Laws of Investing

Jan 20

I recently noticed an article with the title “50 Laws of Investing”. This caught my attention and raised some questions. Are there such laws? It might be very useful if there are. And are there 50 of them?

One of the laws cited revolves around “regression to the mean,” the idea that off-the-charts returns are more often than not succeeded by subpar returns. A manager with a hot hand suddenly has a cold hand and conversely a manager with a cold hand suddenly turns hot. As the saying goes, “nothing grows to the sky.” That sounds like it could be some kind of law.

Unfortunately most of the other laws sound less promising. Some of them make claims that do not hold up to close scrutiny. For example, the claim that the average indexer must always outperform the average active manager.

The idea behind this is that the average active manager cannot overcome the higher costs required to manage actively. The flaw is that there is no such thing as the average indexer. It might be true if every indexer held every stock in the world, but that is impossible.

Every index fund falls short of a pure concept of indexing, of buying and holding the universe of stocks. Many fall far short, and your index fund may not be based on the same index as mine or be constructed in the same way as mine or otherwise look like mine. In addition, no indexer buys and holds forever, many buy and sell constantly, thereby thwarting the index fund ideal defined by index fund pioneer Jack Bogle. In short, we can speak of the “average indexer” but we will not actually find one in the real world.

Another “law” states that as investors we should only be concerned with what we have “a degree of control over.” This is ambiguous in a way that no law should be, but taken literally, it would mean ignoring the world around us, which is nonsensical.

Some of the other “laws” may be true, but also do not sound like laws. Yes, we may confuse luck and skill, and, yes, it may help to “know what you don’t know.” “The only certainty is uncertainty” sounds exaggerated, but how will any of these statements actually help us invest?

This particular set of fifty “laws” seems to have its flaws, but the larger question is whether we can properly speak of investment laws at all. Do they exist? I’ll try to answer that in the next article.