Myopia, or nearsightedness is a common affliction among those who seek to profit from the financial markets.
All too often practitioners, professional and neophyte alike, head straight into back-testing code and fail to think about the big picture.
You can only think about the big picture in investment by considering “history”. In financial markets as in human society in general, the same things have happened again and again throughout history.
What you need to do is to take the long view.
My suggestion is to focus on how to avoid such traps, largely centering on wide diversification over asset classes and geography; and simplicity.
You need to study financial market history before putting finger to keyboard. You need to look at long term stock and bond market returns over the past couple of hundred years before you can extrapolate such returns into the future.
You need to look at the booms and busts of history, since however clever you may be, you are likely to face their equal or worse in the coming years.
Study the South Sea Bubble of 1721 and the Wall Street Crash of 1929 (followed by the Great Depression). Why did these cataclysms happen and why will similar events re-occur again and again in the future?
See for yourself that it can take decades for stocks to recover from such a catastrophic draw-down.
Learn from that sobering fact the value of diversification. See for yourself through back testing how such a catastrophe could have been ameliorated by not putting all your eggs into one basket. How commodities, bonds, real estate and other asset classes may have their part to play.
Understand what leverage would have achieved for you in such a period and ponder the demise of the mighty Lehman Brothers, Barings and so very many others. They failed to learn the lessons history could have taught them: that greed and leverage will sign your financial death warrant unless your luck, skills or ability forecasting is that of a major deity.
Learn that there is no guarantee for the future and that there are no real “experts”, only people with experience who have come through periods you may not yet have suffered.
In a long career you will see many “experts” come and go. Few have the fortitude or perhaps luck of the well-known survivors in the markets. Learn to be a realist in the face of an uncertain and perhaps random universe.
In practical terms and when you get down to planning your investments, this all boils down to a few key common-sense rules.
The fist commandment is to learn humility: your predictions will very probably prove wrong over the long term.
Hope for the best while preparing for the worst. Did you foresee the 2007/2008 disaster? If you did were you correctly positioned to avoid the draw-downs and losses less savvy investors suffered?
Did you know that in the early 20th Century the markets with most sex appeal were Imperial Russia, the Kaiser’s Germany and Argentina? Are you aware that you would have lost every penny invested in those markets?
You can avoid such traps, largely by wide diversification over asset classes and geography; and simplicity. By focusing on fundamentals and realizing that in the absence of the collapse of civilization or a meteor strike you will have done as well as any man can do: simply to preserve your capital over time.
Weltanschauung 