Investing is a huge deal, and I really don’t discuss it as much on this blog as I should.* For many people, their life savings will be invested in various financial products like stocks, bonds, mutual funds, and the like. Their life savings. Investing the fruits of decades of labor can be pretty scary, so how can you make sure you’re doing it wisely? There are a lot of considerations to wise investing, and I want to look at one small but crucial facet today: thinking about and choosing an investment theory to guide your investment choices.
Now, I’m not going to sing the praises of one theory over another today. If you want to know how we invest client funds, you can take a look at our overview or schedule a meeting with us. What I do want to talk about is how skeptically approach an investment theory and evaluate its truth claims.
Skepticism has a bad name, mainly because many people confuse it with cynicism. Definefor.me defines the two terms for us:
Cynicism: An attitude of scornful or jaded negativity, especially a general distrust of the integrity or professed motives of others…
Skepticism: A doubting or questioning attitude or state of mind; dubiety.
Do you see the difference? A cynic will dismiss an idea in the spirit of jaded negativity while the skeptic will not accept an idea unless there is reasonable evidence for the validity of an idea. Why approach investment theories or claims skeptically? Do you really want to risk your savings and investments on an idea without good reasons to think an investment idea’s true? That sounds pretty risky to me.
So, let’s look at an investment theory from the skeptic’s point of view. Our sample investment theory will be investing in the stock market using the influences of the stars. “Wait, wait, wait,” you may say, “it’s not fair that you take on astrology. After all, it’s well known that skeptics don’t believe in astrology.” To which I respond: “We’re going to use an easy example, to keep things simple.”
First, let’s figure out the claim that underlies investing by astrology. I think it’s fair to say that their claim is that, by observing stars and planets, one can predict the changes of price in the stock market (among other things.) Now we ask the skeptic’s question, which is “What evidence do we have to support this claim?”
Remember, it’s the responsibility of the person making the claim to show that the claim is true. It’s not the job of the person evaluating the claim to disprove it. This is called the “burden of proof,” and the burden of proving a claim is on the person making the claim.
So, what evidence is there to support the claim that observing the stars and planets can predict stock prices? Let’s just look at a couple of the most frequent evidences given, and see if they are satisfactory.**
- Look at the track record of this astrologer! See how the stars predicted these investments, and look at all the money you could’ve made by following these predictions. This track record means it has to be true.
- Stock markets run by periodicity, and the stars and planets run by periodicity. It’s natural that one would drive the other.
Unfortunately, neither of these evidences stand up when critically appraised. Firstly, looking at the track record of an astrologer is a pretty risky method of deciding that astrology is a valid method of investing. The problem with looking at an astrologers record is two-fold. First, confirmation bias alone can explain the perception of success of an astrologer. If a fair evaluation of all the astrologer’s predictions is preformed, the evaluator should find that there are many predictions that are wrong and some predictions that are right. However, confirmation bias causes us to focus on the hits, and ignore the misses. Couple that with the likelihood that, amongst a fairly substantial population of stock-market-predicting astrologers, some will outperform that market due to sheer luck, and you have a recipe for the appearance of an effective method, when in fact it’s the intersection of selective memory and logic-busting biases. Unless the astrology theory proponent can demonstrate that their analysis of the success of astrology in predicting market prices is free of these biases, I am going to have to continue to not believe their assertion that astrology predicts stock prices.
The second assertion is just laughable. My dog periodically throws up on the carpet, and I don’t assert that her intermittent stomach upsets are indicative of future stock market shifts. Why? Because, even if her past “unfortunate incidents” are associated with market direction changes, there is no mechanism to drive the association. There is no evidence of a mechanism to tie the spinning of the planets or the apparent shifting of the stars to changes on stock prices, either. Until there is evidence of a mechanism driving the market that comes from astronomical bodies, I can’t believe that astronomical bodies influence market prices.
Now, imagine if went a particularly skeptical person, and you didn’t look closely at the claims of the astrologers who said they could predict the stock market by the movements of the stars. Do you think that your investments would be safe? Sure, things may turn out all right by sheer luck, but is it reasonable to let your life savings be invested according to an unproven investment method? What do you think?
* Why? There are a lot of rules about what a financial advisor can say about investing, and I don’t want to run afoul of them, so I just don’t really talk about it that often. The regulations have a chilling effect on my blogging, that’s for sure.
** I’m sure there are as many reasons given to believe in astrological prediction of the stock market as there are people who believe in astrological prediction of the stock market. I’m just going to limit it to two because I don’t have all day to write this post.