We often hope that our efforts will lead to rewards, believing that free opportunities exist to help us achieve wealth. I propose the use of a “literary truth razor” to discern financial advisors’ effectiveness. If an advisor’s investment advice is not markedly superior to the general life advice found in works of fiction, then such an advisor should be relieved of his duties.
I. Great Expectations and Unfulfilled Returns
Charles Dickens once wrote about Pip, an orphan who aspired to become a gentleman by learning a trade. In “Great Expectations,” Pip achieves his dreams, though Dickens originally envisioned a different outcome. Originally, Dickens wrote that Mr. Pip remains single and briefly encounters Estella, the love of his life and the widow of another man, in London. This alternate ending shows the gap between expectations and reality, introducing the sunk cost fallacy. This fallacy leads people to make decisions based on past investments rather than assessing current and future benefits. In investing, if actual returns fall short of expectations, it’s wise to cut losses.
II. Irrational Hope and Its Pitfalls
Great expectations and hope are deeply ingrained in our minds, but their risk and reward balance has puzzled us since the Pandora’s box myth. Pandora, instructed not to open a box but succumbing to curiosity, released miseries into the world, leaving only hope inside. While hope has a positive impact, excessive hope can lead to unrealistic expectations or complacency (Song Wang et al. 2020). Hope and great expectations can blind us to the sunk cost phenomenon and should be used cautiously in risky ventures.
Picture 2. Pandora and her box
III. The Rate of Return and Prudent Diversification
We often calculate expected stock returns based on historical data, even though they can overestimate actual returns due to financial market volatility. Return calculations and stock valuations can be overly optimistic. It’s crucial to remember that expectations can significantly exceed actual returns in investments. Diversifying a portfolio is essential to avoid relying too heavily on a single asset. The tale of the fisherman and his wife, who wished for grander riches, only to return to their humble abode, serves as a cautionary example. The Wirecard scandal, promising unrealistic returns, parallels this story.
Picture 3. The fisherman and the flounder
End note
I also urge you to approach experts with a healthy dose of skepticism, especially when they make predictions about equally possible and ultimately inconsequential future scenarios. Take, for instance, the predictability of events like the war in Ukraine either continuing, ceasing, or stalling. These kinds of scenarios don’t provide valuable insights or distinctions, and we should be quick to question experts who rely on such vague and uninformative ‘forecasts.’
Have you ever encountered someone online claiming that a stock will either go up, down, or remain unchanged? If so, don’t hesitate to point out these overly general predictions in the comments section below.
References
- Bhowmik R, Wang S. Stock Market Volatility and Return Analysis: A Systematic Literature Review. Entropy (Basel). 2020 May 4;22(5):522. doi: 10.3390/e22050522. PMID: 33286294; PMCID: PMC7517016.
- CFA Institute. 2024 CFA Program Curriculum Level I Box Set (p. 1577). Wiley. Kindle Edition.
- “Great Expectations.” Wikipedia. Retrieved 2023/08/02, from https://en.wikipedia.org/wiki/Great_Expectations#cite_note-s260-40
- Song Wang and others, Neurostructural correlates of hope: dispositional hope mediates the impact of the SMA gray matter volume on subjective well-being in late adolescence, Social Cognitive and Affective Neuroscience, Volume 15, Issue 4, April 2020, Pages 395–404, https://doi.org/10.1093/scan/nsaa046
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