A policeman sees a drunk searching for something under a streetlight and asks what he has lost. The man answers he has lost his keys and they both look under the streetlight together.
After a few minutes the policeman asks if he is sure he lost them here, and the drunk replies, no, that he lost them in the park.
The policeman asks why he is searching here, and the drunk replies, “Because this is where the light is!“
A friend sent me an article in the New York Times titled The Oracle of Omaha, Lately Looking a Bit Ordinary which frustrated me, as most articles about investing usually do. Such pieces often begin with a mathematician with far too much time on his or her hands searching for anything that confirms their conclusions just like the drunk under the streetlight. In a “spreadsheet filled with more than 30 pages of data and formulas”, the esteemed academic discovered that Warren Buffett underperformed the S&P 500 Index for the last 4 of 5 years. Wow! This is news. Not to sound sarcastic, but so what? While he does not state that Warren Buffett’s streak is over, he definitely infers that conclusion.
Observation bias is probably the greatest threat to investors’ success and the reason why the disclaimer “past performance does not predict future results” is required by the government on all performance advertising (newspapers are exempt because you cannot limit free speech even when it is flawed). Since 70% of our learning happens through our eyeballs, our brain naturally assumes that what we see is real. It is why people have more fear of flying than driving. Every plane crash is plastered on TV for weeks but we don’t see that Georgia roads killed 3 fully loaded Boeing 747’s last year alone. We don’t see the tragedy so our brains cannot process the real truth.
The same holds true with investing. Using history to form an opinion of the future is a very dangerous thing when it comes to creating and protecting wealth. Investing is about being at the right place tomorrow and creating the emotional crutches to protect yourself in the short term so you don’t fall victim to our scientifically proven psychological brain failures.
Warren knows what works – buying great companies that produce long term cash flow at a low price. No long spreadsheets needed to figure that out.
When you use past performance – or a newspaper for investment advice, you risk joining the drunk under the streetlight looking for his keys.