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.
- Up to 200,000 are poised to cash in their pensions next April
- Government rolls out consultation on the Bank of England's powers over the UK's housing market
- Pension scammer warning as 77% say they don't know the difference between pension income reforms and pension liberation
- Retail investment sales plunge 70% in September compared to 2013
- House prices dip in September in further sign that market may be cooling
- The ECB has missed the opportunity to end the European crisis
- E.ON launches cheapest energy deal on the market as 'big six' rise to the challenge of the smaller firms
- Average UK house prices climb to all time high but growth rate eases significantly
- Selling may not be the best policy when a star fund manager quits
- Official numbers suggest strong rise in pension take-up as auto-enrolment gains traction