Much of Western science and law is built on a single, important concept, one that is generally misunderstood -- if not just flat-out ignored -- in public discourse. Our core scientific and legal decision-making processes are intentionally biased -- often overwhelmingly so -- toward a particular result. Scientists call this "preferred" result the null hypothesis; judges call it not guilty.
Switching to Rule Breaker investing, we recognize a strong parallel to these biased decision rules. When evaluating our investment candidates, we Breaker Fools should comfortably lean on our own version of the null hypothesis -- Don't buy it.
Now, before you accuse me of biting off the hand that feeds me, I'm not suggesting a complete cessation of Rule Breaker investing among Fools. It's a little more complicated than that. Let's break it down...
Protection, fundamental beliefs, and common misunderstandings
In general, our biased decision-making machinery is designed to protect us. For example, unless presented with overwhelming evidence to the contrary, the FDA will always fall back on its particular version of the null hypothesis -- this new drug is not safe. Similarly, our legal system demands evidence to support guilt beyond a reasonable doubt before it will reject its own null hypothesis -- not guilty.
These biases have become so ingrained in our culture that we have to stop and think for a moment to fully appreciate their magnitude. To promote this reflection, it's useful to state explicitly what we are protecting ourselves from. In the case of FDA drug approval, our bedrock belief is that unintended, negative side effects are a more onerous risk than missed opportunities to heal -- "First, do no harm." Similarly, our legal system reflects a widely shared belief. As a society, we've agreed that it is far worse to risk locking up the innocent than to risk letting the guilty free.
As fundamental as these biased decision rules are, it's surprising that they are so widely misunderstood. To pick an example familiar to almost everybody, there are a lot of Americans who believe that O.J. Simpson was found "innocent" in his highly publicized criminal murder trial. Not true. He was found "not guilty." If this strikes you as a mere semantic distinction, you've missed the whole point of our criminal justice system. Similarly, most business decision makers have been tricked -- by inadequate introductory statistics courses -- into thinking that a test of statistical significance is an objective, unbiased decision rule that precisely cleaves truth from falsehood. Again, not true.
Protection for Breaker investors
As we saw in the general case, our Breaker null hypothesis -- don't buy it -- is designed to protect. While Fools aren't much interested in investing risk, as measured by market volatility, the business risk faced by most Rule Breakers is very real. It's not that Breaker stock prices jump around a lot that worries us. We ignore this noise. It's the non-trivial probability that our young, emerging Rule Breakers, operating in completely undefined industries, will fall leagues short of lofty expectations or, worse, simply cease to exist. And, bottom line, the vast majority of investors can't afford to risk their nest egg -- or a big slice thereof -- on such investments.
Fundamental beliefs of Breaker investors
Again, we draw the parallel. Our null hypothesis is supported by basic, strongly held beliefs. First among these is that Fools love broad, passively managed index funds. We just love the idea of universal participation in capital markets, and we think that the stock market is where you ought to be if your investing goals are framed in terms of decades, instead of years. At the same time, however, we hate that so many investors cut their market teeth in badly managed mutual funds, where so much of their hard-earned money is sacrificed to hyperactive stock-picking and market-timing nonsense.
This is why index funds are the null hypothesis of the Foolish investing framework. In other words, unless you have solid confidence in your abilities, and overwhelming evidence in favor of a particular stock, don't buy it! Just getting into the index fund gets you most of the way home. It will preserve your assets and enable you to share in the broad, long-term growth of our economy.
So -- you might ask at this point -- why do we bother writing about Rule Breakers if we're so cautious about buying them? Well again, the answer comes down to a few fundamental beliefs, although these are more Breaker dogma than Fool.
First, we believe that the long-term benefits of stock ownership are not measured in investment returns only. Win or lose, you learn a lot by carefully following a business that you own. Given that many of us don't have time for more than a few, it makes sense to get a Rule Breaker into the mix. Where else can you learn so much about emerging business and technology trends with the potential not only to maintain your interest, but also, perhaps, to boost your career?
Second, if you're going to break off a small chunk from your broadly diversified index fund base, doesn't it make sense to take some risk with it? A safe, blue-chip ripple is unlikely to move Battleship Index Fund much, but a Rule Breaker wave might do the trick!
Common Breaker misunderstanding
There is one final parallel between Rule Breaker investing and our kick-off discussion of the null hypothesis. This one falls under the "misunderstanding" heading. We often get mail that takes us to task for missing -- not buying -- a particular Rule Breaker. This scolding, however, misses the whole point. Just because we don't buy stock in a company, or you don't buy stock in a company, doesn't mean it's not a Rule Breaker. Only the future can anoint Breakers with such certainty.
Since our null hypothesis is don't buy it, not buying is merely the status quo. It's a "non-event." The bar is quite high, and the real events, in our minds, are those rare occasions when we actually reject the null hypothesis and buy. And by "we" I don't mean our Breaker team here at Fool HQ. I mean you! Only you can know if you have sufficient confidence, certainty, and interest to reject the Breaker null hypothesis.
Wrapping it up
In summary, then, we're not saying, "Don't buy Breakers!" No siree. We're just saying that you probably won't need many and that there should never be any hurry to jump in. In Breaker investing, just as in science and law, it's OK to stand by the null hypothesis for as long as it takes.
P.S. If you're looking for a place to start learning about investing, give The Motley Fool's Beginning Investing Online Seminar a try. You can test-drive the first lesson right now if you want to.
Paul Commins does not own any of the companies that compulsive philosophizing prevented him from mentioning in this story. To see what he does own, at any time, view his profile. The Motley Fool is investors writing for investors.
