One reason we can't have nice investment strategies--a thread (Jim O)

The brightest people I have met share a superpower that would serve investors well—the ability to make inherently complex things simple and understandable. And yet, most humans naturally equate complexity with brilliance. We also prefer the complex and artificial to the simple and unadorned. We are certain that investment success requires an incredibly complex ability to judge a host of variables correctly and then act upon that knowledge.

Prof. Alex Bavelas designed a fascinating experiment in which two subjects, Smith and Jones, face individual projection screens. They cannot see or communicate with each other. They’re told that the purpose of the experiment is to learn to recognize the difference between healthy and sick cells. They must learn to distinguish between the two using trial and error. In front of each are two buttons marked Healthy and Sick, along with two signal lights marked Right and Wrong. Every time the slide is projected, they guess if it’s healthy or sick by pressing the button so marked. After they guess, their signal light will flash Right or Wrong, informing them if they have guessed correctly. Here’s the hitch—only Smith gets true feedback. If he’s correct, his light flashes Right, if he’s wrong, it flashes Wrong.

Because he’s getting true feedback, Smith soon starts getting around 80% correct, because it’s a matter of simple discrimination. Jones’s situation is entirely different. He doesn’t get true feedback based on guesses. Rather, the feedback he gets is based on Smith’s guesses! It doesn’t matter if he’s right or wrong about a particular slide; he’s told he’s right if Smith guessed right or wrong if Smith guessed wrong. Of course, Jones doesn’t know this. He’s been told that a true order exists that he can discover from the feedback.

He entered searching for order when there is no way to find it. The moderator then asks Smith and Jones to discuss the rules they use for judging healthy and sick cells. Smith, who got true feedback, offers rules are simple, concrete, and to the point. Jones on the other hand, uses rules that are, out of necessity, subtle, complex, and highly adorned. After all, he had to base his opinions on contradictory guesses and hunches.

The amazing thing is that Smith doesn’t think Jones’s explanations are absurd, crazy, or unnecessarily complicated. He’s impressed by the “brilliance” of Jones’s method and feels inferior and vulnerable because of the pedestrian simplicity of his own rules. The more complicated and ornate Jones’s explanations, the more likely they are to convince Smith.

Before the next test with new slides, the two are asked to guess who will do better than in the first time around. All Joneses and most Smiths say that Jones will. In fact, Jones shows no improvement at all. Smith, on the other hand, does significantly worse than he did the first time around, because he’s now making guesses based on some of the complicated rules he learned from Jones.

Think of all the times you've listened to the talking heads on #FinTV or read predictions and forecasts in the financial press and on blogs. Who sounds smarter, the person using $10 words and fancy jargon or the simple Sam who cites a few easy to understand and implement "common sense" ideas? Whose ideas are clear, concise and understandable? Sam's. Who are we likely to believe is a brilliant market thinker? Mr. or Ms. Complexity. When you hear or read someone weaving their ideas into a beautiful mosaic of words, try to remember, they are almost certainly wrong. And they might even be honest-minded--they are so good at it that first they baffle themselves with bullshit, and then move on to try and convince everyone else. Also remember, the more certain they sound, the less certain you should be.

Successful investing is simple, but, boy oh boy, it ain't easy.

Notes on three current megatrends — ageing, inequality, and access to information. “The world is driven by tail events. A minority of things drive the majority of outcomes. It’s one of the most important concepts in investing, where a few positions may account for most of your lifetime returns. Demographics, inequality, and information access will have a huge impact on the coming decades. How those Big Things end is a story yet to be told. But when it’s told we’ll have a better idea of where it began”

"QE turned your savings account into your checking account, the bond market into your savings account, the equity market into the bond market, the VC market into the equity market, and crypto into the VC market." - @joemccann

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