What investors should be askingGeorge Mason University economist Tyler Cowen has an intriguing blog post asking a deceptively simple question:
You are an investor with $10 million planning to cash out in 20 years. A genie appears and offers to send you the price of one but only one asset 20 years from now to inform your investment decisions (a stock, currency pair, commodity, equity index, etc.). What do you want to know?
I love this question, but in a very counterintuitive, non-obvious way. It is the logical follow up to yesterday’s post on forecasting.
Almost 100 people responded to Cowen with answers like the Standard & Poor’s 500 index, commodities, the euro-dollar exchange rate, Google, Apple, milk, local real estate prices, the MSCI World Total Return Index, copper and more.
All of the responses are fine and interesting - and they’re all wrong.
It isn’t just that the answers are incorrect. This is reminiscent of the job interviewer who asks an applicant to open a permanently sealed window: it’s a trick question. The purpose really isn’t to find a correct answer, but rather to reveal your thought processes and problem-solving skills.
Let’s explain why the responses are wrong: Just knowing the price of an asset 20 years from now doesn’t give you enough information to formulate a proper, reasonable investment thesis. Asset prices are not only cyclical and volatile, most important of all, they are relative. Price alone is just one piece of information within a vast universe of data points, many of which may be even more important than the price of that single asset and a specific point in the future.
Here’s an example of why this is so. I am confident that if I gave you an asset price for 2036, you could concoct multiple explanations for how it got that way. If oil is $15 a barrel in 2036, why is that so? Is it because of a terrible global recession that destroyed demand; new discoveries of huge and previously unknown reserves; technological breakthroughs in transportation that make filling up at the pump obsolete; or new alternative energies that displace oil? And what of the oil companies themselves? Did they crash and cease to exist, or were the weak acquired by the survivors at premiums to their share prices?
You can create similar scenarios for other commodities, the U.S. dollar, emerging market stocks and so on. The price alone only gives you part of the answer; it doesn’t tell you the important part - is this where you should park your money?
The question itself has you searching in the wrong place for the wrong thing - a single price. What this thought experiment fools you into thinking about is what you would do if only your Mega Millions lottery ticket were to pay off. It may be fun to fantasize, but that’s all it is - a dream that isn’t grounded in reality.
But posing the question does help to reveal one crucial element in the investing equation: That the future is inherently unknown and unknowable. And yet too many investors practice some version of it, leading them to seek the magic stock, the perfect mutual fund, the next great hedge fund manager or in this case, the price of a single asset to own during the next 20 years.
It follows, logically, that this approach to investing is based on a fundamental falsehood - that someone, anyone, can provide you with the definitive answer to your investing questions. Hate to disappoint you folks, but no one can do that for you.
So it turns out that the correct answer is, “Sorry, you’re asking the wrong question.” The sooner investors accept that they don’t have a clue about the future, the better off they will be.
*The author is a Bloomberg View columnist writing about finance, the economy and the business world.
by Barry Ritholtz
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