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Some Philosophy Stuff

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

-Frederich von Hayek, The Fatal Conceit

I don’t follow the stock market.

I would like to say that I don’t follow it because I’m too busy, but that’s not it.  I know loads of other docs in my field, as well as busy surgeons and other specialists, that follow it all day long.  Not to mention people in other busy fields.  Lawyers, engineers, stay at home parents with eight kids.  All that.  They all love following the stock market.

But not me.

Here’s the kicker, though: while I don’t following the stock market, I love the stock market.  Ever since I started learning more about it a while back at the behest of my wife’s former boss, I’ve found it so, so interesting.

It’s a distillation of more money than I can imagine and more people interacting than I can imagine.  It’s representative of the vast wealth and innovation that we’ve seen since the first two hunter-gatherers discovered the concepts of trade, the division of labor, and comparative advantage, and started creating wealth from subsistence.

It’s representative of all of this great project of humanity that allows me to sit in a natural gas heated room on a winter day, typing on a glowing screen attached to a computer that is attached wirelessly to almost all the other computers in the world.  It is part of the phenomena that allow me to down some water with branched chain amino acids that came from one continent, and some coffee that came from another continent with coconut oil that came from another continent, while I wear very affordable and comfortable gym clothes that came from another continent.

And the stock market represents all of this.  It is SO INTERESTING.

But I don’t follow it.

And why is that?  Because I know what’s going to happen to it over the long haul.  I know how this story ends, or rather, continues.

And this is what I know.  So long as humanity doesn’t nuke itself back to the Pleistocene, get struck by an asteroid, or experience some other such catastrophe, the market is going to do very well over the long haul.  And if it doesn’t do well in the long run? Well, it’s because we’ve been hit by an asteroid.  In which case, I’m not going to care about the market anyway.

So, it’s a win-win.

And why do I know it’s going to do well, barring the end of humanity as we know it?  In truth, I don’t actually know it will like how I “know” that the sun will rise tomorrow (thank you David Hume).  But humanity has experienced a steady rise in prosperity for at least several thousand years or so.  And it only looks like it’s going to get better.  So, while I don’t “know” it in an absolute sense, I’m pretty confident.

GDP per capita has grown exponentially since 1500.  And its growth is only speeding up.  What is more, GDP vastly underestimates true wealth creation.  So, we are continuing this spectacular trend that has been going on for at least millennia. Source  

GDP per capita has grown exponentially since 1500.  And its growth is only speeding up.  What is more, GDP vastly underestimates true wealth creation.  So, we are continuing this spectacular trend that has been going on for at least millennia. Source

Yet, if I were to turn on MSNBC or CNN Money or any other such nonsensical pseudo-intellectual show on money, this nearly certain outcome is not what I hear.  I hear about minute changes in Fed discount rates or stories of people standing in line to get the newest Apple product.  I hear of various earnings reports, what the Chancellor of Germany said, or what the head of the IMF ate.  I’m basically hearing a bunch of random noise that someone somewhere is trying to tie together in a tangled web of causality so as to try and predict what’s going to happen tomorrow, next month, or next year.

And while I am fairly sure how the long game is going to look, I have no idea what’s going to happen tomorrow, next month, or next year.

And neither does anybody else.

Why did the oracle say that Socrates was the wisest guy ever?  Because he knew that he knew nothing.  Ignorance by and large is universal.  Everyone has it.  Ignorance is nothing to be ashamed of.  It is shameful, on the other hand, to be ignorant of one’s ignorance.  That is why Socrates was so smart.  Because he realized the profundity of his ignorance.  Only really wise people know how little they know.   And people who say that they know a lot can almost categorically be said to know the least.

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The wiser you are, the more apt you will be to realize that you know very little of the whole wide world.  And vice versa.

This is not only philosophically true.  This is science.  It’s well documented that you’d have better luck figuring out what a stock is going to do by flipping a coin than by listening to a pundit.  Flipping a coin should give you about a 50% chance of success.  Listening to a pundit about 47.4%.   Of course, this isn’t just with economics or the stock market.  Pundits are usually wrong about almost everything.

Thus, if you knew absolutely nothing and flipped a coin, you’d be better off than watching some talking heads.  From just a decision making standpoint, you are worse off for watching the news.

Look at all those numbers and tickers!  They must be telling you something useful!  Nope.  Hayek called this the

Look at all those numbers and tickers!  They must be telling you something useful!  Nope.  Hayek called this the “pretense of knowledge”.  The data have shown that not only do these numbers, and certainly this brunette, give you a less than even chance of knowing what tomorrow will bring, they also give you a better than even chance of doing something dumb with your money and of dying earlier.

But the news is not only bad for your decision making.  It’s even worse for your sanity.  If you are anything like me, having to watch middle aged men and women yell, stammer, speak of the end of the world, and all that for more than about a second starts to raise your blood pressure.  In other words, watching or reading all this nonsense is a surefire way to make you more anxious.

And we know that not only will anxiety kill you, but anxiety leads to worse decision making.

We can thus empirically say that the news, and especially the news about the stock market, will tell you the wrong stuff, make you more likely to make bad decisions, and potentially kill you.

To put this into perspective, remember Kurt Vonnegut, Jr.’s story in his book, Slaughterhouse 5.

The name of the book was The Big Board. . . . It was about an Earth-ling man and woman who were kidnapped by extraterrestrials. They were put on display in a zoo on a planet called Zircon-212.

These fictitious people in the zoo had a big board supposedly showing stock market quotations and commodity prices along one wall of their habitat, and a news ticker, and a telephone that was supposedly connected to a brokerage on Earth. The creatures on Zircon-212 told their captives that they had invested a million dollars for them back on Earth, and that it was up to the captives to manage it so that they would be fabulously wealthy when they were returned to Earth.

The telephone and the big board and the ticker were all fakes, of course. They were simply stimulants to make the Earthlings perform vividly for the crowds at the zoo—to make them jump up and down and cheer, or gloat, or sulk, or tear their hair, to be scared shitless or to feel as contented as babies in their mothers’ arms.

The Earthlings did very well on paper. That was part of the rigging, of course. And religion got mixed up in it, too. The news ticker reminded them that the President of the United States had declared National Prayer Week, and that everybody should pray. The Earthlings had had a bad week on the market before that. They had lost a small fortune in olive oil futures. So they gave praying a whirl. It worked. Olive oil went up.

So, what do we know?  We know that the people on the news do not know what the future is going to bring.  We know that we humans are way, way too psychologically tied to short term stock market variations.  And (unless Vonnegut’s story is not metaphorical but actually true), we know that the stock market is not controlled on a day to day basis by a knowable force, but by randomness.

That last sentence bears repetition and elaboration: The short term trends of the market are random.  But that’s not what we think or hear on the news.  Why?  Because people on the news are making stuff up.

Let’s say that Walmart lays off a bunch of people and the stock market goes up.  What do pundits say?  Something akin to, “the market rallies on news of Walmart making its distribution process more efficient.”

Let’s say that Walmart lays off a bunch of people and the stock market goes down.  What do pundits say?  Something akin to, “the market took a hit on news of unemployment and recent layoffs.”

You have to understand.  The pundits don’t know the reason.  No one knows the reason.  People are just making this up. Humans are story telling creatures and we must have a narrative.  Our brains will gladly make up ones if they need to.  And this isn’t just with Walmart.  Look at any Congressional Budget Office prediction, any movement with the Fed.  Almost any doomsday prediction (ahem, Paul Ehrlich).

When it comes to making predictions about the whole world, and the economy in particular, for the vast majority of the time we just don’t know what will happen.

For a book or two on this, check out Burton Malkiel’s A Random Walk Down Wall Street or Nassim Taleb’s Fooled by Randomness.

So, let’s recap:

  1. While the stock market will likely go up over the long  haul, we have no idea what it will do over the short run.
  2. Listening to pundits about what to do will give you a less than 50/50 chance of making the correct decision.
  3. Listening to pundits makes you anxious.  Anxiety can kill you.
  4. Listening to pundits makes you anxious.  Anxiety makes you make worse decisions.

Knowing these things, what should you do?

  1. Invest in as much of the world as you can.
  2. Invest over the longest period of time that you can.
  3. Stop watching the news.

The easiest way to do #3 is to turn off your TV and avoid the worst websites.

The easiest ways to do #1 and #2 is just to buy an index fund or a group of index funds (or related exchange traded funds or ETFs) and hold them for a long, long time.

This then brings us to the end of the more philosophical part of this article.  Continue onward for some of the more practical applications.

Some Practical Stuff

Alright, let’s review.  As above, we know that we need to stop watching the news and invest in as much of the world as we can for as long as we can.  We also know that one of the ways to do this is with what’s called index funds.

Let’s dig more into some of these details.

An index fund is something you can buy that gives you a small fraction of ownership in numerous companies.  It is called an index fund because the companies you purchase with these funds belong to certain indices, such as “all publicly traded companies in the US” or “all the publicly traded companies in the world”.  Moreover, an index fund doesn’t have to be just ownership of companies.  You can also own something like all of the loans made out to companies or cities, thus having an index fund that is for “all the corporate or municipal bonds in the US”.  You get the idea.

My wife and I buy index funds because it allows us to own a stake in a good part of the world.  And, you’ve seen, we have good cause to be bullish about the world.

My favorite index fund is one that is pretty much the summation of all of the stocks in the United States.  We do this with a company called Vanguard and the fund we usually use is called the Vanguard Total Stock Market Index Fund or VTSMX.

By owning a share of all of the US Stocks we also get to own a share of a lot of international stocks.  This is how that happens:

About 75% of VTSMX consists of around five hundred companies with the largest “market capitalization” (amount of stock shares being traded multiplied by their price).  This has considerable overlap with another index, the Standard and Poor’s 500 (though technically the S&P 500 has since 2005 picked their companies by “float capitalization” or the amount of public shares available times the market price – but don’t worry about this right now).  Anyway, this just means that about three-fourths of all of the companies you own are big U.S. companies.  And remember that most big U.S. companies make a lot of money not just domestically but in other countries too.  Think of how many Europeans have iPhones and Nikes and eat at McDonalds.  Thus, the companies that comprise the S&P 500 get about 40% of their revenue from foreign business.  By owning part of these companies, we are also taking advantage of all of this international business.

Further, the remaining 25 or so percent of VTSMX consists of the smaller companies making up the U.S. stock market.  And you never know which of these will be the next Google or Apple.  This is why I like getting the whole U.S. stock market rather than just something like the S&P 500.  You will miss out on these only investing in the S&P.  It’s always nice to be able to hedge our bets by casting our net widely.

So, we buy VTSMX, we hold it for a long time, and we don’t trouble ourselves with pundits.  But this isn’t all we do or don’t do.  We also don’t listen to real live people tell us what stocks to buy.  And we certainly don’t pay anyone to guess.

After all, the main thrust of my argument is that humans fundamentally cannot know what a large, complicated system like the world economy is going to do on a short term basis.  So, not only should you not listen to pundits on TV, you also shouldn’t listen to yourself.  And you should be very careful about listening to anybody else who says he or she is sure of what’s going to happen in the near term.

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Jack Bogle, the founder of Vanguard and inventor of the index fund.  This guy obviously understands long term investing.  The market may go up or down 20% in the near term.  You can’t let that bother you.  Realize 100 years ago virtually no one had a car.  Realize 20 years ago virtually no one  had a laptop.  Realize 10 years ago there wasn’t such a thing as an iPhone.  Things are getting so much better so fast.  But they might go to hell for a little while tomorrow.  Chin up!

This goes doubly so for anyone who wants to charge you while telling you what’s going to happen in the near term.

For instance, many financial advisers.

The average financial adviser will charge you at least 1% of your total wealth or “assets under management”.  And he or she will likely put you in fee-laden mutual funds. The average mutual fund fee or “expense ratio” is 1.25%.  Thus, investing in mutual funds through your financial adviser is going to cost you at least 2.25%.  Plus, as the Nobel Prize winning economist Eugene Fama and professor of economics Kenneth French pointed out, total market indices outperform actively managed funds 97% of the time.

So, going with a financial adviser will frequently cost you around 2.25%.  And if he or she puts you in an “actively managed account”, your chance of beating VTSMX or something similar over the long haul is a measly 3%.  Yet, VTSMX has an expense ratio of 0.14%.  That’s about sixteen times less than 2.25%.  Further, with enough funds, eventually VTSMX gets upgraded to “Admiral” class, or VTSAX, with an expense ratio of 0.05%.  That’s 45 times less expensive than the relatively poor performing active mutual funds.

In summary, if you go with a financial adviser who actively manages your account, the data shows that you will likely pay 45 times more for something that has a 97% chance of being not as good.

Of course this is your prerogative.  And not all financial advisers are bad.  Some may be worth that 1% of your total income for other reasons  (say, you don’t know how to click a button on a mouse – though if that’s the case I don’t know how you got to this website).

One workaround is that many financial advisers are “fee only”.  There might be many reasons to  use one of these, such as with estate planning, buying insurance, or something like that.  I just would be wary of any investing advice that any financial adviser gives you – fee only or otherwise – unless it is to buy a broad index fund.

That’s about it for practical advice for now.  So let’s wrap up.  Stand up, shake your arms, and take a deep breadth.  If your TV is turned to some finance show, turn it off.  If you’re busy following your stock ticker, stop it.

Close your eyes and visualize all of the progress that we as a species have made.  We have created unbelievable wealth since we got started in east Africa around two hundred thousand years ago.  We have created wonders beyond reckoning even when compared to our recent ancestors.  And while things are certainly not perfect, they are much better than they’ve ever been.  Not only that, but things are likely to continue to improve exponentially.  Within many of our lifetimes the world will become an unrecognizably incredible place.  What’s more, because of things like index funds, even people of modest means can own a fraction of all of this.

You are now free to realize how wonderful and how beautiful the world is.  You are now free to unburden yourself from the anxiety mongers of Fox Business and CNBC.   Let them have no power over you.  Let them harm you no longer.  Everything can be beautiful and nothing can hurt.