No one can predict the future but most financial ‘experts’ implicitly base their advice on the past repeating in the future
Posted by John Reed on
Reading two heavy duty investment books at the same time has caused me to spot a huge flaw in the so-called financial advisor industry.
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The true basic fact is investors want their assets to grow as measured by after-tax, after-inflation future numbers.
That, in turn, requires prescience, a crystal ball, clairvoyance.
.
Absent cause-effect, no one is clairvoyant.
.
I have described expertise as knowing how to cause an effect. For example, expert cooks know that water boils at 212ºF at sea level. That is, if you raise the temperature to that level, the water will boil.
.
The only financial expertise is knowledge of pertinent laws like those of income taxes, contract law, legal tender, and human nature like behavioral finance, irrational exuberance and irrational despair and probability and statistics and logic.
.
Real financial expertise is stated as if X happens, one consequence will be Y.
.
But whenever a purported financial advisor speaks as if he knows the probability of X happening, where X is not in his control, he is a charlatan.
.
Every prospectus contains the statement “Past performance is not necessarily predictive of future performance.” It is correct. But financial advisors constantly speak of risk in terms that presume past performance DOES predict future performance. That is totally invalid nonsense.
.
A common example recently is the use of the bell curve or normal distribution to forecast future events or a range of possible events. The phrase “standard deviation” indicates the use of the bell curve. But a distribution of data matching the bell curve—a lot average but far fewer at both extremes—requires that the data points be a randomly selected sample with variations stemming from natural events.
.
If you select 1,000 male adults at random, you know that their HEIGHTS will very closely match the bell curve: mostly average or near average with far fewer very short or very tall. How tall a person is is a natural event.
.
But nowadays, you will NOT find that their WEIGHTS match the bell curve. That is because a person’s weight is a human-will event, not a natural event. Some people weight more because they eat more.
.
Purchases and sales of stocks and bonds and commodities are also human-will events, as are other things that influence the values of stocks and bonds like wars, laws, fads, droughts, floods, and so on.
.
You can look at past movements of stock prices, for example, and see that some price levels were rarely reached and others were more often reached, suggesting maybe the bell curve applies.
.
Like hell it applies. Stock purchases and sales are human-will events.
.
Financial advisors says some stocks are more risky than others. But their definition of risk is volatility. Volatility is moving up or down rapidly and with greater amplitude. But how can they say a given stock will move in such a manner in the future? Only by violating their own ubiquitous prospectus rule that past performance does not necessarily predict future performance.
.
They would lamely defend themselves by saying it is the best data they have.
.
It is not. It is worthless.
.
Technology is a factor in stock prices. A new invention—canals— was a hot investment in the 1790s. They greatly lowered the cost of transporting goods and people. They were extremely profitable for their builders. But then, in 1860, a new technology blew the canals away: railroads.
.
Could study of the rise of the canals in the late 1700s and early 1800s have told you how risky they were going to be and what their price movements would be in the late 1800s. No. They became far less volatile and obsolete. Then the railroads became the hot stock. They still exist for freight, but they are not go go stocks.
.
America had no horses until Columbus discovered it and later immigrants brought horses. Horses were a great “technology” in North America from 1500 to 1900. Then they were blown away by the horseless carriage.
.
Have some stock prices moved in less volatile ways and others in more volatile ways in the past? Absolutely. Can you decide how risky your portfolio of stocks will be by looking at which stocks were volatile in the past? No. Past performance is not necessarily indicative of future performance.
.
But risk aversion and risk tolerance are the main thing financial experts talk about. It’s a bunch of BS. Saying some stocks are more risky than others means they are going to fall in price. But that is crystal ball talk. No one knows which will fall in price. Yes, they know which ones fell in price in the past, but that is not predictive.
.
AT&T was a safe blue chip nonvolatile grandmother stock for a century. In 1876, Alexander Graham Bell invented the telephone. But in 1984, the DOJ broke up AT&T. Before that, other telecommunications technology arose: radio, trans oceanic cables, satellite, microwave, cell phones, TV. In short, AT&T founded in 1882, a stock that was considered like an untouchable rock—it only fell 60% in the Great Depression when all other stocks fell 95%—turned into just another player is a wildly developing industry. Today’s financial experts would have had you buying that stock if you were risk averse early in the 20th century. Ha!
.
The financial experts says if you are somewhat risk averse, your portfolio should had more bonds and fewer stocks. That is advice for 1930, when the national debt-to-GDP ratio was 17% and we had deflation, not inflation.
.
The charlatans would tell you bonds are safe, non risky. Bull! They are likely to pay as promised in nominal terms. But between now and maturity, their value can fluctuate way down or up. And inflation can render them worthless. And if the are less than AAA, which US Treasurys are now, they may default,
.
What about the main mantra of the financial “experts?” Diversification. Very simply, the more different stocks you own, the more the performance of your portfolio will be the average of all ths stocks which will be closer to the middle that to the highest or lowest prices of some of the stocks in it.
.
Is that safer? It depends on what time period you want to look at. After the Depression, stock prices generally went up and the average was pretty good. Does that mean a diversified stock portfolio is always good and prevents you from loss? Hell, no!
.
In 1929, the stock market famously crashed. 95% of the value of he entire stock market disappeared. So were you protected by diversification then? Not at all. Was anything good to own then? Yes. US dollars and assets denominated in USD like US government bonds. That is because in 1933, the US debt-to-GDP ratio was 17%. The Depression was deflation. In deflation, the thing to own is dollars and dollar-denominated assets.
.
It would not go that way now because the US debt-to-GDP ratio is now 125%. The US government would default on the bonds now.
.
Financial expert diversification is lots of stocks and TIPS bonds.
.
My version is that you own and live on and work on a subsistence farm and you own stocks, bonds, commodities, silos full of grain, real estate. In other words, a little bit of EVERYthing, not just every stock in the stock market. Financial experts have a very distorted, warped micro perspective. To them, the entire world is securities sold by securities dealers on huge exchanges. No, sir. True diversification which really does protect from so many things is ownership and knowing how to operate a farm/game/fish harvesting facility and owning every kind of financial asset including taking delivery of commodities, not just trying to profit from futures contracts in those commodities.
.
The true basic fact is investors want their assets to grow as measured by after-tax, after-inflation future numbers.
That, in turn, requires prescience, a crystal ball, clairvoyance.
.
Absent cause-effect, no one is clairvoyant.
.
I have described expertise as knowing how to cause an effect. For example, expert cooks know that water boils at 212ºF at sea level. That is, if you raise the temperature to that level, the water will boil.
.
The only financial expertise is knowledge of pertinent laws like those of income taxes, contract law, legal tender, and human nature like behavioral finance, irrational exuberance and irrational despair and probability and statistics and logic.
.
Real financial expertise is stated as if X happens, one consequence will be Y.
.
But whenever a purported financial advisor speaks as if he knows the probability of X happening, where X is not in his control, he is a charlatan.
.
Every prospectus contains the statement “Past performance is not necessarily predictive of future performance.” It is correct. But financial advisors constantly speak of risk in terms that presume past performance DOES predict future performance. That is totally invalid nonsense.
.
A common example recently is the use of the bell curve or normal distribution to forecast future events or a range of possible events. The phrase “standard deviation” indicates the use of the bell curve. But a distribution of data matching the bell curve—a lot average but far fewer at both extremes—requires that the data points be a randomly selected sample with variations stemming from natural events.
.
If you select 1,000 male adults at random, you know that their HEIGHTS will very closely match the bell curve: mostly average or near average with far fewer very short or very tall. How tall a person is is a natural event.
.
But nowadays, you will NOT find that their WEIGHTS match the bell curve. That is because a person’s weight is a human-will event, not a natural event. Some people weight more because they eat more.
.
Purchases and sales of stocks and bonds and commodities are also human-will events, as are other things that influence the values of stocks and bonds like wars, laws, fads, droughts, floods, and so on.
.
You can look at past movements of stock prices, for example, and see that some price levels were rarely reached and others were more often reached, suggesting maybe the bell curve applies.
.
Like hell it applies. Stock purchases and sales are human-will events.
.
Financial advisors says some stocks are more risky than others. But their definition of risk is volatility. Volatility is moving up or down rapidly and with greater amplitude. But how can they say a given stock will move in such a manner in the future? Only by violating their own ubiquitous prospectus rule that past performance does not necessarily predict future performance.
.
They would lamely defend themselves by saying it is the best data they have.
.
It is not. It is worthless.
.
Technology is a factor in stock prices. A new invention—canals— was a hot investment in the 1790s. They greatly lowered the cost of transporting goods and people. They were extremely profitable for their builders. But then, in 1860, a new technology blew the canals away: railroads.
.
Could study of the rise of the canals in the late 1700s and early 1800s have told you how risky they were going to be and what their price movements would be in the late 1800s. No. They became far less volatile and obsolete. Then the railroads became the hot stock. They still exist for freight, but they are not go go stocks.
.
America had no horses until Columbus discovered it and later immigrants brought horses. Horses were a great “technology” in North America from 1500 to 1900. Then they were blown away by the horseless carriage.
.
Have some stock prices moved in less volatile ways and others in more volatile ways in the past? Absolutely. Can you decide how risky your portfolio of stocks will be by looking at which stocks were volatile in the past? No. Past performance is not necessarily indicative of future performance.
.
But risk aversion and risk tolerance are the main thing financial experts talk about. It’s a bunch of BS. Saying some stocks are more risky than others means they are going to fall in price. But that is crystal ball talk. No one knows which will fall in price. Yes, they know which ones fell in price in the past, but that is not predictive.
.
AT&T was a safe blue chip nonvolatile grandmother stock for a century. In 1876, Alexander Graham Bell invented the telephone. But in 1984, the DOJ broke up AT&T. Before that, other telecommunications technology arose: radio, trans oceanic cables, satellite, microwave, cell phones, TV. In short, AT&T founded in 1882, a stock that was considered like an untouchable rock—it only fell 60% in the Great Depression when all other stocks fell 95%—turned into just another player is a wildly developing industry. Today’s financial experts would have had you buying that stock if you were risk averse early in the 20th century. Ha!
.
The financial experts says if you are somewhat risk averse, your portfolio should had more bonds and fewer stocks. That is advice for 1930, when the national debt-to-GDP ratio was 17% and we had deflation, not inflation.
.
The charlatans would tell you bonds are safe, non risky. Bull! They are likely to pay as promised in nominal terms. But between now and maturity, their value can fluctuate way down or up. And inflation can render them worthless. And if the are less than AAA, which US Treasurys are now, they may default,
.
What about the main mantra of the financial “experts?” Diversification. Very simply, the more different stocks you own, the more the performance of your portfolio will be the average of all ths stocks which will be closer to the middle that to the highest or lowest prices of some of the stocks in it.
.
Is that safer? It depends on what time period you want to look at. After the Depression, stock prices generally went up and the average was pretty good. Does that mean a diversified stock portfolio is always good and prevents you from loss? Hell, no!
.
In 1929, the stock market famously crashed. 95% of the value of he entire stock market disappeared. So were you protected by diversification then? Not at all. Was anything good to own then? Yes. US dollars and assets denominated in USD like US government bonds. That is because in 1933, the US debt-to-GDP ratio was 17%. The Depression was deflation. In deflation, the thing to own is dollars and dollar-denominated assets.
.
It would not go that way now because the US debt-to-GDP ratio is now 125%. The US government would default on the bonds now.
.
Financial expert diversification is lots of stocks and TIPS bonds.
.
My version is that you own and live on and work on a subsistence farm and you own stocks, bonds, commodities, silos full of grain, real estate. In other words, a little bit of EVERYthing, not just every stock in the stock market. Financial experts have a very distorted, warped micro perspective. To them, the entire world is securities sold by securities dealers on huge exchanges. No, sir. True diversification which really does protect from so many things is ownership and knowing how to operate a farm/game/fish harvesting facility and owning every kind of financial asset including taking delivery of commodities, not just trying to profit from futures contracts in those commodities.
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