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Business

Investment Sayings May Mislead You

Stephen Doty says that the accumulated folk wisdom of the investment community should be taken with a large pinch of salt.

Some people need to invest more in philosophy, not in stocks, so that empty sayings don’t muddle their thinking and mislead them.

A yacht club gentleman gave me a little lecture on investing the other day. He put down his tennis racket, flipped up his collar, and said that the key to investing is to “Buy quality companies.”

That saying is not false, but it is a worthless tautology, because it offers no criteria for determining ‘quality’ – the very thing a buyer needs to know. And it is deceptive, because, in hindsight, it appears to work. We can all identify companies, such as Merck, that we should have bought twenty years ago. Thus, those companies whose stock prices went up may now be deemed quality companies. But when ‘quality companies’ mean ‘those that should have been bought,’ the reasoning is circular. A logician would say that it begs the question.

Or ‘quality,’ at a given time, may be interpreted to mean some general consensus of quality. A consensus, however, that is often wrong. Many analysts recently said that Cisco Systems was a ‘quality’ company – just before it fell from over 80 to under 15. Three years ago, Xerox was considered a ‘quality’ company; it fell over 85%. In 1972, the Nifty Fifty were considered the symbols of quality, before they crashed.

When I told this yacht club fellow that I bought Sony at 75 and sold it at 150, he told me that I violated the saying, “Let your profits run,” since Sony later went to over 300. He said that if I had held on, I could have honored the sacred canon, “Buy low and sell high.” These two sayings sound good and work – in hindsight; for only in hindsight can highs and lows be detected. At present, however, no one can tell if a profit allowed to ‘run’ won’t instead turn immediately into a loss. No one can tell where the high is either – in order to sell at it – because it can always be topped the next day. Most importantly, though, the sayings conflict. When Sony was at 150, one saying advised selling at the high, while the other advised holding for greater profits. And if the price fell to 140, say, I could have wrongly concluded that the profits ceased to run and sold the stock before it hit 300.

He sat back, lifted an iced tea, and said that someone should not have sold at 140, because “You must ride out the dips,” another popular saying. I asked what to do if the price then fell to 70, five dollars below what I paid for it. He said, “You must cut your losses.” These sayings conflict as well. Granted, they each have occasions in which they are correct, but that is only evident afterwards. That’s why they are deceptive. No one can tell which saying to follow at a given time. So, taken together, they are uninstructive. For example, if Sony fell from 140 to 50 and stayed there, then I should have cut my losses at 70; but if, instead, the price later rebounded from 50 to 200, then I should have ridden out the dip.

These five investment sayings fall short in the same way pseudo-science falls short of science. Mathematics – the language of science – is also the language of investing. Investing with the above sayings is like practicing astrology instead of astronomy. Sound mathematical instruction on stock buying and selling, on the other hand, is found in books such as Ben Graham’s The Intelligent Investor. Sayings do not measure up – and they may mislead you.

Stephen Doty has degrees in law and in philosophy and runs a private foundation in Salem, Massachusetts.