I’ve been thinking a lot lately about faith. When I say faith, I’m not talking about religion, at least not in the Old Testament Yahweh sense of religion. I’m talking about investing/trading faith. Stated simply: The more I learn about markets, investing, trading, etc. the more I see that, eventually, everything comes down to faith.
When I was in college, I didn’t much like the liberal arts classes (which is ironic given my current predilection for writing) mostly because the answers were subjective. My interpretation of some work of art (a book, a painting, etc.) was ultimately critiqued by the teacher and/or the class and, if my view didn’t fit with the collective view, I didn’t get a good grade. By comparison, I thrived in math where there was one correct answer.
While I’m a bit old to march off in pursuit of a PhD, I sometimes romanticize the idea that, in some other iteration of the multiverse, I went on to pursue a PhD in math and became a professor spending my days blissfully ensconced in a little math bubble. In this utopian ideal, at least while I was working, everything would have been neat, clean, and tidy. There would have been clearly defined right answers and wrong answers making for a simpler life.
When I first embarked upon my quant finance quest, I thought that it would be like math class - that there would be right answers and wrong answers. Initially, this seemed true. I got some data, ran some simulations, used statistics to qualify these simulations, and was then on my way to hefty profits and absolution from the evils of discretionary trading.
But, after a while, I came to see quantitative investing/trading for what it is: a mechanical implementation of discretionary logic that is chosen mostly based on subjective determinations (i.e. you decide which output from the simulation qualifies a system for use). It also became clear that, with a lot of quant finance, the future needs to look a lot like the past for things to pan out as per simulation born expectations.
Over time, I graduated to the realization that quant finance might actually be worse than other methods simply because it is hard to throw in the towel when you’ve invested a lot of time building a system and you have rock solid statistics supporting your decisions. Of course, these stats only apply to the simulation timeframe (aka sample) and, if the future doesn’t look like the sample, look out.
As a quick aside, I still like systems, but I like them to be based on some fundamental reality. Fundamental realities might include the reality that $500bb plus heads to stocks and bonds each year by virtue of the American retirement system or that human nature doesn’t change (why, IMO, trend following works). If you predicate your system on a fundamental reality and the reality changes, you know it is time to pull up stakes and do something else.
Back to the larger point, the irony of systematic investing/trading is that, when things “break” you’re left with the same tools to “fix” the problem. In the end, systematic trading based purely on backtests is a bet that the future will look reasonably like the past and, if it doesn’t, you’re back to square one using the same tools to design an approach that will, once again, make the same inherent bet. But that’s a topic for another day - today’s topic is faith.
All of the above is a long lead in to the concept of faith in markets. I came to see that, whether they were aware of it or not, by virtue of their actions, system designers ultimately have faith that a system will achieve market success - otherwise why trade it?
As I realized this, I started to look at other market disciplines and I saw faith everywhere.
Take Warren Buffett - he deeply believes in America and stocks. Repeatedly he has stated in interviews that his faith in the American way of capitalism contributed greatly to his success. His recently deceased right hand man, Charlie Munger, said the same.
Wealth managers (or the ones dictating the investment methods they use aka 6040) have deep faith that the future will look like the recent past (although maybe they shouldn’t) and that stocks and bonds will achieve returns much like the past 50 or 100 years in order for their financial plans to manifest. Ultimately, probably unknowingly, they have a lot of faith in modern portfolio theory.
Another example, people who hold for tax efficiency (in the form of long-term capital gains status in the US) have faith that things will go up and, by virtue of that and staying put, they will be rewarded with tax free compounding. Again, perhaps unknowingly, they have faith (or their advisors do).
So, will buy and hold keep on keeping on? Will that system manifest as expected? These and similar questions can be generalized to a larger question: Will our investment plans manifest as expected? We can convince ourselves all we want, but the truth is that we just don’t know because we cannot see the future. So we make decisions based on information and advice available to us and, whether we are cognizant of it or not, by virtue of our actions we are expressing our market beliefs and associated faith. But it all comes down to faith.
Food for thought.
In case you’re wondering, after 20+ years of a lot of trial, error, and research, I have deep faith in focusing on survival and on trading principles. For whatever it is worth, my faith endears me to various Market Wizards and their brethren but tends to put me at odds with the rest of the investment world which, to me, is an interesting reality.
As it relates to retirement investing, you can find my thoughts here:
Good one George!