How to Invest Amid Uncertainty
In the iconic film The Matrix, the main character Neo faces a pivotal choice: take the red pill and learn a potentially unsettling truth or take the blue pill and live in ignorance. Success in investing, much like taking the red pill, demands a frank assessment of the known and the unknown, followed by the development of an investment plan that effectively accommodates the level of uncertainty.
Embracing the Unknown: Lessons from History
Human history exemplifies the power of acknowledging what we don’t know. Prior to The Scientific Revolution, humanity took the blue pill, creating myths and legends to explain the workings of the physical world. The Scientific Revolution was humanity’s acknowledgment of its own ignorance, initiating the use of reason and empirical evidence as means to uncover universal truths. This shift in thinking is evident in the profound change in world maps. Prior to the discovery of the Americas, world maps lacked empty space; with the unknown filled with imaginary worlds. After Columbus’ discovery in 1492, humanity realized in order to advance our understanding of the world, we must first accept the limitations of our knowledge.
How does this relate to investing? Most investors take the blue pill. They listen to forecasters who encourage them to buy when things look good and sell when things look dire. They expect the future to resemble the recent past when historically this has never been the case. In effect, they buy high and sell low, the opposite of what they should be doing. As a result, despite taking significant investment risk, they’re left with anemic returns. As illustrated in the chart below, the average investor would have been better off had they picked virtually any asset class and stuck with it. Instead, by constantly shifting towards what’s “working”, they barely kept up with inflation. Achieving our investment objectives requires us to view the future from a probabilistic lens, map out its potential outcomes, construct a strategy that performs well across a range of these outcomes, and have the discipline to stick with it.
Portfolio Resilience
Airplanes are built to withstand turbulence. During flight school, would-be pilots are taught to resist the urge to counteract the plane’s movements since their delayed reactions exacerbate instability. Modern aviation has been around since the 1950s, with roughly 100,000 planes flying each day, and yet no plane has ever crashed due to turbulence. As shown below, engineers build airplanes to endure stress beyond usual conditions. This concept of building beyond the minimum requirement is pivotal in investment strategies. Rather than reacting to every market fluctuation, a robust and well-thought-out investment plan, adaptable to various economic conditions, is more likely to yield favorable outcomes. Investing is not about predicting the future with precision. It’s about preparing for a range of possibilities, much like a pilot ready for varied weather conditions or a mapmaker open to unknown territories.
Boeing Factory Test
How much stress can a plane’s wings bear?
Summary Points
- Adopt a Probabilistic View: Assess the range of possible future scenarios, rather than predicting a single outcome.
- Discipline and Patience: Stick to your strategy, resisting the urge to make impulsive decisions based on short-term market movements.
- Continual Learning: Stay informed and adapt your strategy as new information and trends emerge.
