The late Stephen Jay Gould was an unusually keen observer of the world. He enhanced his work as an evolutionary biologist with an enormous breadth of knowledge that allowed him to make connections between seemingly incongruous things. Using baseball statistics, the action of worms or the gradually declining size of Hershey bars to explain important scientific observations, he revealed aspects of reality that would not have been accessible or even interesting without his creative reframing.
Gould was particularly focused on the disparity between the world we perceive and the world that actually shows up. He wrote that we carry “historical baggage” of a tradition that incents us to create “sharp essences and definite boundaries,” even though reality is more ambiguous and messy.
In 1982 Gould was diagnosed with abdominal mesothelioma, a particularly nasty and incurable cancer with a median life expectancy of just eight months. He opined that someone on the receiving end of that information would conclude that he had about eight months to live.
Yet Gould knew that median meant that half the patients would not survive more than eight months, and half would survive longer than eight months, perhaps a lot longer. As it turned out, Gould lived another 20 years, never succumbing to mesothelioma.
Gould wrote about his experience to illustrate that our reliance on statistical measurement — as powerful and useful as it is — is not the real world. “Variation is the hard reality, not a set of imperfect measures for a central tendency.” Gould was fierce in making a firm distinction between the truth of the world and the elegant abstractions we create to understand and exploit it.
When biologist Richard Dawkins and philosopher Daniel Dennett attempted to shoehorn all of evolutionary change within Darwin’s framework of natural selection (something that Darwin himself would not do), Gould went after them in a famous intellectual smackdown. He argued that, like every other insight ever made, natural selection could not and cannot account for everything observed in the real world.
Investing entered the modern era when universities started to turn large portions of their intellectual and financial resources towards economics, business, investing and finance. The result is that today we have a greater understanding of almost every aspect of the investment process and a growing toolkit of sophisticated and useful investment products.
The big lesson that came out of academia — at least one that’s on many people’s minds today — is that it is hard, really hard, and maybe impossible, to construct a diversified portfolio that consistently outperforms the market.
The insight that a portfolio built to mimic an index would outperform most professional investors took a while to be accepted broadly. But now that it has, the question being asked by more and more serious investors is, “Should I waste my time trying to find an active manager, or should I just index?” Given recent trends, the answer for many is the latter.
The historical rule on Wall Street is that every successful investment strategy that has ever been created gets too popular at some point. There has never been an exception to this rule — so far.