What seems like a hundred years ago as I was applying for college I had no real idea what I wanted to be when I grew up. My Greatest Generation/Product-of-the-Depression/Corporate Treasurer- father’s influence made my default “engineering” and I was better at math and science than other subjects so that sounded about right. Four years later I graduated with a B.A. in Economics.
Economics was so much easier than engineering. In math, physics, chemistry you had to get correct answers. Get one sign wrong in an algebra or calculus problem and you were screwed. There were no points for effort or using the right approach if you ended up with the wrong answer or the machine you were designing/building didn’t work (think Hubble Telescope)!
In Economics, you didn’t need to get the right answer. All you needed to do was understand the theories underlying the various models economists constantly tinker with and regurgitate them. It was all entirely theoretical and so long as you had a reasonable explanation for your argument, and it didn’t contradict what the professor had been preaching throughout the semester, you did well.
Some economic concepts like the ‘Laws’ of Supply and Demand seem to explain individual, institutional, government and market behavior, but not always! For virtually the whole of economics hinges on two specific assumptions: the Rational Man Hypothesis and the Absence of the Outside Shock. As my boss at a multinational oil company drilled into me, “Assuming something just makes an ass out of u m e.” He was right.
Because there is no such thing as a Rational Man. Mr. Spock, after all, was half Vulcan, so he doesn’t qualify. The truth is, people don’t make wholly rational decisions. Psychology (another imprecise subject far from engineering) obviously plays a huge roll in decision-making.
Similarly, there are frequently wholly unpredictable outside shocks that screw up the ability of economic models to forecast the future. Outside shocks range from tiny to massive. An unexpected labor report figure on one hand, can have outsized impact. A 9-11 on the other hand, messes up everything!
Another thing that makes me question the wisdom of economists. The numbers on which the models and theory are built, the numbers that are supposed to support them, are in a word, crap! Wrapping data in fancy PowerPoint presentations or published reports along with charts and graphs and analysis doesn’t mean the data is any good.
I once had the job of collecting health care expenditure data and decided to go right to the source, what was then called HCFA or the Health Care Finance Administration. Interviewing one of their reported top statistical gatherer/analysts on the subject of the percent of Gross National Product being spent on healthcare, I took a detour to ask how they came up with the numbers.
“Do you interview all the hospitals, doctors’ offices, testing laboratories, clinics, etc. to obtain primary source data?”, I asked.
“Oh yes,” the analyst proudly replied, “We use rigorous sampling methods.”
“And how do you know the data the health care providers are giving you is accurate?” I queried.
“We have to rely on what they submit to us,” he explained without an ounce of skepticism.
“And you just take a sample, not a universal survey?” I pressed.
“Yes.” And he went on for five minutes talking about sampling methodologies. And then I asked,
“When did you last take a sample?”
“At the last census,” he said. (At that point it had been six years.)
“So how then do you know if your data for last year is accurate?”
“We apply inflation and other adjustments to the prior year’s data,” he explained.
In short, unverified source data from health care providers obtained not from all health care providers but from a “sampling” of health care providers six years earlier, adjusted each year by “factors” that came out of the head of one analyst or worse, a committee of analysts, resulted in a proclamation, say, “Health Care Expenditures last year represented 10.5% of Gross National Product” that was used in numerous scholarly journals, the Congressional Record, used over and over to justify arguments that expenditures were either too high or too low by self-serving politicians, and also used by investment analysts to justify portfolio and trading decisions.
Yes, it’s a bad as that. Oh, and by the way, there were six other authoritative studies/surveys done by reputable and lauded experts and their institutions that came up with numbers anywhere from 9.875% to 12%! Does that inspire confidence in the wisdom of economists and experts? If you still have doubt, look up the history of Long Term Capital Management. It was staffed with the smartest guys in the world, and crashed, losing BILLIONS!
Investing and Investment Management are activities that benefit mightily from appearances and the chaos.
If there’s one ‘rule’ that, in our opinion, has universal merit at all times and in all situations, it is the one made famous in the 1976 movie All the President’s Men: “Follow the Money.” It doesn’t just apply to corrupt politics. It applies to human behavior generally, and investment management in particular.
I’m not suggesting that altruism doesn’t exist, it does; just look to your church and your community for examples which thankfully, abound. Altruism just doesn’t exist in finance.
While the inability of economists to reliably explain or predict anything is good for economist job security because the further study and refinement of models must therefore continue, it gives rise to a lot of sound bites and platitudes, not to mention “expert” opinions that contradict one another.
So what does all this mean? Here are my conclusions:
There are no absolutes, no formulas, no algorithms, no laws, rules of thumb, or experts, statisticians or economists who can consistently lead you to correct investment decisions. The guy who made a fortune overnight is today a wizard. When he loses the fortune over the next couple of trades he fades into the background.
No-one cares more about your investments than you do. No matter how much they advertise objectivity, expertise and fiduciary responsibility, if you make money, they make money. If you lose money, they make money.
If you feel you must use an investment advisor of any kind, look beyond track record, slick brochures and the charts and graphs. The most important qualities to look for are transparency, honesty, and conservatism. Here’s a hint: if he or she speaks and behaves like a high-flying success, run away as fast as you can. If he or she looks, sounds like and behaves like Warren Buffett, take a closer look.
And finally, consider the cost of advice. It’s often deeply hidden. Insist on and make sure you understand how your investment advisor is compensated for helping you. The compensation of fee-only advisors is a lot easier to understand and evaluate than that of brokers and agents. But even then, is his or her advisory firm affiliated with a broker-dealer through which any investment trades are routed and on which fees are earned and either accumulated or distributed back to the advisor, albeit indirectly? That’s just one example of a conflict that, even if fully disclosed, eludes most clients.
In short… Be skeptical. Think critically. Trust but Verify. And don’t believe everything you read or hear from economists!
Caveat Emptor.
