This is true for companies, too. American International Group Inc (NYSE:AIG) blew up in 2008 after making suicidal derivative bets. Last month I asked Hank Greenberg, American International Group Inc (NYSE:AIG)’s former chairman and CEO (who left three years before the blowup) whether an investor could have possibly known how much risk American International Group Inc (NYSE:AIG) was taking, even with hindsight. “No, I don’t think so,” he said. “I’m not sure the [annual reports] that they filed were complete … I was a major shareholder of American International Group Inc (NYSE:AIG), the largest individual shareholder. I lost about 90% of my net worth.” Investors thought American International Group Inc (NYSE:AIG)was a good, old-fashioned insurer suitable to hold in a retirement account. And then they learned otherwise.
The evidence is just overwhelming that we know much less than we think we do, even when we’re armed with data and studies. Sometimes especially when we’re armed with data and studies, because they give us a false sense of confidence. British neurologist John Hughlings Jackson once said, “It takes 50 years to get a wrong idea out of medicine, and 100 years a right one into medicine.”
And this spreads far beyond economics. In his excellent book The Half-Life of Facts, Sam Arbesman writes:
Facts change all the time. Smoking has gone from doctor recommended to deadly … We used to think that the Earth was the center of the universe, and our planet has since been demoted. I have no idea any longer whether red wine is good for me. My father, a dermatologist, told me about a multiple-choice exam he took in medical school that included the same question two years in a row. The answer choices remained exactly the same, but one year the answer was one choice and the next year it was a different one.
The takeaway here isn’t a plea to ignore data, statistics, and studies. But they have to be taken for what they are: Fallible and often incomplete. People get tripped up when they take one set of data or one study and put all of their weight behind it. “I’m investing in X because this study shows Y.” Or, “I’m selling everything because this economic report shows trouble ahead.” At best, data guides us in a certain direction, but investors always have to have a healthy appreciation for the unknown. We talk a lot about how bad analysts are at predicting the future, but it’s really worse than that. We barely know what’s happening right now, or even what happened in the past.
Rogoff and Reinhart wrote a book titled This Time is Different, poking fun at what have been called “the four most dangerous words.” I disagree. The four most dangerous in the English language words may be, “This study proves that …”
Check back every Tuesday and Friday for Morgan Housel’s columns on finance and economics.
The article Admit It: No One Has Any Idea What’s Going On originally appeared on Fool.com.
Morgan Housel has no position in any stocks mentioned. The Motley Fool recommends American International Group (NYSE:AIG). The Motley Fool owns shares of American International Group and has the following options: Long Jan 2014 $25 Calls on American International Group.
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