Investing is NOT like Physics
Updated: Apr 7, 2022
Before I became a financial advisor, I taught physics. Investing in NOT like Physics.
Laws vs. Rules of Thumb:
In physics, there are laws of nature that are understood so accurately that we can launch the New Horizons spacecraft from Cape Canaveral and have it fly 3 billion miles to pass by Pluto on schedule 9.5 years later. In investing, we can’t reliably predict what is going to happen tomorrow. It would be nice if there were definitive laws of investing, but humans and human emotions are too unpredictable. Instead, we rely on investing “Rules of Thumb”, which are usually true, historically, but far from guaranteed.
Rules of Thumb like:
Save at least 15% of what you make for retirement.
The stock market is good for long-term investments.
To improve your investment return, you need to take on greater risk
These are all reasonable rules on which to build a personal financial plan, but they only enable you to point your financial spaceship in the general direction of your target.
Investing is more like Medicine:
When medical doctors prescribe a treatment, like a particular drug, they are usually relying on “a study showed that this worked X% of the time for people with this particular medical problem.” And then they say, “come back in Y weeks to see whether it worked for you.” Investing is similar. As a financial planner, I might advocate for a particular client to “invest X$ into your 401(k) to move you into a lower tax bracket and likely get you a greater return than paying down your mortgage.” And then I’ll say, “let’s meet in 2 to 4 months to make sure that nothing has changed in terms of your spending, your plans, or your other investment options.” Both medicine and investing deal with people, and people (and life) are unpredictable and emotional, unlike spacecraft.
Investing is more like Statistics, than Physics:
Nearly all investment projections are based on statistical analyses of past investment results. This is reasonable because that is the data we have to work with. But if you ever took a statistics class, you’ll remember that there was a lot of talk about “uncertainty” and “margin of error.” The same is true with investing, although you rarely hear those terms. You more often hear financial entertainers or salespeople commenting on investment results with confidence, not confidence intervals, as if they were explaining Newton’s Laws. Financial data analysis has serious limitations vs. typical scientific data analysis, because almost always the analyzers are making large approximations and assumptions like, “the value that is varying is an independent variable”, when it almost never is. But again, that’s what we have to work with. Investing is not like physics.
Whenever you hear investment advice, be suspicious of people who claim to “know” what is going to happen. Most investment advice is, at best, educated guessing based on historical results, and at worst uneducated wishful thinking. Because people, including you, and your life are complicated, regular financial check-ups and outside financial advice are useful.