Don’t confuse me with the facts

I have a good friend at work that I often debate investment strategies when we meet. Over the years I’ve found a large number of engineers hold an assumption that scientific analysis can provide an “edge” in investing. Now don’t ask him what he needs to analyze, as I often do, but he holds onto this assumption in the face of very stark quantitative evidence. You can easily find data that compares the performance of active mutual funds to a benchmark index such as the S&P 500. For 2008, over 70% of all active mutual funds trailed the performance of the S&P 500 over the previous 5 year period. So, if a mutual fund manager that focuses on investor return every day of his life and a majority of the time underperforms, why does my good friend still hold on to the assumption that scientific analysis provides an edge in investing?

This story, and others like it, have given me a lot of food for thought about the underlying thinking of people and myself in particular. There is a stated assumption of microeconomics: individuals are rational. In other words a person will make the best decision weighing the benefit to themselves. But as my good friend demonstrates, people don’t always think or act rationally even in the presence of evidence. Why is that?

Another example is the buying behavior in the grocery store versus a car lot. I had a professor that used to own a grocery distribution business in Tennessee. To demonstrate this contrast he would describe how a typical consumer would go through the aisles and make decisions about what to eat based on only a few pennies difference in a can of green beans, price is king. However, take that same person and put them on a car lot and now decisions in the hundreds of dollars are no big deal because the style of the car is appealing. Yet, the choice of green beans bears a risk of health consequence but isn’t a factor in the buyers mind going down the grocery store aisle. I repeat this same pattern in decisions and choices all the time. I don’t always think or act rationally.

The same “rational person” problem exists in all sorts of subjects that have high emotion involved such as politics or religion. I don’t have to turn into Spock and purge myself of all emotion in the face of my moments of irrationality. Basic wisdom and truth are my best resources that will serve me in all situations regardless of subject, time, or place:

  • Learn how the world works – don’t be naive about people, places, and things
  • Learn discretion – how to assess the situation and make the best choice
  • Obtain prudence – foresight of what happens in light of my choices and decisions
  • Get good counsel – many points of view provide sound understanding
But Solomon beat me to this a few thousand years ago and said it far more efficiently when he said in Proverbs 1:
4 To give prudence to the naive,
To the youth knowledge and discretion,
5 A wise man will hear and increase in learning,
And a man of understanding will acquire wise counsel,
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About Steve Ledford
Christian, husband, father, businessman, engineer, and all around regular guy. I have travelled some uncommon paths in life. Over the course of time I have found that truth is always simple, without exception. My life's purpose is to find it, live it, and speak it.

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