How to Approach Investing in a Chaotic World: Two Important Ideas

I received a very good message on my WhatsApp today....

Here goes...

The last two years have reminded us that humans are very bad at predicting the future. In 24 months, we have seen a pandemic, financial recession, double-digit unemployment, 40-year high inflation, social unrest, oil fluctuating between -$20 and $140, multiple bitcoin all-time highs, the largest wealth inequality gap on record, war in Europe, the most severe sanctions ever levied against a single nation, negative yielding debt around the world, and trillions of dollars pumped into the global economy through quantitative easing.

It is an understatement to say that the events that have transpired since March 2020 have been chaotic and unpredictable. The rise of social media makes it seem like the world is unraveling, dystopia is inevitable, and there is nothing that any individual can do to slowdown the madness.

While there have been plenty of difficult times to navigate, humans still live in the safest, most prosperous time in human history. It is hard to balance the long-term trend of improvement for the human condition with the short-term recognition of chaos and uncertainty.

This truth reminds me of two important ideas that have solidified in my mind over the last few years. The first comes from Jim O'Shaughnessy, founder and Chief Investment Officer of O'Shaughnessy Asset Management, who was kind enough to record a podcast conversation with me in August of 2018. We discussed everything from bitcoin to stock indexes to traditional investing insights. I was surprised at how many times Jim said "I don't know" during our conversation. It wasn't once or twice, but over and over again.

The more experienced an investor gets, they tend to feign intellectually humility, but it is usually just a strategy to signal mastery of their craft. This wasn't what Jim was doing though. He has spent decades building software and data sets to overcome human bias and mental inaccuracies. Jim's firm, which has billions of dollars under management, is built on the idea of "I don't know." And as you would expect, he is right. None of us know what the future holds. Humans are really bad at predicting the future. We could all benefit from saying "I don't know" more often.

The second idea that I am reminded of this morning is the importance of probabilistic thinking. According to Farnam Street, "Probabilistic thinking is essentially trying to estimate, using some tools of math and logic, the likelihood of any specific outcome coming to pass." When humans are faced with uncertainty or chaos, it makes us feel comfortable and safe to have a high degree of confidence in a specific outcome. We feel in control. We get the psychological benefit of certainty. But, of course, this is an intellectual error that leads to bad decision-making.

The proper framework is to assign probabilities to a variety of potential outcomes across a spectrum of results. This more nuanced process of evaluating a situation allows for more rigor, more accuracy, and a faster iteration speed to change your mind when you receive new information.

Take the current Russia-Ukraine conflict. Will Vladimir Putin pursue the usage of nuclear weapons? Will Ukraine successfully defend their country from the invasion? Will gasoline prices in the United States reach $6 per gallon in the next 6 months? The answers to these questions, and hundreds more, are unknown. Rather than seeking binary yes/no answers, you are better off arriving at probabilistic outcomes.

So why is it important to say "I don't know" more, while also thinking probabilistically?

Humans are horrible at predicting the future. This is a lesson as old as time. Regardless of the period in history and the specific events that are being analyzed, humans have a hard time analyzing the complexity of a situation and correctly identifying what happens next. We shouldn't fight this truth.

It is important to understand it and act accordingly. When it comes to investment portfolios, it pays to park your wealth in great assets that you can hold for very long periods of time. Trying to trade in and out of financial assets, even in just the last two years with all the various developments, proves to be nearly impossible. The economy is a complex machine with many inputs and intricacies. Individual assets are influenced by macro and micro factors, which makes predicting future moves difficult to say the least.

We don't know the future. No one does. If you want to live a less stressful life, accept this truth and position yourself to win over long periods of time, regardless of what is thrown our way. Your quality of life will be better, your decision-making will be better, and your portfolio is likely to perform better.

So there you go...

A ready reckoner to have a great start to your day.

The above message was exactly the point which Benjamin Graham made. I even wrote about this in yesterday's editorial.

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I already shared this insightful post on my Telegram channel early morning today.

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