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In Doubt? Take The Safe Route

By Austin Pryor
© Sound Mind Investing | May 2011
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Do you become anxious when circumstances compel you to make important investing decisions? You're not alone. If our reader mail is any indication, there's high degree of financial fretting going on out there!

Three recurring comments lead the list of reader concerns:

  1. There's so much at stake. I'd hate to make the wrong decision.
  2. I'm not sure I know what I'm doing. I'd hate to make the wrong decision.
  3. My savings aren't making enough now, but if I make a change I'd hate to make the wrong decision.

What is the "wrong" decision, anyway? If you're thinking it's like saying 2+2=5, you have a misunderstanding about investing. Investing decisions can't be made with mathematical certainty.

Perhaps it's because financial markets deal with numbers (e.g., a 50-point advance, a 6% return) that we get the idea that investing is somehow like scientific research: add up all the facts and you arrive at the correct solution.

Investing isn't that straightforward. Indeed, investing is much more art than science. There are few rules, and decision-making is largely subjective.

This doesn't mean the economy and investment markets are completely random. It only means that we're dealing with probabilities, not certainties and predictable events. (It's somewhat similar to a familar example from everyday life — while scientists can predict with great accuracy when the next eclipse of the sun will occur decades into the future, they can't tell you for certain if the sun will be eclipsed by heavy clouds next Sunday and ruin your picnic.)

All of this is actually good news for you. It means anybody can play. It's like learning to drive a car. After a couple of lessons, you're not an automotive expert, but you've learned enough to travel around town. After all, you're not trying to qualify for the Indy 500 — you just want to reach your destination safely.

In the same way, if you've been reading and applying the concepts in the SMI newsletter for six months or more, you're fairly well equipped to make whatever decisions you face.

Imagine you're in a contest where you are to travel from coast-to-coast before the Interstate system was built. You can choose any route (but they're almost all two-lane roads), travel at any speed, and take as much time as you like. There are no bonus points for arriving first — the only goal is to arrive safely. Everyone who does that "wins."

As you drive along, you must make decisions constantly. Should you take the route to the left or to the right? Is there construction or traffic up ahead? Will there be a motel with a vacancy ahead?

There are no "scientific" answers to these questions. Each decision requires powers of observation, the ability to learn from your experiences, and a little common sense. You rarely come to a point where the decision is obvious.

It would always be helpful to have "just a little more" information — what you know never seems to be enough. But the challenge of the trip is in having to make choices without having all the information. No one ever has all the relevant information. Can you survive on what you do know?

Investing is much like that. When, for example, we point out that conditions seem to be building toward inflation, as we did in last month's cover article, that is not a prediction that it's going to happen right away. It is merely an observation about a probability.

Likewise, when we present a historical indicator, as we do this month with the Bear Alert Indicator, we're not suggesting we've unlocked the secret of the market and this indicator will lead us to the investing promised land. It's simply an observation regarding how the market has tended to behave in the past, which seems to present a reasonable likelihood of boosting our odds of success in the future.

Some readers may look at the Bear Alert recommendations in this month's cover article (On Bear Markets and Boundaries Members Exclusive Content) and feel uncomfortable with the idea of taking a portion (or all) of their stock money out of the market based on such an indicator. Other readers may feel uncomfortable leaving so much of their stock money in the market based on the same information! There's no perfect answer: again, this is art, not science.

We think the new guidelines will work well for most people, but no doubt some will wish to chart a different course. That's fine. We provide the information, but you're ultimately responsible for making your own decisions.

Our new Bear Alert guidelines represent a substantial adjustment in response to what we consider a significant warning signal. But they fall short of an all-or-nothing portfolio change.

Why? Because we not only can't know the future with certainty, we recognize that we can't. It's unknowable. Anyone who would have you believe otherwise is lying to you. It's because we can't know the future that we diversify and stay flexible.

Which brings us to one of the few rules investing does have: protect your capital. That's the only prerequisite for "arriving safely." When in doubt, take the safe route. End

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