Antidotes to the Seven Deadly Investment Sins

If you’re afflicted by a belief in any of the Seven Deadly Investment Sins, I implore you to read The Fortune Sellers by William A. Sherden. Sherden does more than just survey the whole gamut of fortune-sellers, from weather forecasters, to economists, to market gurus. He measures their predictions against what he calls the “naïve forecast.”

The naïve forecast is simply: tomorrow’s weather will be the same as today’s; inflation next year will be the same as it was this year; next year’s earnings will be up (or down) X%, just like they were this year. And so on.

Through rigorous analysis, Sherden shows that only one class of forecasters beats the naïve forecast with any regularity: weather forecasters. But only for forecasts for up to four days in the future. And even then, by only a small margin.

So next time you’re tempted to listen to some guru’s market prediction, remember that you can beat any guru — on average — by simply “predicting”: the market will do tomorrow what it did today. Sherden proves this in his book.

In his Why the Best-Laid Investment Plans Usually Go Wrong, Harry Browne has a wonderful collection of market and economic forecasts whose authors I’m sure wish they’d never written them.

Another great antidote to the 7 Deadly Investment Sins is Benoit Mandelbrot’s The (Mis)Behavior of Markets. Mandelbrot, a mathematician, is famous for inventing “fractal geometry.” In this book he applies that method of analysis to markets. And what he finds is that the assumptions that underlie the conventional investment “wisdom” are dead wrong.

In a nutshell, academic theories like the Efficient Market Hypothesis assume that market prices follow a “normal” statistical distribution.

This would mean that, over the past 100 years:

• There should be 58 days when the Dow moved more than 3.4%.
• The Reality: Mandelbrot found 1,001 such days…an enormous difference.
• The index should move more than 4.5% in one day just six times.
• The Reality: there were 366 such days in the past century.
• Index swings of more than 7% should come once every 300,000 years.
• The Reality: there were 48 such days in the 20th century. (No wonder Long Term Capital Management went bust: their models were all firmly based on the conventional wisdom.)

If you’ve read my chapter The Seven Deadly Investment Sinsyou shouldn’t be surprised that market reality is so different from the investment myths most people believe. (If you haven’t read it yet, just click here.)

What’s really amazing is that this evidence has been there, waiting for someone to just look for it! Those academic theorists in the their ivory towers simply don’t bother to check their beliefs against reality.

Don’t make that same mistake. The Seven Deadly Investment Sins need “powerful magic” to be exorcised — exactly what you’ll find in these three books.