Flat Earth investing
On textbook mistakes, Bernie Madoff, and the moral judgments that investors really can't outsource to any formula
■ Just because something appears in a textbook or is taught in finance classes doesn't mean it's actually sensible. People have believed (and documented) all kinds of idiotic things in the past and will continue to do so in the future. The Flat Earth Society proves that.
■ Investing should be done on the basis of arriving at informed judgments using sound reasoning. The belief that this can be done by substituting a bunch of elaborate formulas for that judgment is like thinking you can create an orange by dehydrating a gallon of Tang.
■ Sound reasoning would have scared any sensible investor away from cryptocurrency. But adherence to the textbook formulas told others that there was an ideal, non-zero amount they should have invested in the new "asset class" to achieve "balance".
■ To invest is to conclude that $1 doing some form of work is exceedingly likely to be redeemable for more than $1, with a rate of increase that satisfies a tolerable time horizon. If it's not that, it's just speculation. And speculation can be fun (just like a trip to a casino), but it's not investing.
■ That may sound terribly moralistic, but if there isn't at least some moral judgment involved, then the investing process is incomplete. Investing is a human endeavor, and the necessary judgments that go into whether an investment is suitable or not simply cannot be automated.
■ Some investments may be profitable but socially harmful (cigarette manufacturing, for instance). Others might look high-risk at first blush, but have such prospects to do good down the road (like high-efficiency small nuclear plants) that their financial prospects are tied in part to their future social utility. And, as the people who placed money with Bernie Madoff learned, numbers don't necessarily tell the truth if the person reporting them is a crook.
■ Institutional investors who think they have to invest according to risk-weighted portfolio formulas really ought to think twice. Just because the risk may involve only a small share of a portfolio, that doesn't mean it's a risk worth taking.