Asked if the markets were overvalued [in 1993], Buffett said, "I've never been a good judge of the markets. I try to evaluate specific businesses. If I could evaluate a few specific businesses every year half-way correctly, I'd look at it as a successful year. I've never made any money guessing which way the market's going." "Questioned about whether it was harder now to find undervalued investments, Buffett said it's harder now but, "It always seems hard at the present time."
We talk a lot on this blog about how easy it is to find so many voices that seemingly earn their livelihoods projecting absolute certainty about interest rates or short-term stock market movements. As I’ve stated in the past I have a suspicion that embracing your own ignorance can be a profitable decision for your finances, freeing you to build things that survive and perhaps even thrive in uncertainty.
A core philosophy of Buffett’s and his mentor Ben Graham is the futility of macro-forecasting. Buffett has said, "Charlie Munger and I have been buying stocks and businesses for 50 years. In that entire time, we’ve never had a discussion of macroeconomic factors in making a decision as to whether to buy, or sell a business." Acknowledging that you can’t predict the future is a theme echoed by the likes of Howard Marks and other investment luminaries.
While the “I don’t know” school of investing can feel extremely uncomfortable, it may come with the structural advantage of freeing the investor from wasting capital on macroeconomic bets. Instead you can focus on some highly practical and actionable strategies.
As an alternative to macro bets, you can commit to “knowing the knowable”. There are a few ways you can play the “knowing the knowable” game. One approach is to study financial statements of individual companies, focusing on micro-level analysis seeking to gain a specialized knowledge advantage over other investors who seemingly get lost in the macroeconomic noise. That’s the type of game Buffett and Munger have played, but it’s not for everyone. Most of us lay folk don’t possess the expertise or have the time to devout to this practice.
The second discipline is perhaps more realistic or practical. I think of it as “knowing the knowable” as it relates to you, the person. It’s first knowing the boundaries around your circle of competence. If you don’t believe you can predict which individual stocks will survive and outperform over your investment horizon, that’s good information. If you know you can’t spend time doing micro level investment research, that’s good to know and knowable. If you know that, you have a solution in adopting a broad diversification approach, one that hopefully allows you to participate in the steady upward drift of human progress without picking the winners in advance.
For those who acknowledge that stock-picking is not for them, they can focus their attention on an even more reliable, highly predictable domain of “knowing the knowable”: their own psychological wiring.
Our own behavior flaws are entirely knowable, though often painful to admit. If you can look in the mirror today and admit that you are prone to panic when your portfolio drops 20%, or that you experience insane FOMO if you hear that your friend's portfolio is up more than yours, that is a “knowable” thing that you can strategize around.
Passive index investing is not intellectually “lazy”, it’s a possible answer to a well thought out strategy in an attempt to win the battle with your emotions. It is your battleplan to outflank your emotional enemies. One way to do this is to embrace broad and largely automated indexing that removes yourself from the decision making loop entirely. By adopting a broad diversification approach, you should capture the steady upward drift of human progress without the need to pick the winners in advance. It’s about managing your own behavioral boundaries and protecting your capital from your own worst impulses.
Whether you choose to tackle the inherent uncertainty of the future by digging deeply into finding individual businesses to invest in or by surrendering to broad based diversification, one thing we also know with certainty is that leverage narrows the range of outcomes anyone can comfortably survive. Keeping your own balance sheet resilient is a sure way to ensure your psychology doesn’t snap at the absolute worst time.
Your psychological edge comes from aligning your actions with your actual circle of competence and that circle must always start with an honest audit of your own reflection.
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