The Limits of Math in Investing: What the Numbers Can't Tell You.
The real trouble with this world of ours is not that it is an unreasonable world, nor even that it is a reasonable one. The commonest kind of trouble is that it is nearly reasonable, but not quite. Life is not an illogicality; yet it is a trap for logicians. It looks just a little more mathematical and regular than it is; its exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait.
G.K. Chesterton
The challenge of investing is so enticing because it seems solvable, and yet for most of us it stays just out of reach. The charts and the data tease us with what seem like patterns, but then the patterns disappear like a mirage when we go to invest based on them. Many have tried to build strategies based on correlations, but the correlations are constantly changing too. A popular expression is that in a crisis correlations go to one, meaning most assets generally fall together. Purely quantitative strategies miss that companies and markets are made up of people, and that people are capable of doing amazing but also crazy things. People exhibit herd behavior in both ecstatic times and in times of distress. The math can’t always predict biology and psychology.
Another challenge is that unprecedented and unexpected events happen regularly in markets. The Dow dropped over 20% in one day in 1987. Bonds had their worst year ever in 2022. Interest rates went below zero in some countries. Strategies built by incredible intellects, like those at Long Term Capital Management which included two Nobel prize winners, have failed in the face of statistically impossible events that nonetheless happened.
Given all this uncertainty, I find that keeping things simple helps. The engine of compounding, the growth in earnings of companies, has historically driven the market up over time. Stocks are not vehicles for gambling, they represent fractional ownership of real companies. Those companies generally strive to grow value or return cash to their shareholders over time. Cash may be vulnerable to inflation, but it is liquid and stable when you need it. Cash can provide dry powder to buy when a good opportunity presents itself, or it provides a buffer for living expenses through market volatility. Liquidity often has a value of its own. Be wary when offered “more return with less risk”, sometimes the risks simply haven’t revealed themselves yet. Having a plan, and not just an illustration, is crucial, so you are prepared when the unexpected happens.
If you’re wondering how to handle uncertainty in your own portfolio and retirement plan, let’s talk! Send me a message through the contact page and let’s talk about what’s possible.
This content is for educational purposes only and does not constitute personalized investment advice. Past performance is not indicative of future results.