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. Both of those professions, by their very nature, lead a person to ask, examine, compare and verify.

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

Why? On what basis? Do we have data for that? Does it always hold? And what if we look at it a little differently?

Not because I automatically assume other people are wrong.

More because over the years I have got used to one thing: even a very convincing claim can be wrong if it rests on bad data, weak assumptions, or if we pick out only the part of reality that happens to suit us.

In research it is entirely normal that showing a result is not enough. You have to explain how you arrived at it, what the assumptions were, what the limits are, and whether someone else could repeat the same procedure.

Teaching is similar. I do not just want a student to know that something holds. It is far more interesting when they can explain why it holds.

That is probably why I am such a doubting Thomas.

And when it comes to investing, it goes double.

You do not have to be an analyst. You do not need to build DCF models, analyse financial statements or calculate bond duration. You can perfectly well leave your investments to someone who understands them better than you do.

But you should know at least the basics.

What am I investing in? Why am I investing in it? Where is my return supposed to come from? And what would have to happen for it not to arrive?

To my mind that is not investment science. That is the absolute minimum.

A good investment will not always look good

This is something I think gets a little forgotten about investing.

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 two or three years.

And that is when it gets interesting.

Because if I have no idea why I invested and how my investment can behave, then during a decline I really have only one piece of information:

“I am losing money.”

And that piece of information can be quite persuasive.

But if I know why I invested, I can ask a different question:

Is this still normal behaviour for this investment, or has something changed that means my original reason for investing no longer holds?

And this, I think, is one of the most important things you can learn about investing.

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.

When I invest in shares, I do not need to be able to value every company to two decimal places.

But I should roughly understand what I own and where my return is supposed to come from over the long run.

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

With a bond I am lending someone money. So I should know to whom, at what interest, and how likely it is that they will not pay it back.

If I use some mechanical investment strategy, I should understand why its rules ought to create an advantage over the long term, and what can happen to it in bad periods.

I do not need to know every detail.

But I do need to know the mechanism.

Otherwise I have no way of judging whether the investment is working as it should, or whether something is going on that is no longer all right.

And this is in fact the same principle as in research.

A result on its own is not enough for me.

I want to know how it came about.

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 at the same time that it is almost risk-free, my first question probably 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 far more cheaply from a bank or a professional investor?

Maybe there is a very good answer to that.

But there should be one.

Because a return does not come from nothing.

And simply making the effort to find out who exactly earns 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.

Understanding an investment helps when it is a good one too

Knowledge is not only useful for spotting a bad investment.

Perhaps more importantly, it helps me stay with a good one.

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

If I know that stock markets fall by 30% or more from time to time, a 30% decline on its own is not proof that everything should be sold.

The decisive question is still the same:

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

If so, perhaps nothing extraordinary is going on at all.

If not, it is time to start finding out why.

Because the point of knowledge is not to convince 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

Or more precisely — it should not be only 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 you a profit either.

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

And this is perhaps where my researcher’s view of investing shows most clearly.

I am not looking for certainty.

It does not exist.

I am looking for reasons, data and a mechanism on the basis of which I can say that a decision makes sense.

And then I keep checking them.

Take an interest in your own money

I do not think every person has to be an investment expert.

There are people who do that professionally.

But between not understanding something professionally and knowing nothing at all about it, there is a fairly large space.

And when it is my money, I want to be somewhere in that space.

I want to know where it goes.

Why it goes there.

Where the return is supposed to come from.

What risk I am taking for it.

And what can happen when the investment does badly.

This knowledge will not guarantee me a profit.

Nobody knows the future.

But it will help me tell a normal bad year from a broken investment. It will help me not to panic when something happens that I had allowed for. And it will help me pay attention when the reason I invested starts to fall apart.

And that, I think, is quite a fundamental difference.

Trusting is fine. Blind faith is not.

Maybe I am a doubting Thomas.

But when it comes to investing, that strikes me as an advantage rather than a problem.

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.