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Why Smart People Lose More Money

Although I have a very passive and low-maintenance portfolio I like to read about financial markets regularly to learn more, especially at times like this when something new or unusual is happening. Unfortunately there aren’t that many wise and practical things you can say about the market so this quickly devolves into reading a bunch of senseless garbage (often promoting some newsletter or book). It all sounds like a reasonable, logical, and detailed analysis and yet it has no basis in reality.

On another side, I’ve noticed that certain family members don’t understand the markets that well. The strange thing about it is that even after losing tens or hundreds of thousands of dollars they still think they can predict what will happen next. And these are people who work in a somewhat obscure statistical field (when I tell people what they do I have to spell the job title) so they should have the capacity to figure it out.

I think both examples come back to the same thing which sounds kind of crazy: being smart is a disadvantage when it comes to investment markets. The reason is simple as this comic shows. Smart people think they can take the information that’s available and figure out what’s happening. So they automatically start trying to do that with any numbers and charts they can find.

But this approach is far too simple since you can only analyze a few numbers at a time. Investment markets are driven by millions of factors. Most of those are only known to a few people and some aren’t known until much later. Many of them are completely illogical. It’s the perfect trap. It looks like a puzzle that a smart person can solve. But if they actually try they will just get lost in it and never reach the end.

Nassim Taleb talks about this a bit in his latest book Antifragile with a story that is probably dramatized a little: when he started trading he expected to find other traders walking around with calculators and using pricing formulas all day. To his great surprise he found that the best traders were almost anti-intellectual and uneducated. The top trader in Swiss francs couldn’t even locate the country on a map.

This is important to remember when you’re reading anything about the markets. Any analysis and prediction, as clever as it sounds, is missing important information and is probably wrong. Trying to guess what will happen next is a bad idea.

I chose a different approach by following a passive, diversified model. As long as our portfolio is prepared for many different outcomes I don’t need to know what will happen next. I do tilt and tweak this a bit but you’ll never see me making one big concentrated bet. I do my best to not get too smart. Only time will tell if it’s working.

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