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The Asch Experiment
After taking a quick look at the chart above, can you tell me which of the three lines on the right is equal in length to the one on the left? If you can, you too can increase your investment success rate to 99.9%. Let me explain how.
Last Thursday the Dow shed another 380 points bringing the 17-day fall to 1,162 points. A lot of us were sitting around feeling helpless and wondering what to do next.
On that day I happened to be in San Antonio, Texas visiting with Frank Holmes, CEO and chief investment officer of mutual fund manager U.S. Global Investors (GROW:NASDAQ). U.S. Global is still relatively small compared to some of its competitors, but its performance is virtually unmatched.
U.S. Global is responsible for managing three mutual funds that have earned Morningstar’s highest five-star rating. Many of its other funds have the respectable four-star designations from the leading mutual fund rater.
So there’s not much of a better place to be to see how some of the world’s top-performing fund managers react to a stubborn market. Regardless of the market movements and impact of the subprime meltdown, they were continuing to scour the markets for opportunities. They weren’t throwing in the towel, but continued to move on with business as usual and use their quantitative and fundamental models to take advantage of what the market gives them.
Before I left, Frank handed me two books that are required reading material for all analysts at U.S. Global. One of them is Michael Mauboussin’s More Than You Know, Finding Financial Wisdom in Unconventional Places. The book’s deep insights and simple explanations couldn’t be a better read than now while the markets are taking a nosedive.
Within it are a number of helpful hints and paradigm-shifting ideas that will help keep you sane during current market conditions as well as help you position yourself for big returns when the rebound comes.
It only took a few hours to read the whole thing, but it was definitely time well spent. Now, let’s get back to the chart of the Asch experiment. In the chart above, which line on the right matches the line on the left?
Obviously, it’s C. But what if everyone else said it was A? Would you still think it was C?
Psychologist Solomon Asch wondered the same thing. More than 50 years ago he showed the same chart to dozens of groups of eight college students each. But he told seven of each group to say the short bar was the same length even though it obviously was not.
In the end, one-third of the testers unaware of what was actually going on went along with the group and agreed that the short line matched even though it obviously did not. Asch’s experiment proved the herd is not always right and it’s best to stick to what you know is right.
With the market falling, that means not selling off and running for the exits with the rest of the herd. I know it can be hard, but that’s the best thing to do right now. Just take a look at the chart below.
Detailed above is the probability of earning a positive return, or making money on your investments over time. As you can see, the odds of turning a quick buck in just an hour is just a hair over 50/50. At one month, the odds of making money move up slightly to 56%.
However, when you start looking at investments with a longer time perspective, your odds go up immeasurably. With a one-year time horizon, you’ve got a 72.6% chance of coming out ahead. And if you use a 10-year time horizon, you’ve got an astounding 99.9% shot of ending up with more than where you started from.
In the end, the longer your time horizon, the better odds you have at coming out ahead. Heck, even if you had 100 years, it would be a virtual 100% lock that you came out ahead.
But I realize that not many of us have a 100-year time horizon. But if you’ve got just 10 years, you’ve got a 99.9% chance of coming out ahead in the end. Those are pretty good odds and provide statistical proof that a 17-day drop, regardless of how bad, isn’t too much to worry about. After all, the Dow is still up 6% for the year.
But you don’t have to take my word for it. The positive return probabilities are the work of Michael Mauboussin, who is currently the chief investment strategist for Legg Mason Capital Management and an adjunct professor at Columbia Business School.
After reading through Mauboussin’s More Than You Know, I understand why Frank of U.S. Global Investors has made it required reading material.
Good investing,
Andrew Mickey
Editor in Chief, BreakAway Investor
P.S. Imagine if the organization that invented the most profitable industries in the history of Wall Street told you that it has a jaw-dropping stock in an explosive new industry that could turn $5,000 into a million -- you'd be crazy not to buy it.
This rare chance is now yours!
Be among the first to get in on this stunning, urgent opportunity… follow this secure link!
P.P.S. If you’d like to pick up a copy of Mauboussin’s More Than You Know for yourself, simply follow this link.
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