Listening to ‘wise’ heads can be dangerous

December 10th, 2008

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Very often, you may hear the more experienced investors saying things like this

I’ve been investing for the past x number of years. In my experience,

  1. … it is such a time of maximum fear and panic that an investor makes a killing.
  2. OR

  3. … markets eventually recover soon.
  4. OR

  5. … investments in stocks/property/whatever has never disappoint in the long term.
  6. OR

  7. … blah blah blah

Therefore, accept what I just told you because I have more experience then you.

Today, we will not be arguing over the correctness of the points (1) to (4) that follow the phrase “In my experience.” These points in themselves may or may not be true. But this phrase (that precedes the points) is a very dangerous one. Why? This is because it has the potential to cause you to fall into a mental pitfall. It is often invoked to stop the less experienced investors from thinking and to bulldoze their arguments.

Other variations of this phrase may include:

  1. According to research, over the past x number of years,
  2. Warren Buffett has been investing successfully for the past 4 decades,

What is wrong with this phrase? It is a form of mental pitfall called Lazy Induction. As we wrote in Mental pitfall: Lazy Induction,

The trouble starts when the sample that we used for our observations is drawn from our own personal bias. Then, from the observations of the biased sample, we make generalisations based on our flawed observations.

For example, if you invest in the Australian stock market over the last 20 years, you will do very well despite the recession of the early 1990s. Some ‘wise’ heads will use this experience as a basis to extrapolate into stock investments in general. Will the next 20 years yield the same result? We wouldn’t go into that for this article.

But consider this: what if you invest in the Japanese stock market over the last 20 years? Well, in that case, your investment performance will be a disaster.

The point is, no matter how experienced a ‘wise’ head is, his experience is still confined to either (1) a specific market or (2) a slice of time in history. That is, all the experience that a ‘wise’ head has is still limited in the bigger scheme of things. Therefore, to stop thinking and extrapolate blindly from this limited perspective into the general is a dangerous trap to base one’s investment decisions on.

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