The tricky thing about investing is that there is no single “right” approach. A little while back, I talked about the “five minds” of the investor—the optimist, the pessimist, the analyst, the economist and the psychologist. But why these five? There are, in fact, many ways to be successful: You could invest in real estate, you could follow a quantitative strategy, you could invest in private companies—and these are just a few examples. There are plenty of people who do very well with these other approaches.
But there are also lots of approaches that, deceivingly, only look like they might work. Here are four other common investing styles that—attractive as they may seem—are, in my view, worth avoiding:
1. The Raconteur: A raconteur is no ordinary storyteller. According to Merriam-Webster’s dictionary, a raconteur is “a person who excels in telling anecdotes.” That’s exactly what’s dangerous about this approach to investing. Though their evidence might be anecdotal, raconteurs truly believe they are using facts to support their views. Suppose, for example, a raconteur is trying to research a consumer electronics company. They might speak with someone who works for the company or might try one of its products. In both cases, they’re collecting real data, but it’s too limited to be conclusive. Nonetheless, that information can be woven together into a story that sounds compelling.
Raconteurs, in fact, love to invoke the concept of “buy what you know,” an idea popularized by Fidelity Investments veteran Peter Lynch. In the introduction to his book One Up on Wall Street, Lynch argued that individual investors should buy stock in companies that they know and understand. “If you stay half-alert,” he wrote, “you can pick the spectacular performers right from your place of business or out of the neighborhood shopping mall…” He goes on to describe how he discovered several winning stocks—including Taco Bell, Dunkin’ Donuts and Apple—using just that method. But raconteurs overlook one key fact: It’s not that simple. Yes, Lynch recommended that investors keep their eyes open for new ideas. But he didn’t stop there. Read the rest of Lynch’s book, and you’ll quickly see that anecdotes were just his starting point. He then moved on to hard analysis. The bottom line: Lynch didn’t achieve his astounding results just by hanging around the shopping mall. Sure, that’s where he collected many ideas. But then he spent hours reading financial statements and speaking with corporate CEOs to learn more.
2. The Statistician: If the raconteur’s weakness is that he glosses over the need for reliable data, the statistician is the opposite: He never met a spreadsheet he didn’t like. Statisticians love to pore over companies’ financial statements, including sales figures, profit margins and more. Then they build models to forecast where those numbers might go in the future. Ask a statistician to tell you the r-squared on his latest regression analysis, and you’ll make his day. The problem with this approach: While the math might be impressive, a spreadsheet still can’t forecast the future. They can’t foresee things that will impact the overall economy, such as a pandemic. They can’t predict things that might impact specific industries, such as technology changes, price wars, or even floods. And they can’t predict things that might impact specific companies, including competition and regulatory challenges. I speak from experience here. I used to do this kind of work, and I learned the hard reality that world events can upend even the most detailed analysis.
3. The Gunslinger: A few weeks back, I talked about a fellow named David Portnoy, who may be the most prominent among today’s day traders. Portnoy’s signature line: “Stocks only go up. They only go up.” But while Portnoy might be the most well known, he’s hardly alone. Day trading has seen a significant resurgence this year due to the pandemic. And day traders aren’t the only gunslingers. The reality is that plenty of professional investors are too. Look at a typical actively-managed mutual fund, and you’ll see a “turnover” figure of nearly 100%. What this means is that fund managers are, on average, buying and selling almost every single one of the holdings in their funds each year. But while it might be fun to be a gunslinger, the data show that this isn’t a good strategy for professionals or for individuals.
4. The Philosopher: The philosopher is similar in many ways to the statistician. But philosophers focus on bigger, longer-term trends. One of today’s most well known philosophers, for example, is Nouriel Roubini. An economics professor at NYU, he earned the nickname Dr. Doom for being one of the first (and only) to predict the 2008 recession. Among his current concerns: the potential for military conflict with Iran, a crash in US Treasury bonds resulting from conflict with China, desertification in East Africa that could create “biblical-scale locust swarms,” and the risk that the current pandemic turns into a “Greater Depression.” Could Roubini be right with these doomsday predictions? Of course. But here’s the trouble with philosopher-style investing: Any one of these predictions could come true—or they might not. And even if one of these risks were to materialize, even Roubini can’t predict the timeframe. So what’s an investor to do? Should you sell everything and hide out in a bunker? The bottom line: The philosopher might sound like a sage—and might even be right over some time period. But it’s hard to translate these prophesies into practical solutions.
5. The Pragmatist: The pragmatist sees himself as the voice of reason, attempting to integrate the raconteur’s stories, the statistician’s numbers, the gunslinger’s bravado and the philosopher’s worries. Among these other four, the pragmatist sees himself as the only rational person in the room—unbiased and unemotional. In a lot of ways, that’s a good thing. It’s certainly better than any of these approaches in isolation. The problem, though, is that combining these four approaches doesn’t necessarily lead to a better answer. Pragmatists still can’t see around corners. That’s why, as an alternative, I recommend the “five minds” approach, which offers an asset allocation framework that is usable even when the future is unknowable.