For over a year, I’ve been kicking around a blog idea in my head that I just couldn’t figure out how to write. The premise – America has a math problem. That math problem became painfully clear to me during the early days of the COVID-19 pandemic. I cringed each time I heard a misguided quip about how dangerous the virus was (or wasn’t) depending on the commenter’s news source. I clutched my pearls whenever I saw a tweet criticizing the failure of models to accurately predict daily new cases, hospitalizations, or deaths.
There’s something profound about our inability to think in terms of percentages or to analyze large sets of data. Our flaws as long-term investors are directly related to this weakness.
I never figured out how to write that post.
I’ve listened to a few podcasts recently that have altered my premise on this subject. Now I am diagnosing the problem more broadly.
America has a science problem.
We don’t understand the basic concepts of scientific methodology, the importance of admitting the limitations of models and experiments, or how to interpret results. When these shortcomings are combined with our predisposed natural tendencies to seek patterns and cling to certainty over skepticism, the public health failures we witnessed last spring are less shocking. But this is not a post about public health during 100 year pandemics. I’m more interested in how it harms our ability to become successful investors.
Former Defense Secretary, Donald Rumsfeld, who died last week, is best remembered for a press briefing in 2002, in which he coined the phrase “unknown unknowns” – the things that we don’t know, we don’t know.
“There are known knowns. There are things we know we know. We also know there are known unknowns. That is to say, we know there are some things we do not know. But there are also unknown unknowns, the ones we don’t know we don’t know.”
He caught a lot of flack for that tongue twister, but he described the most important, yet most frustrating, concept in science. We have blindspots. They are the things that we do not know that we do not know.
Blindspots are dangerous for investors. They are risks that can come from left field and throw a wrench into an entire investment strategy. Mohamed El-Erian spent a lot of money at PIMCO researching how to overcome blindspots. The best solution he found was to add gender diversity to portfolio management teams. In extremely overgeneralized terms, men and women think differently. We can use that to our advantage.
A few months ago, I stopped my daily Twitter habit. After 10 years, I decided it was time for a change. In my time reclaimed each day, I began an earnest study of the game of chess. I honestly have no idea why chess hasn’t been a hobby my entire life. It is the ultimate ‘in your head’ experience that appeals to my introverted nature. I feel like I am making up for lost time.
At first, I thought I was catching on to chess quickly. But chess turned out to be the fastest peak of the Dunning Kruger curve I’ve ever experienced. For those unfamiliar, the Dunning Kruger effect is the tendency of the unskilled to overestimate their own ability, without ever knowing that they lack skill. Ignorance is bliss I suppose.
On the other side of the Dunning Kruger curve, the more skill one acquires, the more self-aware one becomes about how much more one does not know about a topic. I am firmly in the realization that I know absolutely nothing about chess, and I am thirsty to study it.
How does this all tie back to America’s science problem, and our predisposition to be bad long-term investors?
We love certainty. This is why the humble honesty of public health experts like Anthony Fauci drove us crazy last year. Why couldn’t he make up his mind?! Better to follow the leader who lies to us with confidence, right?
The need for certainty leads us to fall under the spells of charlatans calling for the next stock market crash on TV. If he’s on television, he must be an expert, so I should be worried, right? Likewise, uncertainty causes anxiety. We don’t want to be told the truth. The future is unknown. But that truth shall set us free.
I would argue that humility is the best trait an investor could have. True humility helps us avoid what I call ‘unforced errors’ like having too much conviction about any market prediction.
In the end, diversification is the only solution. No one loves to hear that. It means participating less in what’s working today for a chance to survive this next downturn. It means owning bonds even though the 10-year Treasury yields less than 1.50%. It means giving up the highest potential returns to narrow the expected outcomes 40 years from now. It’s so boring, you’re probably about to stop reading this post; the two of you who made it this far.
Imagine what the world was like 100 years ago. How many unknown unknowns have been discovered since then? We’ve gone to the moon, mapped the human genome, and connected the world with technology. How many unknown unknowns will be discovered in our lifetime, in our children’s lifetimes? I am humbled to ponder that thought, humbled and amazed with wonder.
