From Black Magic, Sorcery and Monsters to Finance 3.0

The following comes from Robert Hagstrom’s highly underrated book, Investing: The Last Liberal Art. Hagstrom is discussing author Michael Shermer’s book How We Believe:

Shermer suggests that we can better appreciate the role of the belief system when we think back to the Middle Ages. During this period, 90 percent of the population was illiterate. What little scientific information was available was possessed by only a few – the intellectual elite. Everyone else relied on black magic, sorcery, and monsters to explain the workings of their world. The Plague was caused by the misalignment of the stars and planets. The death of a child was caused by vampires or ghouls who lived in caves. A man who saw shooting star or heard the howl of a wolf in the night would be dead by morning.

The Newtonian revolution accompanied by the overall rise of literacy worked to reduce outlandish superstition. Chemistry replaced alchemy. Pascal’s math explained bad luck. Social hygiene reduced disease, and improved medicine prolonged live. Overall, we can say the Age of Science worked to reduce the errors in thinking and irrational beliefs.

Shermer’s tales of the transformation in thinking from the Middle Ages to Age of Science dovetails nicely with the world of finance and investing. Let’s assume that Finance 1.0 was all about the intellectual elite relying on black magic to sell products to clients. Churning portfolios to earn commissions was the sorcery of this period. With no Internet and few good options for sound financial advice, there wasn’t much of an alternative.

I would consider the financial crisis in 2008 to be the dawn of Finance 2.0. The playing field has been leveled to a large degree as the information barrier has been lifted. The magicians no longer hold all of the knowledge. Brokers are a dying breed. Certain hucksters can still take advantage of investors by preying on people’s search for certainty and authority on the financial markets, but things are definitely better than they used to be.

There are more options and better choices. The Internet makes it easier than ever to access a wide array of account options. Costs are much, much lower. Information is plentiful, so investors can educate themselves if they are so inclined. Also, there are more voices that offer perspective and understanding as opposed to grandstanding and daily stock picks (although you can still find that if that’s what you’re interested in – something for everyone). It’s now easier than ever to build a low-cost, broadly diversified global portfolio utilizing different fund structures, asset classes and risk factors that average investors could only dream of even a decade ago.

I had a reader leave a comment in a recent post about the 1987 crash. He said he found out about the Black Monday one day 20% plunge on the radio on his way home from work. Compare that situation to what we have available today – real-time stock market pricing, 24-hour financial news channels, social media, blogs and a constant stream of up-to-the-minute analysis on every single economic data point, earnings release or blip in the markets.

During the sell-off in late-September and early October, anyone that was on Twitter got a front row seat to the wild swings in emotions that can accompany a stock market correction. It’s something of a real-time barometer of investor sentiment, something that would have taken a landline phone survey in the past.

If Finance 2.0 was about leveling the playing field, decreasing costs and increasing investor understanding, I can’t wait to see where Finance 3.0 eventually takes us. My guess is that it’s going to marry technology with behavioral finance, something that’s already beginning to take place as Silicon Valley elbows its way into the finance industry. There will be systems and portfolio tools that will make things even easier for investors. I’m excited about where things are heading as more and more intelligent people continue to disrupt the old guard of the finance world.

What will we look back on in a couple decades about the investment industry and consider it the black magic, sorcery, and monsters of this day and age?

Investing: The Last Liberal Art

Further Reading:
Things just keep getting better and better for investors
The style box of the future


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