WARREN BUFFETT HAS said that, when he’s in his office, he spends about 80% of his time reading—as much as 500 pages each week. And for good reason. One of his mottos is that “knowledge compounds.”
Judging by his track record, this approach seems to work. Even in his 90s, Buffett believes there’s always more to learn and that more knowledge will lead to better investment results.
At the same time, investors often invoke expressions that suggest otherwise: No one has a crystal ball. No one can see around corners. Be careful of unknown unknowns. In other words, all the reading in the world can’t help you predict the future.
Author and retired investor Nassim Nicholas Taleb has written several books on this topic. His view: Investment markets may be somewhat predictable. But the most important events—what he calls “black swans”—are entirely unpredictable, and they can be devastating. Even when we think we’re seeing repeatable patterns in investment markets, Taleb says we’re really just being “fooled by randomness.”
Taleb uses the analogy of a billiards table: When a player, even a novice, hits the first ball, he can be pretty sure which way it’s going to go. A skilled player might be able to control what will happen when the first ball hits the second. But beyond that, it’s anyone’s guess. Things are just too random. Taleb sees the economy and investment markets the same way. Because there are so many variables at play, it’s nearly impossible to know how things will turn out.
I noted last week, for example, that Tesla’s success in the electric vehicle market can be attributed to a number of factors that were unpredictable. Perhaps most significant: Toyota—the largest car maker in the world—has been skeptical of electric vehicles and, as a result, has chosen to stay largely on the sidelines. That was a decision no one could have predicted. In fact, it’s the opposite of what many expected. And yet, it’s added immeasurably to Tesla’s market value.
If it’s difficult to know where any one company is going, it’s even more difficult to know where the overall economy is headed. We’ve seen this in living color over the past few years. At least five events couldn’t possibly have been predicted, no matter how much research an investor had done.
First was the initial emergence of COVID-19. While the risk of a global pandemic was generally understood by experts, no one knew that it would occur in 2020 or what its effects would be. Indeed, there had been coronaviruses before, but none had spun out of control like this one.
As we know now, the government’s response, in the form of stimulus payments and other programs, led to an inflation spike. Many foresaw this, but I don’t think anyone could have predicted how the Federal Reserve would respond.
Throughout 2021, as inflation climbed, Federal Reserve Chair Jerome Powell assured investors that it was “transitory.” Because of that, Powell and his colleagues at the Fed declined to take action. It wasn’t until November of last year that Powell acknowledged that perhaps inflation wasn’t going to be transitory. “It’s probably a good time to retire that word,” he said. That was the second unexpected event.
The third event: After denying that inflation was a problem, Fed officials did an abrupt about-face and began hiking rates in dramatic fashion.
The fourth event: Russia’s February invasion of Ukraine. Because Russia is a major energy exporter, and because Ukraine is a key grain producer, commodity prices spiked, contributing to an inflation rate that was already climbing.
The fifth and final unexpected event: China’s stubborn pursuit of a “zero COVID” policy. By continually shutting down major cities—and their factories—China’s autocrats have further contributed to rising prices by prolonging product shortages.
To be sure, the past few years have been unique, but they aren’t unusual. The reality is, unexpected events occur all the time. As investors, what should we make of this? On the one hand, knowledge and expertise must count for something. It’s hard to imagine Warren Buffett is wasting his time when he sits and reads 500 pages a week. At the same time, no amount of research would have helped any investor—no matter how skilled or experienced—to predict these events.
So far, I’ve been talking only about predictions. But a particularly depressing data point calls into question even the facts we think we know. In the early 2010s, scientists discovered that the results from a surprisingly large number of research studies couldn’t be replicated. This has been found in diverse fields, from psychology to medicine to economics. In some fields, fewer than a quarter of studies can be reproduced—to the point that this phenomenon is now known as the “replication crisis.”
Where does this leave us as investors? I have a few suggestions. First and maybe most important, see investment markets for what they are. Economics is not a science in the same way that chemistry or physics is. That’s because, as Taleb explains, there are simply too many variables at play.
But that doesn’t make investment research worthless. It just means we need to adopt the right posture when looking at investment data. We can’t view market-related information as definitive. Instead, we need to see it only as a point of reference. Because of that, we should view the future in terms of ranges and probabilities—not absolutes.
In economics, there’s no such thing as an E=mc2 type formula. But there are approximations. For instance, the relationship between interest rates and bonds, as I discussed recently, is fairly reliable. It’s worth reading and learning, as long as it’s done with the understanding that this information can help us make educated guesses, not guaranteed predictions.
How can you put this philosophy into practice? Unless there’s a clear and present danger, try to avoid making big changes all at once. Thinking of changing your asset allocation, paying down debt or starting a new business? See if there’s a way you can implement these decisions in half-steps. Similarly, investors should always be looking for ways to hedge, to diversify or to split the difference on big decisions. That can be invaluable if things turn out differently than expected.
A related point: Because investment markets are so unpredictable, it’s important to develop a plan that’s flexible—one that will work whether the stock market is up or down. That can help you stick with your plan throughout market cycles, through good news and bad.
It’s a balance, though. Yes, you want to stay consistent with your investment plan, but you don’t want to be overly wedded to it. There’s a point where consistency can cross over into stubbornness.
Aesop talked about the difference between a giant oak tree and a lowly reed. While the tree is bigger, the reed is more flexible. This gives the reed an advantage during storms: It can bend, while the oak, because it’s rigid, might simply break. How can you apply this kind of flexibility to your finances? There’s the expression that one should “hold opinions loosely.” I see this as a helpful idea. If we aren’t too adamant with our opinions, it’s much easier to avoid cognitive dissonance when we’re exposed to contrary opinions.
A final thought: I don’t know what Warren Buffett reads, but my guess is he casts a wide net. Because investment markets are influenced by such diverse factors, I recommend this same approach. Look at news and data the way you might look at puzzle pieces on a table. At first, it’s hard to see the big picture. But the more pieces we collect—and the more time we spend thinking about how things might fit together—the better informed we’ll be as investors. No investment puzzle will ever fit together perfectly, but that’s okay. After all, even Warren Buffett—at age 92—is at his desk every day working on these puzzles.