In the field of investments, simple answers are often non-existent because simple questions are almost non-existent. Most of the important questions we face are complex. Therefore, do not accept any simple answers without careful thought, especially when dealing with complex issues. In recent years, investors have paid a painful price to learn this lesson: any stock market profit-making method that is easy to spread by word of mouth and widely used often fails because it is too simplistic. Baruch Spinoza concluded in “Ethics,” “All perfect things are not only rare but difficult to obtain.” This applies not only to philosophy but also to Wall Street. From this, it can be inferred that complex questions are difficult to answer.
Your AI-powered meeting assistant — Huddles
Summarizing “knowledge” similar to “smart investing” is tentative because it is based on the generalization of experience. In principle, the next experience is likely to be unexpected. Real probability knowledge is based on reality and must accept repeated testing and confirmation through real observations, so there is no absolute general knowledge. Uncertainty arises from the method of generalization knowledge, and thus, uncertainty cannot be overcome. Once a generalization is proven to be false, many similar examples often follow. Once a rule is proven to be incorrect, we often discover many exceptions as if seeing the light again. And as long as one exception is found, it can be overturned. This exception may be a black swan, so the generalization that “all swans are white” is self-defeating.
By extension, once accounting issues come to light, many other issues will also be exposed. After some accounting issues at Enron were exposed, many other accounting issues followed, not only at Enron but at many other companies as well. Investors became more alert to problems and began scrutinizing related data such as cash flow statements more carefully. The discovery of a small piece of truth often leads to the discovery of a big truth or even many truths. The U.S. Securities and Exchange Commission not only began investigating Enron but also other companies with similar problems. In this way, discovering fraud spreads like an epidemic. Next, the country seemed to be in the midst of a widespread epidemic of accounting irregularities.
How can we prove whether the law of diversification in investment is true or false? We already know that it is easy to make mistakes when simplifying complex topics with simple ideas, so we can use logical deduction to apply this generalization to this specific situation. Since investment is a complex subject, the simple advice to “diversify investments” must be wrong because it oversimplifies complex issues, so it cannot apply to all situations and all investors.
Therefore, we must prove that someone has indeed made money by concentrating their investments. Bill Gates concentrated his investments in one company, Microsoft, which he owned, and made billions of dollars. However, when Gates diversified his investments, he lost money. George Soros bet heavily (with $10 billion) against the local currency (the pound) in 1992 and made $1 billion. However, when Soros no longer concentrated his investments and instead focused on hedging and diversifying, he lost money.
So, the key is not diversifying or concentrating investments but making the right investments at the right time. Diversifying or concentrating investments is not related to profitability. Given this, we should focus our efforts on studying individual investments, observing what practices are reasonable and meet expectations, rather than worrying about diversifying or concentrating investments. If we really diversify our investments, we should not believe that our investments will be safe as a result. On the other hand, we should not assume that we will make a profit by concentrating our investments.
Diversifying or concentrating investments is not closely related to profitability. Neither strategy has achieved the real goal because investment success is actually quite complex and mainly related to having the right things at the right time. The idea of diversifying investments cannot be applied in all situations. If it were applicable, investing would become extremely simple, and everyone who diversified their investments would make a profit, and within a few months, they would own the world. Therefore, most investment advice is nonsense. As an overgeneralization, the idea of diversifying investments takes us away from the real situation and leads to mistakes. As a simplification, it hides the truth and prevents us from taking the right actions.
Facing a problem and believing that there are only two possible answers to choose from or assuming that there is only one cause is a form of erroneous thinking, and the root of this error lies in overgeneralization. Stephen Gould referred to this type of error as the “false dichotomy” in his book “The Mismeasure of Man,” which is used to describe our tendency to explain complex and continuous realities using a dichotomy. The false dichotomy is thinking in terms of black or white, good or bad, which is called “black-and-white thinking.” This type of thinking is erroneous because it oversimplifies complex situations, causes us to overlook the complexity of a situation, and weakens our ability to come up with alternative solutions.
In the theory of biological evolution, when tracing back from one species to its ancestors, regardless of how different it is from its ancestors, the difference must have occurred through countless small steps and processes in a continuous and smooth manner. This is known as gradualism. However, proponents of punctuated equilibrium theory found in the fossils of mammoths and mastodons that there have been sudden changes in the Earth’s environment and massive extinction events. Since environmental changes can be sudden, changes in biological characteristics can also appear sudden, suggesting that the process of evolution should be rapid, abrupt, and discontinuous. Since then, the debate between gradualism and punctuated equilibrium has never stopped.
However, in the mid to late 20th century, the conflict between gradualism and punctuated equilibrium was resolved by two new theories working together. The first theory is known as punctuated equilibrium theory. They believe that the speed of biological evolution is not constant but can be fast or slow. Most of the time, organisms undergo very small, continuous, and smooth changes, forming what is called an equilibrium state. Their characteristics only change rapidly, abruptly, and discontinuously during certain brief time windows. The second theory is known as neutral theory. They argue that while the variation of gene sequences at the microscopic level is random, the impacts occurring at different locations are different. Harmful variations are quickly eliminated, leaving behind a large number of neutral variations and very few beneficial variations. This pattern of variation is reflected in the macroscopic characteristics of organisms, showing an intermittent equilibrium state, which includes long periods of boring equilibrium and very short periods of rapid change.
In the field of investment, one of the most famous false dichotomies is growth versus value. So-called value investing involves buying stocks that are relatively cheap in terms of their earnings and potential, while growth investing targets stocks that are expected to grow rapidly and have higher valuations. This recognition of long-term potential is derived from the idea of these stocks. Drawing a clear line between growth and value investing is not helpful and somewhat artificial, and it does not contribute to investment returns.
Investing should inherently involve investing in valuable companies, as a company without value is not worth investing in, so the term “value investing” is redundant. Growth investing holds an equal position with value investing. Value investing leans toward dividends, while growth investing leans toward growth. Only growth has value, and there is no value without growth; growth is implicit in value. Therefore, what we should do is identify growth-oriented companies, and this growth must be based on creating value.
In the case of such a dichotomy, Charlie Munger never gets involved in the debate between value and growth. In his view, all smart investments are value investments. This puts an end to the debate between value and growth. Charlie Munger pointed out that the concept of growth investing has nothing to do with the high multiples of price-to-earnings or price-to-book ratios that are paid for it because you have wisely made a decision that the bright future is so certain that you are still getting more value than you are paying for, even if you buy so-called growth stocks at 35 times earnings. If this is reasonable, it is because you are getting more value than you are paying for, but it is still value investing.
Therefore, complex problems have many solutions, not just one or two. The inference of black-and-white thinking is incorrect. Black-and-white thinking cannot consider all possible ways to solve a situation or problem.
The future is contingent, not predetermined. This is also a theme in the science of complexity, randomness, and uncertainty. Of course, there are things like the timing of the next solar eclipse or the position of Mercury that can be accurately predicted. The gravitational forces of the Moon and the Sun create tides and currents, and annual tide and current tables predict daily tidal and current movements. Most sailors know that this information is generally accurate, but there can be errors at times, and even tide tables can be disrupted by factors like wind, unusual weather conditions, or other unexplained factors. However, something that can be accurately predicted often has little to do with human interests. What is relevant are human problems, such as the uncertainty of human existence. For example, what will the stock index be at a certain day in the future? Which company’s stock is a better investment? But such things are usually uncertain and cannot be known with certainty. The future has not yet arrived, and only today can be certain. So, be wary of any absolute predictions about future events, as predictions are always subject to errors.
The causal connections of events often arise from chance, and what we often do is explain what has already happened rather than predict what will happen in full. A year before Enron’s bankruptcy, Enron’s management falsely inflated profits by nearly $1 billion. In addition, the company’s executives began to use insider information to manipulate their own stocks, manipulating stock prices so that they and their friends could make a profit while the other 64,000 unsuspecting stock investors paid the price.
Investors could not have known all the details before Enron’s collapse, but they could have detected clues through analysis. In 1999, someone asked Warren Buffett whether to invest in Enron, and his answer was that Warren Buffett, Peter Lynch, and he all believed: “Never invest in a company you don’t understand.” If you don’t understand Enron’s business, don’t invest in it. If you could analyze the statements of Enron’s executives wisely, you would not invest in Enron either. If you knew about their conflicts of interest and inconsistencies, you would be even less likely to invest in Enron.
Understanding conflicts of interest helps us unearth hidden meanings and thus guides us to a better understanding of the truth. To discover conflicts of interest, one must analyze inconsistencies. Inconsistencies often occur when conflicts of interest arise. When people say one thing and do another, actions should be considered higher evidence of credibility. Any inconsistency in words and actions can serve as evidence of fraud, hypocrisy, dishonesty, or stupidity. Try to use evidence of inconsistencies in words and actions to assess people’s character, and this will benefit us greatly. Once character analysis is made, it can predict potential troubles in the future, and actions can be taken accordingly.
Former Enron CEO Ken Lay was promoting the purchase of Enron’s stock by employees and the public while selling his own Enron stock. According to Aristotle’s logic, two contradictory things cannot be true at the same time, so one of them must be false. Either Enron stock was worth buying as Ken Lay claimed, or it should have been sold. We now know that if you knew the condition of Enron like he did, you would have sold Enron stock just like he did, despite his claims of bankruptcy being impossible.
Reality exists in such a cruel way. Because reality exists, we must deal with real things from a realistic perspective. And the truth refers to things that actually exist, not things that do not exist. Most real-world problems are not as simple as problems with fuel or food. In the short term, clear thinking may bring trouble, but in the long run, clear thinking is often beneficial. Laziness, conformity, and reluctance to accept anything novel or different not only hinder progress but also stifle thinking. Clear thinking, more than any tool, tells us what might be true and what might be false.