7) Investing 101: Preparing For Contradictions

by · August 23, 2010

Investing is not an exact science

Investing is far from being an exact science.  Although it can be learned in school, from experts or through tutorials like this one, the important fact about investing is that there are no indisputable laws, nor is there one correct way to go about it. Since there are different investing styles and strategies, two approaches may contradict each other but can be both successful at the same time.

In a hard science, like physics or chemistry, there are precise measurements and well-defined laws that can be replicated and demonstrated through experiments. Economics and finance, on the other hand, fall under social (or soft) sciences. Theories and models of how the economy works can be developed,  but you can’t put an economy into a lab and perform experiments on it.  Such is one explanation on why there are contradictions in investing.

Humans are emotional, unreliable and unpredictable by nature. No matter how rational we think we are, many times our actions say otherwise.  That is why it is difficult to predict with 100% certainty how the market (a large group of humans) will react when given certain information about a company. There are trends, but these remain as trends. Anytime, one trend can be replaced by another without the slightest warning that it will happen. This is one of the reasons why economists, academics, research analysts, fund managers and individual investors often have different and conflicting theories about how the market works and why it behaves that way. In the end, these theories are nothing more than opinions. As opinions go, some are better thought out than others.

Contradictions in investing style
In the following examples, take a look at how contradictions play out in the markets.

Candice buys small companies that have a huge potential to grow at extremely high rates because she believes this is how she would strike big in her investments. Common examples of these companies are technology and biotech firms that sometimes don’t even make a profit. So Candice often watches for the newest, most cutting-edge technology, and typically puts her investments into these firms. Sounds familiar, right? Well, of course! How many times have we read news about startup Internet companies founded by college dropouts that are suddenly worth millions, even billions, of dollars after a few years?

Peter, however, is not comfortable spending his hard-earned money on a risky investment. The key to investing for Peter is to buy good companies that are selling at “cheap” prices. For him, he likes to put his dollars in firms that have a proven track record and pays out a large dividend year after year. While Peter’s investing style can be quite conservative, it can’t be denied that many other people have had success in this kind of investment.

So who do you think has the superior style? The answer is neither.
It can be said that Candice and Peter’s investing strategies are quite the opposite of each other. Yet, there is no reason that the both of them can’t be successful. Candice is a growth investor who likes to invest on new ideas that have good growth potential. Peter is a value investor who prefers stable companies. The approaches described in the examples are two of the most common investing strategies.

These theories seem to contradict one another, but each strategy has its own merits. Each strategy have aspects that are suitable for certain investors.  The goal of the investor, that is you, is to be informed enough to understand and analyze what you learn. Then you can decide which strategy best fits your investing personality.