Have you ever heard the term “bloodletting”? Bloodletting was a tactic used by the medical community to prevent or cure illness. In the old days, the collective wisdom was that our blood was one of many systems in our body that must remain in balance at all times. If you walked into a doctor’s office with a common affliction like the flu or a cold, the doctor might determine that you simply had too much much blood in your body. A common prescription was to apply leeches to your skin to bring relief.
Why did they believe this craziness worked? Their anecdotal experience, speculation, and conjecture.
So how did we figure out that bloodletting was probably doing more harm than good? Researchers began applying science to the practice of medicine in the late 1800s. The scientific method of hypothesizing, gathering data, testing, and using analysis to come to a reasonable conclusion helped us figure out that our problems were not because we had too much blood. They came from other things like viruses, bacteria, and our genetics.
Evolution of Investing
This revolution in western medicine is similar to what we’re seeing in investing today. For years and years the investment process has been driven by anecdotal observation and conjecture.
For example, how many times have you read an article in Forbes or The Wall Street Journal that profiles the “next big stock to pop”? In the 90’s it was tech stocks, in the 2000’s it was banking and pharmaceuticals, and since then it’s been social media and tech stocks. Buying a stock that you think is about to pop, or is undervalued, has been one of the preeminent investment strategies since the early 1900s.
The same goes for “tactical” asset allocation. Boosting your portfolio’s allocation to oil stocks because you think OPEC is about to cut their production quotas, or selling bonds because you think interest rates are about to rise are strategies based on speculation about the future.
Why do so many people invest this way? Because of our life experience & anecdotal observations. Everyone I’ve ever met has at least one person they know who invested early in Facebook or Microsoft and made a fortune. We believe this type of investing can work because of our anecdotal experience.