Best of all is knowing that you know or knowing that you don’t know; worst of all having the illusion of knowing.
– VJ Arjan, CEO of ConCap℠
After a successful career in the 1980s and 1990s as the head of Salomon Brother’s fixed-income arbitrage group, in 1993, John Meriwether founded his own hedge fund to profit in the financial derivatives market using similar arbitrage methods. On the board of directors of this hedge fund were economic luminaries, Myron Scholes and Robert Merton, who shared the Nobel Prize in Economics for their pioneering work on the valuation of derivative contracts. The promising endeavor, named Long-Term Capital Management, netted after fees, 21% the first year, 43% the second year, 41% the third year.1 For some comparison of how staggering those returns were, the S&P 500 has averaged 9.49% in annual returns since 1928.2 In 1997, following the Asian and Russian currency crises, LTCM suffered catastrophic losses of $4.6 billion in less than 4 months, more than 90% of its capital had been wiped out. The cause of this calamitous failure? – being caught on the wrong side of the market while utilizing astronomical amounts of financial leverage. As a lender of last resort, the Federal Reserve was required to intervene to prevent a total financial collapse. In an ironic twist of fate, Long-Term Capital Management was closed down in a mere 7 short years after it was established. It’s ambitious flight to the sun, led Icarus plunging to his doom.
One of the principle elements of The ConCap Way℠ is the knowledge that our financial situation is deeply rooted in our psychology, and that cultivating emotional intelligence along with some common sense can lead to a greater likelihood of success in one’s investing career and a higher likelihood of attaining financial freedom. There is seldom a greater cancer in one’s psychology that wrecks a person’s financial well-being than a lack of humility. History, particularly military history, is rife with such examples demonstrating this principle at work. More often than not, pride inevitably comes before the fall. Whether it is Napoleon’s defeat at Waterloo, Hannibal’s defeat at the battle of Zama, or Hitler fighting and ultimately losing a war on two-fronts, foolhardy and calamitous mistakes due to a person’s pride has cost, not only individuals but also entire nations, everything. Hubris has such devastating power that it stakes all in the hopes of predicting the future and ultimately loses everything in the end. As a philosopher once said, we can learn from our history rather than repeat the mistakes of the past.3
From a financial point of view, nor you nor I know where the market is going in the short-term. Even legendary investors, Warren Buffett and Charlie Munger, are loathe to predict where the market will go in the short-term. If that is so for such luminaries of the financial world, it is the height of folly for the rest of us to pretend that we know better. There is an overconfidence among market participants who employ short-term, high-leverage trading strategies, with the hopes that they can predict the future. A 2018 study done by the SEC seemed to confirm that an “overconfidence in financial knowledge is a key factor in driving low literacy investors to pursue higher-risk leveraged trading strategies.”4
Any person, whether a broker, a media figurehead, or your neighbor, who tells you they know where the market is headed in the short-term, is lying to you. And it is precisely this dangerous illusion of knowledge that leads many of us to lose over and over again in the financial markets. Studies have consistently shown that investor return is often considerably lower than investment return for precisely this reason.5An investor’s hubris in predicting the markets fundamentally affects their bottom line. With so much information pulling us in this direction and that, so many pundits who have called “this bottom” and “that top”, we are given the illusion of certainty, founded upon noisy information, upon which we can be expected to act with the pretense of confidence.
Humility, when it comes to the market, is the knowledge and acceptance that we can be wrong. If Icarus had the humility to consider the heat of the sun before his flight, he might have reconsidered using wax as an adhesive, or used another viable alternative like an air balloon, before plunging to ruination. If we do not admit that we can be wrong, then we can often take calamitous risks that we may not be able to recover from. Many people who trade the market are often prone to this defect. They look at the market like a casino and bet on this or that, all or nothing, on a golden ticket, usually a penny stock, futures, or option contract, with the foolish belief that they can successfully predict the future. Trading, therefore, is and for the considerable future will be, for the vast majority of people, a fool’s errand.
The good news is that the fundamentals of investing don’t change over time. The rules have been pretty much the same as they were 50 years ago, and they are likely to be the very similar 50 years from now. Economies may evolve, new technologies may emerge, but yesterday’s radio, is today’s cell phone, and may be tomorrow’s virtual reality headset. Yesterday’s Bill Russell is today’s Michael Jordan, and may be tomorrow’s Lebron James. The fundamentals of investing, as well as basketball, haven’t changed drastically since its inception. As Buffett would say, “invest in stocks as you would in a farm.”6
We have had panics and financial crises before and we will continue to have them in the future, despite the world’s central banks efforts to eliminate such gyrations. We all complain about volatility today, but consider that markets have experienced such volatility in the past as well. Investors in the 19th century went through the War of 1812, the Civil War, the emergence and the demise of the Greenback currency, at least 5 financial panics, 6 recessions, and 2 depressions.7
One thing that has changed in the last 50 years is the accessibility of the investing world to the public at-large. This can be attributed to the mutual fund and ETF industry, particularly the valuable contributions of the late, great, John C. Bogle, along with technological innovations that have given, with amazing ease, the ability of the lay person to participate in the financial markets. Unfortunately, this ability has also given access to an overabundance of information (or what may be termed misinformation) literally at our fingertips, most of which is completely irrelevant and has no bearing on the market whatsoever. To give some perspective, 2.5 million gigabytes of data are created every day and 90% of the entire amount of information on the Internet was created in the last two years alone.8
The lack of discernment of which information is material and which is immaterial, which is absolutely essential and necessary with regards to thorough and critical thinking, has led many investors to confuse information with knowledge. Once information has been mistaken for knowledge, then information can be computerized, and effects can be falsely calculated with unscientific precision. The logical consequence is a herd-like response to information. The temptation is always to do something; the information must have some effect.
Infinitely frightening is the rise of electronic bot trading, where artificial intelligence, completely devoid of human judgment, is trading the market based on information that it considers to be knowledge. An electronic trader, however, that calculates without human judgment, may inevitably fail with horrifying consequences, just like Knight Capital’s high-frequency computer trader that lost $440 million in 45 minutes.9
What is truly needed is a professional financial advisor who approaches the market with true humility, not a broker who is a part of the herd. We invite you, fellow ConCapper, to employ this strategy to approach the market by not participating in the noise, but to keep one’s outlook on the long-run. This requires the humility to accept that you don’t know where the market is going in the short-term, and by taking this approach you may bring financial well-being and peace of mind in the future.
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Sources:
1Slivinski, S. (n.d.). Too Interconnected to Fail? Retrieved May 7, 2019, from https://www.richmondfed.org/-/media/richmondfedorg/publications/research/econ_focus/2009/summer/pdf/economic_history.pdf
2Damodaran, A. (2019, January 9). Annual Returns on Stock, T.Bonds and T.Bills: 1928 – Current. Retrieved May 7, 2019, from http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
3Santayana, G. (1905). Reason for Common Sense (Vol. 1). p. 284
4Ko, K. J., & Rapkin, S. (2018, March). The Financial Illiteracy and Overconfidence of Margin Traders. Retrieved May 7, 2019, from https://www.sec.gov/files/dera_wp_fin_illiteracy_and_overconfidence_margin_traders.pdf
5Roberts, L. (2017, October 21). Americans are still terrible at investing, annual study once again shows. Retrieved May 7, 2019, from https://www.marketwatch.com/story/americans-are-still-terrible-at-investing-annual-study-once-again-shows-2017-10-19
6Crippen, A. (2014, February 24). Warren Buffett\’s three \’fundamentals of investing\’. Retrieved May 7, 2019, from https://www.cnbc.com/2014/02/24/warren-buffetts-three-fundamentals-of-investing.html
7Zarnowitz, V. (1996). Business cycles: Theory, history, indicators, and forecasting. Chicago, IL: University of Chicago Press.
8 Ko, K. J., & Rapkin, S. (2018, March). The Financial Illiteracy and Overconfidence of Margin Traders. Retrieved May 7, 2019, from https://www.sec.gov/files/dera_wp_fin_illiteracy_and_overconfidence_margin_traders.pdf
9Harford, T. (2012, August 11). High-frequency trading and the $440m mistake. Retrieved May 7, 2019, from https://www.bbc.com/news/magazine-19214294
