Perhaps the hardest thing to do on the way to becoming a successful investor is unlearning everything you think you know about financial markets and the economy. The difficulty lies in admitting you do not know very much at all. Face it: You probably will not be able to add extra return to your investments by using your “knowledge” of the markets and economy. You may even hurt yourself.
This is important because the illusion of knowledge and foresight prods us to act. After all, if we know what we are doing and understand the ways of the market, why should we sit back and let it push our portfolios around? Why shouldn’t we take action and make changes based on our convictions?
Maybe we should heed the lessons posed by professional investors. It appears that no one has found the magic key that allows him or her to master the markets. If someone had, we would know: We would all be working for that person by now because he or she would control a majority of the world’s economic capital. Sure, a few very wealthy individuals such as Warren Buffett have realized extraordinary returns in the markets. But even they control only a small fraction of the world’s investable capital, and even their fortunes rise and fall with market and economic trends.
Why are you so certain that the stock market is going to fall because (insert your reason here) of some event happening today or predicted to happen tomorrow? Try examining your own simple predictions about your personal future. Go back a few years and honestly assess whether you predicted then where you would be living now, with whom, what your work would entail, where your children, parents, or grandparents would be, who would be your president, your congressman, your mayor, or what type of summer we would have in 2005. The possibilities are endless and the answer is the same: a few of your predictions came true but many didn’t. Life was constantly surprising, wasn’t it? If you cannot make correct predictions about your personal future—something about which you have some real control—what makes you think you can do so about a larger and more complex system over which your influence is non-existent?
Rather than trying to control the markets by taking actions with our portfolios (a habit shown to be financially damaging according to studies of thousands of individual investor decisions by several finance researchers), investors would do better to trust the capital markets to reward their participation. Capitalism is predicated on a proven phenomenon: the combination of labor, natural resources, intellect, and financial capital results in the creation of wealth. All an investor need do to grab his portion of that wealth is to put his own capital into a diversified portfolio that spreads it across the world’s financial markets. The reward will be the capital market rate of return in each market. There seems to be no question that those returns have offered great profits to investors over long time periods. Simple participation, without frequent decisions and activity, is rewarding to those who muzzle their inner control freaks.