Why investors should avoid oversimplifications
- 17 January 2012
We like to think that all problems have solutions. The reasons may be complex and difficult to grasp, but our faith is that if we understand the causes, we can cure the effects.
And the simpler answers are better. The appearances of things are often confusing, yet if we dig deeply enough we will get to the core of truth that will give us more control over events. But that belief is getting harder and harder to sustain.
Investors, for example, used to try to focus on "the fundamentals" of a stock to determine if it would grow in value. Was the company well capitalized? well managed? strategically positioned in the market? Brokerage firms used to employ analysts to study such factors in order to advise their customers. But, then, economists looked at the data more closely and discovered that no analyst actually out performed the market systematically. The best an investor could do was to diversify, assemble a large basket of securities that covered the range of possibilities. That discovery led to the birth of index funds. They don't solve the problem for investors, but they make it easier to live with it.
Recently Jonas Lehrer wrote in Wired about how science too is failing us. He focused on the pharmaceutical industry's efforts to produce drugs that target specific ills, and he gave the example of an extremely promising drug to treat cholesterol developed by Pfizer. In the final phase of clinical trials it turned out that the drug did not work. Indeed, in many cases, it harmed patients. (See, "Trials and Errors: Why Science Is Failing Us.")
More from Mindful Money:
Sign up for our free email newsletter here, for your chance to win an Amazon Kindle 3G Wifi.
- More signs of Currency Wars emerge and some songs for #Indyref day in Scotland
- What to do about the problem that is Japan and its economy?
- Storm warning – Investors must not believe the current benign times will persist indefinitely
- The thing we definitely know about the Scottish vote - sterling will react one way or another
- English subsidy of Scottish tax breaks must stop, says taxpayers group
- Scottish income tax changes could make it a haven for pensioners
- UK retail sales edge up in August - helped by a dash for vacuum cleaners
- Latest mortgage lending estimates point to best August since 2008
- Federal Reserve asserts rates will not rise until a "considerable time" has passed after the end of QE
- Is volatility imminent? Investors must not believe the benign backdrop will persist indefinitely...