The Greek philosopher Socrates walked the streets of Athens in a dirty cloak, talking with people throughout the city, and sources differ as to whether he ever held down any kind of a job other than professional philosopher. Despite his apparent lack of interest in business and finance, I think he would have been a great investor, since in many ways he was the original contrarian. Socrates urged everyone not to accept the conventional wisdom at face value, but always to question it. Just because an authority figure, or the majority of the population, claimed that something was true, that didn’t mean it necessarily was. Wherever he went, through his pleasant demeanor and a rigorous application of logic, Socrates debunked pervasive myths and flawed thinking, and was utterly fearless in questioning every aspect of things that most Athenians took for granted.
Ultimately, his open-mindedness and methods of aggressive probing and questioning proved to be his undoing, as a group of his enemies successfully argued that he was guilty of corrupting society. The accusations led to a trial in which Socrates was convicted and sentenced to death. Socrates took the news with equanimity, and willingly drank a cup of hemlock, an act that has been captured in numerous works of art over the centuries.
If you walk down virtually any Main Street in the U.S. today, and ask the first person you meet how they invest their money, chances are good that they will tell you they invest in mutual funds. Socrates would have hated mutual funds, since it would have been obvious to him why they make no sense. The vast majority of mutual funds fail to beat the indexes. They charge a variety of fees that eat into your returns over time. In order to protect against simultaneous redemptions, they can keep large cash balances, which hurts long run performance. They are tax inefficient, turning over their portfolios at astonishing rates, generating frictional costs, and unwanted short term capital gains tax events. They can be overdiversified. Furthermore, it’s very hard to pick a successful mutual fund manager. And on and on.
Yet the conventional wisdom is still that mutual funds are a sensible way to invest your money. This is amazing to me, as it would have been to Socrates. Why is it that enormous swaths of people’s money are tied up in instruments that systematically erode their wealth over time versus what they could achieve via dramatically simpler strategies, such as buying index funds?
Socrates’s natural suspicion of the consensus view would have caused him to question the conventional thinking on mutual funds. While Socrates would have liked index funds, I think the idea of quantitative investing would have appealed to him even more, as it offers additional obvious, logical advantages. Just look at the empirical evidence. If you invest in certain strategies, then over long periods of time, you are going to outperform even the indexes.
These strategies take advantage of predictable patterns in financial markets, and are often based on human behavioral phenomena. I think Socrates would have liked the idea of using the predictable behavior of crowds to make money.
So heed Socrates, whose example is instructive. Don’t follow the herd and put your money where everyone else does. Be a seeker of truth. And the truth is that putting your money into quantitative strategies could be one of the best decisions you ever make.
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