Why there could soon be a fresh burst of market selling. Plus, what are your ‘big beliefs’ about investing?

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Morgan Housel is a former columnist at The Motley Fool and The Wall Street Journal who is now a partner at the venture capital focused Collaborative Fund. His most recent blog column, Big Beliefs, is a typically brilliant explication of the importance of identifying core concepts in investing and indeed most complex endeavours.

The post begins with a reference from the self-help book Succeeding by John T. Reed, which argues that studying any field of knowledge requires much less memorization than most people believe. Instead, there are usually between three to 12 core principles that need to be identified, and then the bulk of the rest is just combinations of these principles.

Mr. Housel then recounts his core beliefs about investing, starting with a vital one: “The inability to forecast in the past has no impact on our desire to forecast the future.” The short-term future of markets is unknowable but the risk of losing investment capital, combined with the fantastic profits that a working crystal ball would generate, often have investors talking themselves into following highly fallible pundits and indicators.

He also discusses the difficulties in identifying the difference between investing skill and dumb luck. He notes that investing is a game of probabilities. “You can make a good bet with the odds in your favour and still lose, and a reckless bet and still win,” he writes. “It makes it difficult to judge others’ performance.”

Michael Mauboussin, a finance professor at Columbia University and head of consilient research at Morgan Stanley Investment Management, has done considerable work on the luck versus skill issue. He believes the mark of a game of skill is that it is difficult to lose on purpose.

Consider that it’s not that easy to lose a stock-picking contest even if one tries. History even suggests throwing darts to pick an investment could beat a professional manager over a short time frame.

Mr. Housel’s column also discusses another issue related to luck versus skill. The author argues that no asset manager’s success is believable until they survive a calamity. I agree with the sentiment but would apply it slightly differently.

For every market event, there will be fund managers and strategists that predicted it and are happy to tell us about it at length. This is admirable but no proof they can do it again. The best managers can repeatedly find market turns, both up and down – although importantly, all of them will make mistakes over time.

The best example I know of a strategist with the ability to see market turns is Richard Bernstein during his tenure as Merrill Lynch’s chief quantitative strategist. In March 2000, Mr. Bernstein published Attention Venture Capitalists: Leave Silicon Valley for West Texas. The report simultaneously called the top of the technology bubble and the beginning of a near six-fold rally in crude prices.

Mr. Housel also discusses the dangers of good investing ‘stories’, how calm periods in markets often lead to disasters and the importance of sitting still. I highly recommend that investors read the piece in full.

— Scott Barlow, Globe and Mail market strategist

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