There’s so much room for misinformation with investing

Published in The Sunday Times on November 27th 2022.

Could you estimate the distance between the GPO in Dublin and New York’s Statue of Liberty? If you know your geography, a very good guess would be within a few hundred kilometres of the actual distance, which Google reliably estimates to be just over 5,100 km.

This estimate is approximately right, but we could measure the distance more accurately if needed. In the hard sciences like physics and chemistry, experiments often produce estimates accurate to ten decimal places. That is akin to an estimate of the distance from the GPO to the Statue of Liberty being accurate to within a few millimetres.

Economics and Finance are part of the social sciences 

The field that I work in, economics and finance, labours under the uncertainty associated with the human condition. There is very little certainty in the social sciences. There’s a lot of nuance and lots of grey areas. This is what makes it such an interesting field – there’s room for debate and argument. But equally, there’s also lots of room for misinformation. 

In a ‘post-truth’ world, where people are more likely to accept an argument based on their emotions and beliefs, even incontrovertible facts can be disputed, and doubt raised. The vagueness that permeates the world of finance creates an even greater void where fuzzy half-truths can blossom far more readily. 

So what? Unfortunately, we live in a world that rewards those who speak with conviction — even when it is misplaced — and gives very little airtime to those who acknowledge doubt. There are a lot of very successful spoofers in economics that understand this dynamic quite well. 

The economy is not a machine

Deep in the recess of our minds, we’ve inherited the belief that the economy is a machine - if we understood its parts, we could predict the whole. The economy is not a gigantic machine - it relies on human beings, not machine components. When I studied economics, I thought a grand unified theory was possible - where well-defined problems should have well-defined solutions. 

A twenty-five-year career in financial markets has disabused me of this notion – it didn’t take all 25 years! For every seemingly simple finance question, there is more than one answer. Take for example the following question - are you better off investing in passive funds or funds that are managed actively?

Seemingly simple finance questions

There’s a simple and appealing answer to this – much of the evidence points to passive investing producing better outcomes. This stands up to some level of scrutiny. Certainly, the objective evidence about active manager underperformance against benchmarks would support the argument for passive. But as with most things in finance, it’s not that straightforward. I don’t propose to lay out the arguments for that debate here, I merely want to convince you that there is one. Pretentions to certainty should be treated with scepticism. 

Or my long-time favourite finance question – how should we measure investment risk? Again, there’s an alluringly simple answer to this one. Volatility is the widely accepted measure of investment risk in finance. No investment practitioner worth their salt would ever measure risk under such a narrow definition, but it unduly influences every investment decision investors make. Again, I don’t have sufficient word count to expand on this, but I’m simply highlighting there’s more to this than meets the eye.

One-handed economist

There are many other questions in finance that are subject to the same nuance. US President Harry Truman once pleaded: “Give me a one-handed economist. All my economists say ‘on the one hand...’, then ‘but on the other…’” Economics’ moniker as the ‘dismal science’ is well earned.  

The problem is that at the core of economics and finance is the idea of opportunity cost –there are usually trade-offs to each decision. There is no such thing as a free lunch. Most people don’t like hearing about the negative side of a scenario, or the full consequences of a policy. If you’ve ever delayed a visit to the doctor when feeling unwell, you’ll know what I am talking about.

Investment implications with a lack of certainty

The plea for a one-handed economist is essentially a plea for certainty or analysis without trade-offs. I meet with clients continually. The most common failing I see in client decision-making is actually indecision. The second most common failing is taking the path of least resistance – paying to avoid some risks, which may be very salient but unimportant – like volatility and short-term capital decline. And in doing so, substituting in other risks which are not as obvious but are much more critical – like shortfall or real (after inflation) returns risk.

We live in an unpredictable world. For investors, unpredictability is often not the problem. The problem is that faced with clear risks, we either fail to act or take the path that offers the best short-term comfort. 

There’s no obvious antidote to this, but advice is a good starting point. Beware – side-stepping advice in relation to investment problems, much like delaying a visit to the doctor, is only human, but potentially very costly. 

Gary Connolly is Investment Director at Davy. He can be contacted at gary.connolly@davy.ie or on twitter @gconno1.