I Don’t Know and You Don’t Know Everything That We Already Know
Many people mistakenly believe that the name of the investment game is to be like Stuart Smalley: good enough, smart enough, and maybe well-liked enough to gain a profitable edge on other market players.
The problem with investing like you’re a contestant in a game show is that it isn’t expected to work. There are two main reasons for that: ¹ the market’s whole is smarter than its parts (i.e., you), and ² the costs to compete are typically insurmountable.
The Market Crowd Knows More Than You Do
To “beat” the market, you have to be better than others at correctly forecasting future prices. Not just now and then but consistently, again and again. Think about that. As described in this excellent, two-minute video “The Power of Markets,” our friends at Dimensional Fund Advisors describe the power of collective wisdom by referencing a classic study in which a group of people are asked to guess how many jelly beans are in a jar. Individual guesses vary widely, with only the rare and statistically random individual coming close to the correct number. But the average of all the guesses combined comes eerily close to the correct number.
This same jelly-bean incident was also cited in James Surowiecki’s classic bestseller, “The Wisdom of Crowds,” along with countless other similar illustrations. Surowiecki’s book is a good read, wherein, you’ll also learn that crowd wisdom can be a double-edged sword. The trick, or the “paradox of the wisdom of the crowds,” is that “the best group decisions come from lots of independent individual decisions.” That sounds a lot like the market, doesn’t it, where so many of us think we know so much, but apparently never so much as we all do combined.
Bottom line, you’re facing some tough odds indeed when you try to outguess the wisdom of a free-wheeling market. And that’s before we even address the second hurdle of overcoming the costs of investing. Lest we have too much fun in any one post, we plan to turn to that subject next. Stay tuned!
