Keep It Simple (But Not Too Simple)

Listen to many market pundits and prognosticators, and they will make the stock market seem like a completely understandable world that, with time and dedication, can be mastered. But in a great piece on his Above The Market blog, Robert Seawright says that neither overly simplistic theories nor incredibly complex ones will give you all the answers.

“We love complexity,” Seawright writes (h/t to The Reformed Broker for highlighting the piece). “We should of course go with the simpler explanation or approach unless and until something more complex offers greater explanatory power. But we don’t. We want to include our pet political ideas, convoluted conspiracy theories or favored market narratives.  We are ideological through-and-through, and the more complex the better.” Indeed, investment managers use complexity as a marketing tool, he says, both to protect themselves against blame for poor performance, and to make clients think they need a professional to guide them through the complex web of the market.

But on the other hand, oversimplification isn’t the path to success either. “Markets are binary.  They can only move up or down,” Seawright writes. “That makes it seem as though it ought to be simple. We even talk that way.  The market rallied today due to positive earnings releases. But markets are actually moved by the interrelationships of an infinite number of variables. We tend to want to focus on one big thing — e.g., the Fed, trading sentiment, or the political landscape — and to concoct if/then scenarios in response. We want a tuned market.”

How then should you approach investing? “The best we can hope for is to create and test an appropriately probabilistic outlook, recognize its limitations, and act accordingly,” Seawright says. “As always, investing is really hard.  It is therefore imperative to keep things as simple as possible but no simpler.  We should resist complexity for its own sake.  Proper default settings and a data-driven approach are vital.  The markets aren’t tuned.  They are a boisterous cacophony of competing forces and interests.  If we are to succeed, we need to keep things as simple as possible, but no simpler.”