almostthere wrote:
Finally, stock picking is a lonely hobby b/c no one believes it possible anymore, and those who do understand financial theory think anyone who does it is simply ignorant. It takes a brave soul to admit to loving it. Thanks Jacob. Without your example, I'd still be scared to give it a try.
In research, it's commonly observed that it takes about 20-40 years for cutting edge understanding to appear in non-fiction books suitable for a mass audience. This is also about the time it takes for the same information to appear in technical courses for undergraduates. For something to become general public knowledge (not just those who've read the nerdy non-fiction books but those who've talked to the people who have) takes 50 years or more.
For example, when I was an undergrad in physics (in the mid-late 1990s), the last thing we were taught was the kind of physics that had been discovered in the 1950s and 60s. Learning more would have taken more time than was possible for a few years in undergraduate and thus such classes were only available to grad students. In any case, you can now read popular
non-fiction books about the
standard model although we're yet to arrive at the point where most people in public understand what a meson is in the same way they understand what an electron is.
Modern Portfolio Theory was invented in 1952. A Random Walk Down Wall Street appeared twenty years later in 1973. Bogle came out with the first index fund a couple of years later. Starting around 2005, over half a century later, index investing finally reached a mass audience and became hugely popular. In many ways, the timeline for financial research in terms of public understanding parallels the timeline for the public's understanding of particle physics.
Now, for some strange reason and unlike particle physics, some, indeed many people appear to believe that financial research and innovation came to a complete stop in 1952. Indeed, after 1952, some people believe very strongly, as we can see in this thread, that the "
Theory of Everything" regarding finance had been discovered and that nothing further could be learned This is curious because this behaviour is not observed in fields like physics, chemistry, or biology. Nobody thinks they know everything there is to know about physics because they read
A Brief Of History of Time or they took a course in astronomy when they went to college, but somehow some people think they know everything there is to know about investing because they read the combined works of Malkiel, Ferri, Swedroe, and Bernstein and/or once took a freshman course in finance.
Indeed, although I'm sure some people will find it hard to believe or accept, financial research and innovation did in fact NOT come to a complete halt in 1952. It kept progressing just like any other field. For example, when it comes to risk management, starting from discovering the principle of diversification in 1952, the cutting edge in the 1970s was time series analysis, then co-integration in the 1980s, principal component analysis in the 1990s, algorithms in the 2000s and AI/big data in the 2010s and onwards. These are not all the methods that have been discovered since diversification. They are just some of the more dominant ones. A lot of this stuff is published (and free!) on ssrn.com. You can go and read about it. Or you can pick up an advanced grad level text, like e.g.
Carol Alexander's series of books. I recommend them. The rabbit hole goes much deeper that simple diversification (aka "poor man's version of risk control") and it has done so for more than half a century by now! Ignorance is not really an excuse anymore.
Thus saying that "the market is unpredictable/random" (the 1952 understanding) is pretty much the biological equivalent of saying that "DNA doesn't exist" because Crick didn't discover DNA until 1957. Or that nothing important happened in medicine after the introduction of penicillin in the 1940s.
At best such statements lack nuance. At worst they are woefully and sometimes destructively ignorant.
Another weird belief when it comes to finance is that many people also strongly believe that amateurs are completely incapable of acquiring knowledge beyond popular non-fiction books or 101 college courses and thus they shouldn't ever bother to try. That's like saying that nobody is capable of learning how to program in any language more modern than BASIC (from 1964) at a professional level on their own insofar they don't have a graduate degree in software engineering.
I grant that not everybody can learn to program well enough on their own to make useful programs and also that it requires a certain talent to program well and that many people simply can't be taught no matter how hard you/they try. Consider how many programmers with a degree in computer science who can't program their way out of a wet paper bag! However, also consider the programmers who program exceedingly well despite lack of formal education. Apparently the ability to program takes a combination of talent and learning. Saying that a well-written program is simply a matter of "luck" is going waaaay to far.
In terms of numbers, about 10% of investors are able to consistently outperform the market (as judged by broker reviews of retail accounts, industry norms, etc.). This is the case at BOTH the retail level and the professional level. Indeed the numbers are similar at both levels. Why? Because mostly pros and retailers focus on completely different aspects of the investment game. While understanding transfers somewhat between the two levels, the actual skills rarely do. This means that in a lot of cases, retailers are actually NOT competing directly with professionals. A metaphor might be the difference between sailing on a small yacht (the retail investors) and being a crew member on a large
tall ship (the professional investor). They're both on the same water/ocean, but the skill set is quite different in the two cases. None of the skills I used and taught to the juniors when I worked in industry transfers back to my retail level investment strategy.
What we have online in terms of financial debate is the proverbial Mt Stupid, where the peak of Mt Stupid is dominated by what I would call a fairly un-nuanced and somewhat misinformed version of MPT and EMH combined with a strong belief that they know everything there is to know about finance. The plot curve is actually somewhat wrong when it comes to finance. The curve after the valley behind Mt Stupid actually stays under the peak of the mountain but goes much farther out to the right. In other words, most online debate (especially in the pf space) regarding investing is predominantly ignorant and quite so compared to the totality of what there is to know given how the peak is now 64 years behind the times.
What we have here is not a debate where both sides have good points or are about equally right. We are also not debating something that hasn't been settled yet. What we have are two sides where one side is simply wronger than the other side. To paraphrase Isaac Asimov: "If you believe that the Earth is flat, you're wrong. If you believe that the Earth is round, you are also wrong (the Earth is slightly compressed at the poles). However, if you believe both of these are equally wrong, you're wronger than wrong." Or to quote Big Bang Theory: "It’s a little wrong to say a tomato is a vegetable, it’s very wrong to say it’s a suspension bridge." ... on a similar note: It's a little wrong to say that the market is random, it's very wrong to say that it's impossible to beat it.
So what's the take-away here?
* Anyone who insists on MPT/EMH dogma hasn't kept up with financial research since the early 1950s. They are simply ignorant; indeed some of them are too ignorant to realize how ignorant they are (the Dunning-Kruger effect). Note, that these types mostly concentrate in the personal finance investment space. You don't find them as much on seeking alpha or wilmott forums.
* Since 1952 financial academics and practitioners have come up with newer and better ways to understand the market. "The intelligent layman" is capable of learning these insights just like he/she is capable of learning other things like programming, tax-planning, cooking, ...
* About 90% of investors fail to beat the market because it doesn't depend only on learning but also on talent. The odds are therefore against you but there's a big difference between "impossible odds" and "1:10 odds".
So with that in mind, I hope this makes for a somewhat more rational and deliberate decision as to whether financial understanding is worth pursuing for a given individual. Should one do it? Well, that question requires three more questions?
1) Are you interested in learning the skills? It's pretty hard to learn anything if one isn't interested in learning it. There's simply a lot to learn for starters and it's an ongoing process that requires some maintenance once learned. If the markets aren't exciting to you, there's no need to bother. Go invest in index funds.
2) Do you have the talents? That's a really hard question to answer. So far the question can only be answered in the negative. That's what I tried to do with the cigar post above. If there's a difference between the dogmatic voices on in the personal finance space on internet forums (unfortunately, including this one) and successful investors, it's that the latter habitually question themselves as to whether they really have the correct understanding, both in terms of fundamental theory but also wrt current market developments. All these guys have what could be called a "learning-mind", always happy to latch onto anything that might increase or question their understanding. Conversely, dogmatic types, who are the anti-thesis of the learning-mind and not only think they know everything but specifically that it's impossible to learn anything new, should not bother. Instead go invest in index funds.
3) Are you capable of coming up with novel ideas? A good indicator that you're not is if you tend to lean heavily on argument by authority and wanting references for everything. This is not going to work. Investing is forward looking, not backward looking, because unlike the rest of the business world, investing is one of the few areas where most of the advantage goes to the first mover instead of the one who comes in, copies the idea, and executes it better. In other words, if you had to be completely honest with yourself, do you have some aspect of yourself that sets you apart from most other people (maybe it's an ability to concentrate really well, maybe it's the ability to see patterns in complex situations, ... )? If not, you probably shouldn't bother either. Instead go invest in index funds.
Now, if you're still with us, it doesn't mean that you're definitely one of the 10% who consistently beats the market. However, it is more likely that you're not definitely part of the 90%. The rational way to proceed is then to start learning theory and practice. Start small and scale up according to demonstrated success. If you start failing, scale down again. This is the professional way to go about it. The biggest lesson to understand is the importance of matching your personal confidence to your personal understanding (i.e. a perfect Dunning-Kruger match if you will). Any mismatch between the two and the market will either take your money, gladly, or you will not make as much as you could have done. This is a very difficult lesson to learn.