One of our favorite business writers is James Surowiecki who has an interesting piece over at the New Yorker. In it he discusses the role of chance and context in discussing the over-hyped struggle between Airbus and Boeing for supremacy in commercial aviation.
Surowiecki notes that as of late Boeing seems to have gotten the upper hand on Airbus in terms of new plane orders. However just a few years ago it seemed that it was the other way around. Airbus had left Boeing in the dust and was receiving universal acclaim. Predictions abounded that Boeing would never regain its status as the world’s largest plane maker. Surowiecki writes:
The problem with such prognostications is that they infer basic truths about a company’s prospects from its short-term performance. In fact, present success is often determined as much by context and chance as by fundamental viability.
We here don’t have much real interest in this business story, but it helps reinforce why we do not focus on “forecasting” or “predicting” as a basis for our investment philosophy. The fact of the matter is that human beings are, by and large, poor predictors. In addition to our penchant for overconfidence, Surowiecki notes:
People are generally bad at accepting the importance of context and chance. We fall prey to what the social psychologist Lee Ross called “the fundamental attribution error”—the tendency to ascribe success or failure to innate characteristics, even when context is overwhelmingly important.
Luck and chance clearly play an important role in investing. Any one who has spent any time researching and analyzing investments has first hand experience with the vagaries of the market. Often it simply takes time for certain “inevitabilities” to come to pass. However investors know that being early is often synonymous with being wrong. The best investors realize that luck and chance have an important role to play in any portfolio.
Because we underestimate how much variation can be caused simply by luck, we see patterns where none exist. It’s no wonder that management theory is dominated by fads: every few years, new companies succeed, and they are scrutinized for the underlying truths that they might reveal. But often there is no underlying truth; the companies just happened to be in the right place at the right time.
The very best investors have honed their investment techniques with this in mind. They recognize that they will be wrong a significant percentage of the time and have a method to deal with these inevitable failures. In addition, most but not all, recognize their fallibility by investing a limited amount on any investment idea.
Whether we like to admit it or not we live in a world that is to a degree unpredictable. Understanding that we cannot predict the future is, in our opinion, a good first step in becoming a better investor.
*For those interested in the role that chance plays in investing you can visit Nassim Nicolas Taleb‘s site or read his excellent book, “Fooled by Randomness“.