Avoiding the Extremes

In a speech to USC Law School graduates, Charlie Munger shared his thoughts about the problem with extreme viewpoints:

Another thing I think should be avoided is extremely intense ideology because it cabbages up one’s mind. When you’re young it’s easy to drift into loyalties and when you announce that you’re a loyal member and you start shouting the orthodox ideology out, what you’re doing is pounding it in, pounding it in, and you’re gradually ruining your mind.

Conviction in your views can be a good thing when making decisions. But taking those convictions to the extremes can allow little room for error or opposing points of view. You become single-minded and it’s much harder to be well-rounded. As Munger explained about the hammer syndrome, “To a man with only a hammer, every problem looks pretty much like a nail.”

Extreme views are nothing new to the finance industry. Here are some that I see constantly in the world of finance along with the gray area in-between that’s closer to reality.

Extreme Views: You have to be all-in the market right now. Forget that, get out while you can and go to cash.

Reality: There are going to be times where it would make sense to be all-in or all-out. And everyone will only know for sure in hindsight. But 99% of investors cannot psychologically handle being all-in or all-out. It’s hard enough living with underperformance in a diversified portfolio. When investors try to go all-in or all-out between cash and stocks without a specific catalyst or defined process for buy and sell decisions, it becomes a nightmare of stress and second guessing. Even with those constraints in place, it takes a steady hand and disciplined process. For everyone else, it makes sense to pick an allocation or make smaller, more methodical moves over time.

Extreme Views: You have to invest exclusively in index funds. No, active funds are the only true way to invest.

Reality: Extreme factions of passive investors think all forms of active management should be banished. And extreme factions of active managers think passive investing is the dumb money that will only blow bubbles and cause instability in the markets. There’s nothing wrong with believing more strongly in indexing or active management. To each their own. But these two schools of thought need each other to survive. Without one, the other wouldn’t work and vice versa. And neither one is ever going away. Human nature and market forces would never allow it. Both serve a purpose.

Extreme Views: The Fed is useless and can’t do anything. Ha, the Fed is the only thing propping up the markets right now.

Reality: One of the quotes going around about Fed policy is that if people truly understood how it really works, it wouldn’t work at all. Hard to say for sure, but many people have been wrong over the years about the consequences of the Fed’s actions. There’s obviously been an impact, but some people want to have it both ways. The Fed can’t be all or nothing. It’s had an impact but you can’t say it’s the man behind the curtain pulling all the strings. They’ve aided the recovery, but markets don’t move or not move exclusively because of central banks. There are too many other factors involved.

Extreme Views: My way is the only true way to invest. No, I hold the secret to the markets.

Reality: There isn’t one singular way to invest that’s perfect for every investor. That’s just not realistic. How much pain you’re willing to take over time will have a lot to do with the strategy that fits your personality. There are no perfect portfolios – only what works for each individual or organization. You can’t fit a square peg through a round hole.

Extreme Views: The market is about to crash. The market is bottoming and about to rip higher.

Reality: Most of the time the market is nowhere near an inflection point. It’s just somewhere in the middle of the current cycle. Inflection points are very rare. We’re not always at a top or a bottom. It’s not always a bubble or a crash. There are times when the markets move up or down but end up going sideways for long stretches. Markets are cyclical.

Extreme Views: The markets are totally inefficient, so beating the market is easy. Actually, markets are perfectly efficient, so beating the market is impossible.

Reality: Yes, beating the market is possible over longer time frames for probably 5-10% of investors. But that doesn’t mean things are wildly inefficient. Markets are hard. Most of the investors that mock the efficient market hypothesis have never actually beaten the market. It’s possible but ridiculously hard, because it requires patience, emotional control, and being different than the market, something most people aren’t equipped to deal with.

The market is more or less efficient most of the time. Most investors are probably better off acting like the market is efficient and keeping their costs low and focusing on their behavior.

Further Reading:


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