member said to me in recent weeks, “who do I trust?”. For example, ratings from FundExpert or Morningstar, or some fund “buy list”?
It isn’t a matter of who you should trust. It is about what you trust. You trust the numbers.
You trust the numbers which you know work with a level of consistency that you cannot beat in any other way.
If you want to know whether you can trust someone’s fund recommendation or ratings, ask them for the numbers – the numbers which illustrate with a high degree of success that the process underlying what they are telling you has a track record of success.
Embrace losses, and lose the ego
With any successful system investing there will be losses. Anyone who tells you there is no risk, that there can be no losses, is lying. Just ask investors who gave the money to Bernie Madoff.
If you are someone who was used to being right at school, the problem when investing is that you need to get used to being wrong – which is how losses feel. This is difficult for many people who were once regarded as very bright, and who still might be regarded as being very bright, perhaps operating in a complex professional field.
But it means nothing when investing, in fact a superiority complex is one of the greatest handicaps to long-term success.
The markets don’t care about how many ‘A’ grades you got, or whether you went to a top university, and are now at the top of your profession. When you are investing you have to do something you probably have never done before - building in an assumption that you’re wrong.
There is a deep human desire to seek out certainty, and there are very good reasons why this should be so from a survival perspective. But when you are investing you are literally buying uncertainty, and if that thought is uncomfortable then self-directed investing is not for you.
Learn and be confident
It is vital you have a willingness to learn. If you are someone who gets angry when your investment value falls, and you hang onto it in the belief that one day it will turn around, you are unlikely to learn. If on the other hand you see losing money as an opportunity to learn, if you try not to personalise your decisions, you are undoubtedly a potential investing winner, if not already one.
As one gentleman said “if you think education is expensive, try ignorance”.
if you have a simple reliable truth, which is effective and efficient, that’s all you need. You need have no regard to the barrage of experts and pundits and economic studies, and you don’t need to make investing any more complicated than it needs to. If you apply momentum (such as Dynamic Fund Ratings or otherwise) across the range of funds as we do, you don’t need to worry about being an expert on China or European Smaller Companies, or whether Sterling will be good or bad for large UK businesses - you just need to identify the trend, identify the funds with momentum, and jump on board.
You have a choice
Of course you can pretend that the volume of research which highlights what works when investing doesn’t really exist. And you can kid yourself that you have some better way which hasn’t yet been discovered in the last 300 years of financial market history.
Or you can believe that someone out there (I often hear them referred to as “my usual source of advice”) has some special inside knowledge unknown to the rest of us.
Or you can trust the numbers. They don’t lie.
These are your choices.
Don’t try and be the smartest person in the room, nor the most well-informed. Because those people are never the most consistently successful longer term investors.
Where should you start?
Where should you start? By getting better organised, and focusing on how you can clean up what you have now.
If you have already done that, sit down and write a plan, one which will give you absolute clarity on how you will invest.
Do let us know how you get on. You are most welcome to raise specific points on the tidying up or the plan in the Monthly Teleconference, or share your thoughts in the Private Facebook Group – you are not alone.