Chess is the ultimate thinking person's game.
Regardless of how often you play or the number of times you beat Uncle Joe at Thanksgiving, there's always room for improvement. It's been estimated that the number of possible chess positions -- or "permutations" for all of you quant geeks out there -- is approximately 10 to the power of 120. I have no idea what that number is called, so you're going to have to trust me on this one -- it's a lot. Far too many for any individual to learn in a lifetime, let alone effectively apply in actual chess games.
Therein lies the beauty and fascination of chess -- no single person has ever completely figured it out. Sure, there are a few exceptional whizzes who have achieved Master or even Grandmaster status, but even they aren't able to capitalize on every single scenario. In fact, they don't even try.
Masters know less than you do
A common misconception is that expert chess players gain their advantage because of an astonishing ability to see dozens of moves ahead of their opponent, and are believed to have the calculative abilities of an Intel (NASDAQ:INTC) microchip. However, research has shown that chess masters actually tend to consider fewer options than less experienced players.
In the 1960s, psychologist and chess master Adrian De Groot conducted studies that investigated the cognitive differences between how amateurs and masters processed information. He found that Grandmasters didn't calculate excessively, but instead, tried to position their pieces in a way that gave them the biggest likelihood of success. In other words, De Groot found that success in chess oddly reflected the ability to sidestep unnecessary calculations!
Of course, it takes years of practice to be able to know what "good" position looks like, and this is precisely where chess masters gain their advantage: They have a deeper understanding of chess than their opponent -- not necessarily a higher I.Q.
From tops to bottoms
By the same token, beginning investors often believe that investment success is due to superior forecasting abilities of Wall Street professionals like market analysts, strategists, and economists -- you know . the usual suspects who regularly appear on financial TV.
To the average person watching, these "experts" really do give the impression that they have the brain power to interpret vast amounts of macroeconomic data in order to make predictions about the stock market. They also seem to make perfect sense when they argue for the purchase of specific stocks because, of course, they're the ones that will benefit most from their prescient forecasts.
On the surface, this top-down approach to stock picking appears reasonable enough. But in truth, picking stocks based on prophetic forecasts is akin to making a chess move based on the precise knowledge of 10 to the power of 120 chess positions: Sounds great in theory, but both are nearly impossible to apply in reality.
Forecasting fumbles
It's no secret. The track record of professional forecasters is downright ugly.
Instead of telling us what's going to happen, economists and analysts alike simply tell us whatever has just happened. Don't take my word for it. All you need to do is glance over some charts in the Survey of Professional Forecasters (fun reading on a Friday night) to understand what I mean. The charts clearly show that forecasters have a tendency -- albeit a naturally human one -- to take the most recent events and extrapolate them into the future. It should come as no surprise, then, that the historical calls of forecasters have always lagged actual events, rather than predicted them.
Now, does this mean that market forecasters are all small-f fools only disguised as intelligent people? Obviously not. Economists and investment strategists are some of the brightest individuals in the world with astronomical I.Q.s. But just because something is somewhat possible doesn't necessarily make it probable. Forecasting market events or calculating 32 precise chess moves in advance are all theoretically possible. Risking hard-earned savings or trying to win a chess match based on actually being able to accomplish these things is a completely different story -- no matter how smart you are.
Fools always focus
No, my Foolish friends. The key to investment success doesn't lie in any unusual predictive powers like many on Wall Street or the financial media would have you believe. Those who have achieved superior gains over several decades -- as opposed to the short-term good luck that each of us has once in a while -- don't do any complicated calculations at all.
From Benjamin Graham, the father of value investing, to the modern day master Bill Miller of Legg Mason Value Trust (LMVTX), investment champions simply position their portfolios within attractive risk/reward situations and give themselves the best probability of winning over the long run -- in the same way our chess master friends position their own pieces. So, just as De Groot discovered with chess, investment success also perversely reflects the ability to avoid unneeded calculations.
Foolish investors should channel their efforts on what's completely under their control while simultaneously drowning out the noise of the financial markets. Avoid listening to forecasts about whether the economy is in for a boom or bust. Forget about what the stock market is going to do. Instead, pick out a small handful of businesses -- within a couple of industries you understand -- and concentrate.
Make the easy move
Being right about a few individual businesses is always a better bet than having to first be right about the entire economy and then the specific stocks that will benefit most from your predictions. Use sound business judgment instead. I mean, did you really need to study the Fed's policy on money supply in the late 80s in order to get rich by investing in Microsoft (NYSE:MSFT)? Was a sophisticated understanding of the inverse relationship between inflation and unemployment required to buy Costco (NASDAQ:COST) shares in the mid-90s? Both of those companies would have built a substantial amount of wealth for anyone who studied their business models and the sustainability of their competitive advantages, rather than worrying about the economy.
It's not easy to do, but throwing out your crystal ball is crucial to long-term investment profits. Don't try to forecast dozens and dozens of stock market moves in advance if there's a perfectly fine business staring you right in the face. Remember, each one of your investing moves counts. Play from a position of fundamental strength, and don't ever speculate on your ability to forecast way out into the future.
Invest like the chess Grandmaster Richard Reti who, when asked how many moves in advance he usually saw, answered "I only see one move ahead. But it's the right one."
Microsoft and Intel are Motley Fool Inside Value selections. Click here to discover the latest value recommendations. It's all free for 30 days.
Costco is a Motley Fool Stock Advisor pick.
Fool contributor Brian Pacampara prefers speed chess because he loses a lot faster that way. He own shares of Costco but none of the other companies mentioned. The Fool's disclosure policy is always the best move.
