Don't Dis Simplicity
by Jim Stevens (JimStevens@aol.com)
Burlington, VT (June 8, 1999) -- It's fun to watch new Fools discover the Workshop. When new Fools first learn and understand these seemingly effortless ways to crush mutual funds, they become filled with glee and enthusiasm.
Who wouldn't be pumped up about the possibility of 20%, 25% or higher long-term returns with very little effort? After these first feelings of wide-eyed wonderment subside, next come the obligatory doubts and skepticism.
Although much of the skeptical torturing that mechanical investing is subjected to is healthy and justified, there is also a ton of it that's grounded only in emotion. It is human nature to doubt and look down on the simple and mundane, even in the face of obvious and compelling evidence.
On the website for James O'Shaughnessy's investment company, he offers an enlightening rundown on some psychological research that illustrates exactly that. Particularly charming was a study designed to see how people reacted to completely bogus reasoning, even when it flew in the face of their own very reasonable conclusions.
A Professor Alex Bavelas set up a study where two people, A and B, are seated looking at a screen. They can't see or talk to each other, because of a partition between them. Each is told they must learn by trial and error how to tell the difference between slides of healthy cells and sick cells. For each slide, they must push one of two buttons in front of them, "Healthy" or "Sick," whereupon one of two lamps, labeled "Right" and "Wrong," will illuminate. Person A gets correct feedback, meaning his "Right" lamp lights when he's right and his "Wrong" lamp lights when he's wrong. The As learned to tell the difference between healthy and sick cells with about 80% accuracy.
Person B got a different treatment. His right or wrong lamps lit based not on his own guesses but on Person A's guesses. He doesn't know it, but what he is doing is trying to determine order where none could possibly exist.
A and B are then instructed to collaborate on what they think the rules are for determining healthy vs. sick cells. A tells B straight up what he's learned and what simple characteristics he looks for to tell the difference. B's explanations, by necessity, are subtle, fuzzy, and complex.
After this discussion, all Bs and nearly all As believe B has a better understanding of healthy vs. sick cells. In a follow-up test, the Bs show almost no improvement, but the As' scores drop because the As have incorporated some of B's completely baseless ideas. For more reading, see How Real is Real: Confusion, Disinformation & Communication by Paul Watzlawick (New York: Vintage Books, 1977). It is currently out of print -- check your library.
When it comes to predictions of future trends in stocks, don't we hear those same subtle, fuzzy, and complex explanations all the time? From short-term stuff like the shape of a price chart or a small company working on a "little known" new technology, to longer term things like the effects of Y2K and the retirement of baby boomers, it seems investors just can't seem to get enough fuzzy, unusual explanations and predictions.
Give your friends a boring clue like "invest in large growth companies whose stock prices have gone up recently." You'll usually hear the proverbial "Well, d'oh!" The point being that the unusual, seemingly more cerebral predictions have more curb appeal; they're sexier. Simple, quantitative predictions are often viewed as much too obvious to actually have any value.
We see analogies of this kind of thinking everywhere. It's the rare, unusual and often inconsequential that garners the most interest, while the ordinary, specific and highly consequential don't even rate a thought. I've actually seen three TV news stories about the danger of turbulence to passengers on jet airplanes (something that I think has claimed one life in the history of aviation), but I can't recall a single probing expose on the dangers of adults not wearing their auto safety belts.
It's amazing how an investment strategy that's simple, boring, and obvious can be wildly successful but still remain unpopular.
Since Friday was the day to update the hypothetical mechanical models that I've been following on a monthly trading schedule, here's an update on how the two models did through June 4, 1999:
Month Year-to-date 5/7/99 - 6/4/99 01/01/99 - 6/4/99 UG5 7.88% -10.53 UG10 5.92% -5.95For the complete UG History from January 1987, see UG History.
Relative Strength-Investor's Business Daily:
Month Year-to-date 5/7/99 - 6/4/99 01/01/99 - 6/4/99 RS-IBD5 1.24% 76.56% RS-IBD10 2.94% 41.95%Fool on!