20/20 Money

See the Markets Clearly and Invest Better Than the Pros

Michael Hanson

• Publisher: Wiley
• Year: 2009
• ISBN:
  9780470493724
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

20/20 Money: See the Markets Clearly and Invest Better Than the Pros

To be a more successful investor, you need to see the investment landscape more clearly. 20/20 Money —from Fisher Investments Press—can help you achieve this goal.

Designed to help you think differently about your investing choices, this reliable resource addresses new ideas and challenges widely held conventions. With 20/20 Money as your guide, you'll quickly learn how gaining a firm understanding of various concepts—from stock market and systems theory to neuroscience and psychology—can help you begin making better investment decisions. Along the way, you'll also discover some of the most successful strategies for thinking and learning, and how they can be applied to your investing endeavors.

To become a better investor, you have to have the discipline to make tough choices—choices that may not always be in line with tradition or commonly accepted invested wisdom. But the approach outlined throughout these pages can help you gain the vision to begin making better-informed investment decisions.

1

INVESTING IS A SCIENCE

Seek simplicity, and distrust it.

—Alfred North Whitehead

. . . but somebody said, “I don’t believe it,” and we had an interesting conversation because I said, “You don’t have the option not to believe. Believing is not optional. If you accept that this is replicated science, then belief is obligatory.”

—Daniel Kahneman¹

If we want to see investing clearly, one of the first things we must do is view its foundations—the ideas investing is supposedly built upon. This first chapter is going to be a doozy. In it, we’re going to take a careful look at science and mathematics—two subjects that serve as the foundations of modern knowledge, especially for investing—and debunk them. Well, not fully debunk, really. More like cast serious doubts on them both as panaceas for investing knowledge.

Math and science are, at their core, philosophies. They are ways of seeing the world; they are not some rules about the world we’ve discovered. I realize that will sound blasphemous to many. But as we uncover the inherent limitations—and benefits—of math and science, much will be uncovered about how exactly stock markets and investing work.

APOLLO’S ARROW SHOT CROOKED

In the Greek Pantheon, Apollo was the god of reason. He represents light and the sun, truth and prophecy. He carries a bow and arrow—a master archer—and shot straight and true. He is an oracular god—the bringer of truths and clear vision.

And Apollo lives today! His spirit pervades the western world, dominating our way of thought through math and science—our religions of the twentieth and twenty-first centuries. Science and math are great things. But we put far too much faith in them. Like all methods, philosophies, and theories, there are flaws. Math isn’t perfect; science can skew us. The limitations of both are prevalent in investing.

I call science and math “religions” because they tend to conjure a kind of faith in us. We “believe” they give us truths about the world as if they are an eternal set of rules we’ve discovered. Today’s hyper-rational faith has led many to believe in a deterministic, predictable, clock-like universe that always moves in a straight line according to set rules. We only need to discover them. As a culture, we tend to bow at the altar of science the same as Greeks bowed to the Oracle at Delphi or prayed to Apollo thousands of years ago.

Math and science are great things, but they’re not worth our undying faith. That’s the Apollonian impulse. Instead, it may be better to think of them as excellent methods of describing what happens in the world.

Math and science are great things, but they’re not worth our undying faith.

Most investment knowledge is predicated on math and science. This chapter won’t dismiss either, but it will provide a different perspective to help us see both in a way that helps us invest better. They are not religions, but useful ways of seeing the world sometimes by breaking down or contradicting reality. Good science holds skepticism as its highest value—that is what we wish to cultivate. Even to be skeptical about science itself! Often enough, mathematical theories contradict or compute results that simply do not translate into reality. As neuroscientist Jonah Lehrer said, “No truth is perfect, that doesn’t mean all truths are equally imperfect.” The findings of science are the best we have at objective knowing, but that doesn’t mean they are a panacea.

Sometimes, Apollo’s arrow of knowledge is shot crooked.

DIONYSUS—MORE THAN JUST A GOOD VINTNER

Somewhat in opposition to Apollo, there was always Dionysus. He is the god of wine, the inspirer of ritual madness and ecstasy, the messiness of life and its sometimes chaotic nature. Dionysus represents that which we cannot compute or rationalize but nevertheless is. He is the “liberator” from pure reason.

Dionysus was a popular Greek deity, but in today’s world he’s pushed to the fringe—the god of wine and frivolity, fun and spirits. (Many know him best by his Roman name, Bacchus, the root of “bacchanalia.”) We dare not let him into the fray of our work or allow him to dwell in the investment world—he might disrupt this rational and ordered territory we believe in so deeply!

If we cut the brain down the center into two hemispheres (right and left), we’d find that differing sides serve different functions—reason on one side and creativity on another. (This is, of course, a gross generalization and both hemispheres hold parts of each, but nonetheless is generally true.)

The left brain is traditionally logical, sequential, rational, analytical, objective, and tends to break things apart to look at the constituents instead of the whole. The right brain is more intuitive and holistic (it sees things as a whole instead of parts, synthesizing and subjective). The right brain is where we think abstractly, where the imagination resides. The right’s flighty creativity can be disruptive to the left’s desire for rationality. Today, most believe Dionysus—the messiness of creativity—is a figure to be overcome, not embraced. But this is wrong—both the creative and the logical are valid and important modes of thought for investing.

We tend to favor one side over another, but most everyone has the capacity to utilize both. Thinking with both sides of the brain can readily create paradoxes—we can see things as a whole, or just the parts; we can see something rationally, or colored with imagination. We can see things from many perspectives. So the brain itself is capable of these different ways of thinking and can create its own paradoxes.

The distinction between the right and left brains is something like the problems between Apollo and Dionysus. Taking in as many viewpoints as possible and assimilating them all is the way to better thinking and investing—it is the heart of true inquiry. Throughout this book, we will attempt to shift perspectives and see things in ways many fail to.

We ultimately cannot reason very well without Dionysus. Abstract thinking, imagination, and creativity are not paltry things—they are essential for good investing. We cannot, nor would we wish to, be computers. There is no advancing of thought or discovery of new things without the imaginative component and the ability to change perspective. No inspiration for new investing paradigms ever came without a dose of imagination.

No inspiration for new investing paradigms ever came without a dose of imagination.

Investors tend to have a near dogmatic belief that purely left-brain thinking is the optimal way to approach investments—check the data, run the analysis, and so on. This is true enough insofar as it goes. Market analysts are usually hyper-developed in the logical modes of linear thinking. But it’s very much worth noting those usually thrown into the “genius” category were highly developed creative thinkers too. And we’re not talking about artists—it’s true for the sciences as well.

My favorite examples are physicists: Carl Sagan, Richard Feynman, Albert Einstein. In particular, I have read Richard Feynman’s autobiography, Surely You’re Joking, Mr. Feynman!, many times—whenever I need to remember the importance of developing many types of intelligence to be good at what I do. Mr. Feynman, along with being a Nobel-winning physicist, also was a painter and noted player of the bongo drums. Carl Sagan was well known for the almost child-like wonder and glee he got from contemplating the possibilities and mysteries of the cosmos.

In any case, what separated the great physicists from the pack wasn’t the mathematics they knew (they all at least had a few peers in that), but their creativity. Each had an uncanny ability to imagine and associate their knowledge, to put ideas together in ways no one had before and create new insight. Einstein himself often regarded his imagination as tantamount or superior to his rote math skills. (Of the many biographies of Einstein out there, I prefer to read the quirky but fascinating writings from the man himself: The World As I See It and Ideas and Opinions are two good options.)

Einstein was a terrible investor, but his method of thinking holds true for investing. A dirty little secret about great investors is that they’re all tremendously creative thinkers. It rarely looks that way to the public because most put on airs of being rigid, starched, disciplined, linear thinkers. After all, most folks want nothing but the most “computer-like” minds to manage their money! But the fact is, the only way to get an insight—to know something others don’t know—is to have huge and deep creative thinking about the world that must—by definition—defy convention.

The fruits of creativity (new ideas) come less often from some sudden insight (as we tend to romanticize it), but rather from many small insights building upon one another after many thousands of hours of labor and thinking.

USE THE METHOD, NOT THE DOGMA

That said, if the behavioral sciences have taught us anything, it’s that our natural brain wiring can cause biases and distorted views of the world. This is sometimes referred to as the issue of grounding, which means if we know our senses can deceive us, how do we know where deception ends and truth begins? How can we “ground” ourselves to a clear perspective? Do our brains deceive us about everything? Or just a few things? If we could just get some foothold on reality, perhaps we could be grounded enough to be both rational and objective in their due course.

Here is where science comes in. The best answer we have to the problem of grounding is science. Science can provide us that “foundation” of knowledge, revealing to us through experiment and objective results, verified over and again, how something works in the world. It’s the method of science that we are after to become better investors, not its dogmatic claims to truth.

I THINK, THEREFORE I INVEST

Most have heard of Descartes and his famous proclamation “I think therefore I am.” Philosophers call this turn of phrase the cogito. Either way, it’s an important statement for how scientific thought is done. Particularly for investing methodology, the cogito is the foundational statement of objective thought.

Objectivity is the opposite of subjectivity. Subjectivity is the idea you can only see things from your point of view, with your own personal biases and ego. We are stuck inside ourselves—there’s no other way to see things except through our own eyes. That’s a problem because we know biases and emotions can sabotage our thinking and lead us to act wrongly. Neuroscientists have known for years we can’t think without emotion—all thinking has emotion wrapped up in it in some way. This means we cannot surmount subjectivity since we cannot escape our brains. So how can we go outside ourselves and surmount our inherent subjectivity?

Descartes was among the first to make a formal statement attempting to separate oneself from the world and acknowledge the world inside our heads and the world outside our heads is different. This is objectivity.

Why is objectivity important for investing? It forces us to acknowledge a framework outside our biased and subjective selves—the point of the scientific method. Science helps us systemically and objectively (as possible) attack problems.

I know of no investing success story—ever—that achieved riches by trusting intuition and emotion over the long run. But I do know the world is chock full of many who got poorer that way. Your brain needs a system or framework that disallows personal biases and intuitions to interfere. We should strive to be as objective as we can be about how we observe the world. The framework you set for yourself will influence all your conclusions. Academics sometimes call it heuristics (more on this in Chapter 8). I just call it clarity.

THE SCIENTIFIC METHOD

Descartes may have brought us a long way in articulating objectivity, but just what is it exactly in the real world? Is it following the right procedures? Is it an attribute of the person—like emotional detachment? Luckily, Francis Bacon had an answer.

Bacon wrote the Novum Organum (Latin for “New Instrument”) in 1620. Many considered Bacon a philosopher, but he didn’t propose a new philosophy—rather, a new method of thinking and gaining knowledge. He deemphasized human intuition and feelings, asserting that one should proceed through inductive reasoning from facts. He wrote, “The cause and root of nearly all evils in the sciences is this—that while we falsely admire and extol the powers of the human mind we neglect to seek for its true helps.”

Bacon declared that the thinker must free the mind from certain false notions or tendencies that distort the truth. Bacon called these “idols.” He named four types of idols, or biases, a person can have:

• Idols of the Tribe: These are biases all people have—natural, inborn instincts. For example, fear is an emotion, arising in everyone in the presence of danger.

• Idols of the Den: These are beliefs a person comes to believe on their own through subjective experience. People often mistake their personal experiences for the larger whole.

• Idols of the Marketplace: These are biases that stem from the misuse and misunderstanding of language and other forms of communication. (Think about it, we misunderstand each other through e-mail and speech daily!)

• Idols of the Theatre: These result from an abuse of authority where people are led to believe dictums of the state by virtue of author...

Table of contents

• FISHER INVESTMENTS PRESS
• Books by Ken Fisher
• Title Page
• Copyright Page
• Dedication
• Acknowledgements
• Introduction
• Chapter 1 - INVESTING IS A SCIENCE
• Chapter 2 - INVESTING IS A DISCIPLINE
• Chapter 3 - HUMAN BEHAVIOR
• Chapter 4 - SENTIMENT AND THE MEDIA
• Chapter 5 - HOW STOCK MARKETS REALLY WORK
• Chapter 6 - FORECASTING, PART 1—THE PRINCIPLE OF PROBABILITY
• Chapter 7 - FORECASTING, PART 2—RECOGNIZING PATTERNS
• Chapter 8 - PRACTICAL PORTFOLIO MANAGEMENT
• Chapter 9 - THE NATURE OF RISK AND NAVIGATING MARKETS IN TROUBLED TIMES
• PARTING THOUGHTS
• NOTES
• SELECTED BIBLIOGRAPHY AND FURTHER READING
• ABOUT THE AUTHOR
• INDEX