Why in the world am I writing about such a ‘dry’ topic in a blog that is meant to be light and informative? Because I want to teach you that even as far back as 1920, John Maynard Keynes understood that ‘inferred probability’ was a very important trait in being able to successfully predict the likely outcome of investment and economic decisions-making.
What good macro economists and investors do is read and study current political, economic events and business models/metrics and then attempt to match them up against related and similar historical patterns in order to predict high-probability, future outcomes.
Here is what John Maynard Keynes wrote:
“There is a distinction between the part of our belief that is rational and that part which is not. The highest degree of rational belief, which is termed ‘certain’ rational belief, corresponds to knowledge. Thus knowledge of a proposition always corresponds to certainty of rational belief in it and at the same time to actual truth in the proposition itself. We cannot be said to know a proposition unless it is in fact true.“
… Now the tricky part …
“A probable degree of rational belief in a proposition, on the other hand, arises out of knowledge of some corresponding secondary proposition. (a) A man may rationally believe a proposition to be probable when it is in fact false, if the secondary proposition on which he depends is true and certain; (b) while a man cannot rationally believe a proposition to be probable even when it is in fact true, if the secondary proposition on which he depends is not true.”
…simply put, a predicted outcome can be said to be based on probability if related to a secondary model that is known to be true. However, even if a predicted outcome occurs, the advanced assertion cannot be said to be based on probability if the secondary model is not true…
“Thus rational belief of whatever degree can only arise out of knowledge, although that knowledge may be of a proposition secondary to the proposition in which the rational degree of belief is entertained.“
SUMMARY:
Be very wary of how you formulate your investment decisions; especially if based on “mental models” (secondary propositions). If your mental models are good, then they are based on knowledge that is true and your probability for a successful outcome should increase. However, if your mental models are bad, then your decisions will be based on secondary propositions that are not true, and you may deceive yourself into believing that you are making high-probability investment decisions, but instead you will just be speculating.
Sadly, many novice or part-time investors use mental models that are not true and sabotage their investment results. This is precisely why for more than 50 years, Wall Street has advised “Defensive Investors” to utilize asset allocation and diversification to protect themselves from such dire mistakes. It turns out mom knew best when she said, “Don’t put all your eggs in one basket.”
On the other hand, “Intelligent Investors” will utilize sophisticated mental models, tested and retested through rigorous research and investing knowledge in order to make high-probability (intelligent speculation) decisions in their selection of securities. Intelligent investors, with sound mental models, will tend to concentrate their investments in order to maximize their potential returns.
While Wall Street markets its financial ‘candy’ in order to make it appear that anyone can be an intelligent investor, the reality is that there is a chasm of difference between these two groups; with the vast majority falling into the first set, and a relatively small number comprising the second.
Blog: Alfred L. Angelici http://www.walnuthilladvisorsllc.com
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