Trusting is fine. Blind faith is not.

I have trouble believing things blindly. Experts included.

Perhaps it is an occupational deformation. I am a researcher and a teacher, and both of those professions naturally lead a person to ask, compare and verify.

When someone claims something, my first reaction is often not “fine”, but rather:

Why? On what basis? Do we have data for that? What if we look at it differently?

Not because I automatically assume other people are wrong. More because even a very convincing claim can rest on bad data or weak assumptions.

In research, showing a result is not enough. You need to know how it came about, what assumptions it rests on and what its limits are.

Investing is similar.

You do not need to build DCF models or analyse financial statements. You can perfectly well leave your investments to someone who understands them better. But you should know at least this much:

• What am I investing in?
• Why am I investing in it?
• Where is my return supposed to come from?
• What would have to happen for my original assumption to stop holding?

To my mind that is not investment science. That is the basics.

A good investment will not always look good

Sooner or later a period comes when an investment does badly.

Shares fall. Bonds can lose value. A company can cut its dividend. A strategy that worked for a long time can trail the market for several years.

If I have no idea why I invested, then during a decline I have essentially one piece of information:

“I am losing money.”

And that one can be very persuasive.

But if I know the reason I am holding an investment, I can ask a much better question:

Is this still normal behaviour for this investment, or has something essential changed?

That is, I think, one of the most important investing skills.

Not predicting the future. Nobody can do that.

But telling an unpleasant development apart from a bad one.

I do not need to know everything. I need to know how it works.

With shares I own a part of companies that do business, generate profit and possibly pay dividends.

With a bond I am lending someone money. So I should know to whom, at what interest, and what risk I am taking.

With a mechanical investment strategy I should at least roughly understand why its rules ought to create an advantage over the long term and how it can behave in bad periods.

I do not need to know every detail.

But I do need to know the mechanism.

Otherwise I cannot judge whether the investment is working as it should, or whether the reason I entered it is falling apart.

Where does that 20% actually come from?

This goes double for investments that promise a high return and low risk.

If someone offers me 15 or 20% a year and claims it is almost risk-free, my first question should not be:

“Where do I sign?”

Rather:

“Where does that 20% come from?”

Who earns it? On what? Why are they able to pay me, of all people, 20% a year? And if the whole thing is that safe, why do they not borrow the money more cheaply from a bank or a professional investor?

Maybe there is a good answer to that.

But there should be one.

A return does not come from nothing. Simply trying to understand who creates the money my return is supposed to come from, and how, removes a fair share of “miraculous” investment opportunities.

When I do not understand something, that does not automatically mean it is bad.

But until I understand it, I cannot reasonably say it is good either.

Knowledge helps with a good investment too

Understanding an investment is not important only for spotting a bad one.

It also helps me stay with a good one.

If I know my strategy can trail the market for two or three years, two weak years need not mean it has stopped working.

If I know that stock markets can fall sharply from time to time, a decline on its own is not a reason to panic.

The decisive question stays the same:

Is something happening that I allowed for when I made this investment?

If so, perhaps nothing extraordinary is going on.

If not, I need to find out why.

The point of knowledge is not to keep persuading myself that my investment is good under all circumstances. Quite the opposite. It is to help me recognise the moment when it no longer is.

Investing is not about belief

Nobody knows what will happen in a year, in five years or in ten. Investing always means working with uncertainty.

But there is a difference between saying:

“I believe it will go up.”

and:

“I understand why this investment should create value over the long term, I know its risks, and I know what would have to happen for my original assumption to stop holding.”

The second sentence will not guarantee a profit either.

But it is, I think, a much better basis for making decisions.

I am not looking for certainty. It does not exist.

I am looking for reasons, data and a mechanism that make a decision make sense. And then I keep checking them.

So take an interest in your investments.

Not so that you become an investment expert.

But so that you know why you are putting your money exactly where you are putting it.

Trusting is fine. Blind faith is not.