If you follow the science news, you’ve probably run into a number of stories recently about supposed structures on the surface of Mars — buildings, doors, pyramids and the like — even evidence of humanoid people walking around.
Researchers have a word for this: apophenia. Our brains are hardwired to see patterns in the world. It’s why we cotton to lucky numbers, happy coincidences and all manner of reassuring “facts” that cannot be proven or even replicated.
The same thing happens when we go to invest. There’s an entire industry of investment advisors out there who seek to take advantage of your need to see order where objectively there is no order at all.
The most obvious of the money tricks is technical chart trading, the supposed wizardry of divining the short-term direction of a stock based on the recent past. But that same fallacy of seeking patterns shows up nearly everywhere in the investing business.
Financial journalists run polls of economists to try to predict the direction of interest rates or an index. Analysts peer deeply into the books of a company to derive the “fair value” of a firm and, from that, predict whether a stock will go up or down.
Traders use stock almanacs to develop theories as to why stocks go up in some months and down in others. What sports event outcomes predict a good or bad year for the stock market. How hemlines can be used to prognosticate, and so on.
All of it, unfortunately, relies on apophenia to work. Sometimes the chart-readers will be right, and sometimes wrong. Sometimes the analysts will nail an outcome, and sometimes they won’t.
The times when they fail, we tell ourselves, are due to exogenous factors, one-off events that weren’t expected and were not calculated into the prediction.
Average out the winning predictions and the losers and what happens? It starts to look a lot like guessing. In fact, it is guessing, but we want to believe (our brains really, really want to believe) so we plow on looking for reasons.
We really want the lady walking across the Martian sands to be real, and to live in a pyramid. Never mind how improbably such an outcome is in reality. Our brains want random reflections of light to make it real for us.
The solution, from an investing point of view, is to avoid any kind of attempt at guessing what’s next. You can’t be fooled by randomness, to quote the economist Nassim Nicholas Taleb, if you manage to ignore it.
What can you do with your investments that makes sense? Buy a portfolio that matches your own tolerance for volatility. Invest steadily over years. Rebalance periodically, even it hurts your brain to do so.
Keeping your retirement on track is a matter of avoiding the many intellectual traps set for you by your own brain. It won’t be easy at first, but once those first few years of investing sensibly roll by and you see the results, you wouldn’t have it any other way.