The Power Of Ignorance : Or, The Importance of Setting & Following Rules



Ignorance, like happiness, is usually a state of existence. It is often a ‘default’ state of existence, i.e. we always start life ‘ignorant’ of things. It takes an effort of will, or experience, to push us out of this ‘default’ state. ‘Experience’ is a euphemistic synonym for ‘mistakes’. When we make mistakes (sometimes repeatedly), we set rules to avoid making them again. That is why it is often said that the only perfect man is he who has made all possible mistakes.

Declaimer: This article written was originally in January 2007 and some of the data points may be outdated.

word in the world of markets and investing. Uncertainty is what prevails all the time in markets. To work this backward, I would conclude that my investing philosophy is based on a foundation of ignorance.

Under conditions of uncertainty, therefore, I am only as smart as my ignorance. The smarter I get, the more I become aware of my ignorance (this my regular readers and students must have heard before).

Compare this with your attitude, dear reader. You, the real fools, think yourself wise…sure you know what you cannot possibly know. Will the markets go up? Of course, yes…or no, whatever We use rules when we don’t know what to do…this situation is simply called ‘uncertainty’, a very common it be…but you are very sure!!!

Rules are needed to handle uncertainty. “What if I kill my wife? Will I get that nubile young thing next door? “

You mull it over, then you decide against it…….you aren’t sure of the consequences. You obey rules because you can’t deal with the uncertainty. If you knew how things would turn out, you might ‘take a chance’… and a nubile young thing would get seduced. But since you don’t (know the consequences), our country has too many fat women.

Should I buy overvalued stocks? That depends……..do you know where they are headed? And if you don’t, should you focus on your confidence or your ignorance?

That is why we need rules. When in doubt, DON’T (i.e., murder your wife or buy overvalued stocks). Both might be bad for your health. And meanwhile, work towards clearing your doubts.

Of course, this (ignorance) is not the biggest of crimes. There is one other crime still bigger……thinking that you KNOW when you DON’T. The biggest mistakes of history have not been made under conditions of uncertainty but of misplaced certainty. They were misled not by ignorance but by knowledge. What they thought was so, turned out to be not so.

Hannibal thought he would cross the Alps. Hitler felt Russia was weak and could be taken. The first missed out on the fact that elephants don’t live in the mountains, and the second forgot that humans don’t live in Siberia (with good reason). Similarly, investors in 1992 and 2000, thought stock prices only go up. We know from hindsight, that they suffered from ‘misplaced certainty’.

Will the markets go up now? I don’t know. My ignorance is my biggest asset.

I buy, but with a sense of fear, conscious of the uncertainty facing me. What if the US housing market tanks 25-40%, the yield curve inverts, and the US goes into recession/ slowdown? What if the Dollar drops 10-20% and impacts US consumption, their imports, and brings down their Current Account deficit?  What amplified impact will it have on China, bringing down its growth rate in all sectors? What if the combined effect in China of post-Olympics construction slowdown, falling investment demand because of tightening rates, and a sharp slowdown in export growth rates, results in a supply overhang in virtually every commodity worldwide? What if high real estate prices start to flow down into the real (product) economy, creating cost-push inflation, which in turn makes pressure on interest rates in India? What if India’s predominantly commodity-driven companies show a sharp drop in Operating Margins, together with rising leverage and debt service costs? What if………..the market wakes up to the fact that all of the above is already happening?

Ignorance never lets you down. It forces you to be modest, scared, and willing to learn. You are open to new ideas. You go back to what you know best, and you follow rules to keep out of trouble.

You don’t kill your wife…and you don’t buy overvalued stocks. Both are enjoyable activities…but you know the rules, don’t you?!!!



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