Friday, December 5, 2014

Finally I Get a Central Truism About Investing.

I'm reading a book called The Myth of the Rational Market, a book recommended by a favorite econ blogger of mine, Noah Smith. Here's the excerpt:
Bachelier used the assumptions of the bell curve to depict price movements on the Paris exchange. He began with the insight that "the mathematical expectation of the speculator is zero." That is, the gains and losses of all the buyers and sellers on the exchange must by definition cancel each other out. This isn't strictly true -- stocks and bonds have delivered positive returns over time -- but as a logical framework for investing or speculation, Bachelier's diagnosis remains unsurpassed. The average investor cannot beat the market. The average investor is the market.
So simple, and yet the basis for the truism -- that average investors, supposedly you and me, shouldn't think we could beat the market -- always eluded me. Not any longer.

The important point is the bell curve.

What part of average don't you get? (The stock market level at any given point is always the average of all participants. The Dow is short for Dow Jones Industrial Average.)

Of course I've done well in this bull market, quite well indeed, so I must not be an average investor. Then again, a monkey could probably have done well in this market. Why?

Stock market performance the last five years.

So, have I beaten the market? Hmm. I might as well be honest. I do have a personal financial advisor. Here's a recent photo:

Great guy. Always a fountain of information. Hasn't steered me wrong yet. Some say he's just an average monkey. (Don't tell anybody, but he's actually an ape.) I think he's above average, like me.

Seriously, though, the average investor can't beat the market because all of the above. What about predict the market? Not a chance. Not even an ape can do that. Then again, you can develop some rational expectations -- what the economy will do, what the Fed will do, how the herd will react when they misinterpret what the Fed has just done, etc. -- and run with them. Good luck with that.

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