I could not have asked for a better question. I was a few weeks into my student-teaching days at Robert F. Wagner Junior High School in Manhattan, and in front of me sat 30 inner-city teenagers.
On the first day of school, my supervisor pulled me aside. “Teaching,” she said, “consists of a few moments of actual learning within quasi-organized chaos.” So I began — each morning standing in front of the class and gamely going through my lesson plan.
“Mister Jaffe!” The voice came from the back of the room. “Mister Jaffe! Why should I care about the Civil War? It’s just a bunch of facts that have nothing to do with me or my life. Why do we need to learn this s**t?” There was a long awkward moment of silence as I realized something profound. I felt the same way.
What is history? The Merriam-Webster dictionary defines it as, “The study of past events, particularly in human affairs.” Alternatively, one could claim that history is everything that has transpired in the world up until now.
While it is impossible to know everything that happened, limiting history to events artificially constrains our understanding of how it influences and informs who we are today. The society we are born into, its culture, morals and government, and the lens through which we perceive the world all exist in their present form because of history.
Informing the Future
Individually or collectively, history informs us where we come from and who we are, so we can make informed choices about our future. Yet in the minds of most people, history is something between a useless waste of time and an interesting but otherwise meaningless intellectual exercise.
It’s going to be a long time (if ever) before the importance of history becomes a cultural norm. Most of our individual and national attention is on the future. History is just water under the bridge. We’re far more interested in what’s coming up.
Earlier this year, Howard Marks of Oaktree Capital Management wrote a memo to clients entitled “Expert Opinion.” Donald Trump’s election was still news, as was the huge failure of pollsters and the mainstream media to see the groundswell for the Republican candidate.
Marks noted that this was just one example of the mediocre record of expert prediction in general. And yet whenever (and wherever) Marks spoke to audiences, he was always asked for his predictions.
Our opinion of experts and expert prediction is historically low. Yet we continue to have expectations that the role of experts (especially in investing) is to predict — that their value is tied to success in anticipating things. Stated another way: Prediction is the prerequisite for success.
The greatest and most respected investors, with the best track record, over the longest periods of time, repeatedly say that they do not make their decisions based on prediction. To even a casual observer of expertise, it is obvious that its value cannot be related to prediction — therefore prediction cannot be related to success (except from luck).
In a free market, demand will always find supply. The emotional need for certainty — even false certainty — remains robust. Despite a mountain of evidence that prediction, in the best of circumstances, is a long-odds proposition, the lure of its promise is nearly impossible to resist.
‘Illusion of Certainty’
The real-world alternative: Confidence, while a rational and far more reliable tool, cannot compete with the promise of certainty. Prediction offers investors the illusion of certainty — a behavioral weakness that has been and will continue to be exploited by one investment scheme after another.
The demand for certainty turns failure, any failure, into an unacceptable outcome. Thus, sensible choices that are an important part of the process of building a successful and personalized investment strategy are not pursued, because partial failure is always a potential outcome. One of the hardest challenges I have faced as an advisor is getting investors to abandon their fantasy of eliminating risk by embracing the achievable reality of managing it.
John Kay wrote a Financial Times column some years ago, “Darwin’s Humbling Lesson for Business,” in which he said, “Evolution is a process with three elements; variation, selection and replication. Changes happen, a few of these changes yield advantages, and such changes tend to be reproduced in subsequent generations.”
Kay saw a direct correlation between the mechanics of variation, selection and replication in nature and business. He noted that modern business developed as a result of variation that comes from experiments in products and methods, selection by customers and capital markets of adaptations that add value (and the rejection of those that do not), and the replication by competitors of strategies that succeed.
On first reading, I thought Kay’s column was a massive oversimplification, stretching an analogy farther than it should. But seeing connections between things that don’t appear to be connected sharpens and expands our vision — allowing us to perceive things we didn’t see before.
My take on Kay’s message is this: Nature’s formula for risk management and success has been time-tested and perfected over billions of years. All of it may not be applicable to business and investing, but it would be irresponsible to ignore an historical lesson of that magnitude.
In Thinking, Fast and Slow, Daniel Kahneman relates a story that illustrates what happens when even the smartest, most experienced and thoughtful people make decisions without incorporating the lessons of history into their thinking.
Years ago, Kahneman was in the midst of a project to develop a curriculum and textbook for high school students. After a year, he asked all but one of his colleagues to estimate how much longer they thought it would take to complete their project. The estimates ranged from 18 to 30 months.
Then he turned to the one person he had left out, a close friend who was an expert in curriculum development, and asked him how long he thought it would take them to finish. His friend fell silent and seemed embarrassed.
“I never realized this before, but in fact not all the teams at a stage comparable to ours ever did complete their task,” the author said. Then he told them that only 40% of projects like theirs ever finished, and the ones that did took between seven and 10 years. Kahneman’s group took another eight years before they were done.
In early May, I received a call from a client — a good friend and an experienced investor. He told me that he felt the political, economic and existential risks of a Trump presidency were unprecedented, and he was instructing all of his advisors to reduce exposure to stocks to levels that would allow a portfolio to withstand a true calamity.
He was calm, he was rational, and he had legitimate concerns — ones that I had considered as well. And he had a narrative of how these risks could play out, one that was well reasoned and logical.
What does history teach us about something like this? Quite a lot, if we realize there are two important kinds of history to consider. The first is the history of market declines, how often and how far markets fall. But it is only half the story.
The other half is the history of investors and investor choices — both individual and collective. A well-thought-out narrative can easily become a compelling call to action. So even though the likelihood of the combination of his narrative being correct and the market collapsing is, in probabilistic (and historical) terms, close to zero — powerful narratives always beat statistics.
That doesn’t mean he’s wrong. He could be right. He might have an insight into something that others can’t see. But the probabilities of that are so low that only luck would be the reason for the outcome.
If investing is the discipline of stacking the odds in our favor for a desirable long-term outcome, then the history of markets and the history of investor behavior are not simply interesting facts: They are critical tools designed to keep our decision-making aligned with the lessons of history, yet flexible enough to remain relevant in a changing world.