Investing is a Problem-Solving Exercise

 

 

What is investing?

This is a much more subtle and challenging question than you might imagine, one that should not be dismissed lightly. Rather, it is one of the more difficult problems you will confront in your lifetime.

The dictionary definition is not much help: “The act of allocating resources, usually money, with the expectation of generating an income or profit; to put (money) to use, by purchase or expenditure, in something offering potential profitable returns, as interest, income, or appreciation in value.” Those definitions are both correct and useless.

Over many years, I have found myself crafting a definition that might be more useful:

Investing is the art of using imperfect information to make probabilistic assessments about an inherently unknowable future.”

The more I think about investing generally, the more it looks like a massive problem-solving exercise. To succeed at this, you need to manage a series of concepts that may appear to be incompatible. The paradox is that any of these ideas — either side of the argument  — may be correct at different times.

The best investors are intellectually flexible but approach their craft as a discipline with a specific process. They understand Probability Theorem but view mistakes as learning opportunities. They use a variety of Mental Models, many of which may occasionally contradict each other or lead to different results. They engage in second-order thinking, use counterfactuals, are aware of information hygiene. They possess a high level of self-awareness regarding their own psychological states.

For many people, the solution to this investing as a problem is deceptively simple: Buy a few index funds, add to them via dollar-cost averaging, rebalance once a year, ignore all the noise, behave, and wait a few decades. (I endorse this approach for lots of folks). But that deceptively simple solution reflects a massive amount of insight, nuance, and complexity.

To successfully incorporate this simple investing solution is not so simple. Consider all you must understand:

Probability of choosing outperforming funds
Impact of costs
Significance of investor behavior
Understanding behavioral finance
Compounding
Differences between Signal & Noise
Asset allocation versus stock selection
Recognzing congitive issues
Self-discipline and control

This list is incomplete, but it shows just how difficult and nuanced the challenge of investing can be. It is a conclusion that can only be reached by recognizing and understanding complex issues.

My definition of investing is a loaded sentence. Analyze it, and you will find it applies to many circumstances beyond investing.  How have formed your beliefs about Vaccines? What do you think happened on January 6th and in the 2020 election? Is global warming real, and if it is, what is causing it? These are emotionally charged, politicized questions, but when you consider them as problem-solving exercises, the parallels to investing appear.

Asked differently, if you had to place money in a fund managed by either Neil Young or Joe Rogan, which one would get your dollars?

This is what makes investing so fascinating. Markets cycle, but no two cycles are identical. The world changes, technology advances, information travels at the speed of light. It is dynamic. Everything is different, except human nature, which appears to never change. And I would not assume that under the right circumstances, at some point (far) off in the future, even that may transmute.

But until we see evidence that our behavior is somehow evolving, I am sticking with the view that the only thing that remains the same in investing is human nature.

 

 

 

Previously:
Spot the Logical Fallacy (June 4, 2021)

The 10 Most Useless Phrases in Finance (September 25, 2020)

Reduce the noise levels in your investment process (November 9, 2013)

The Many Hats of Great Investors (May 22, 2011)

 

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