Investing 101: Contradictions - Part 5

An important fact about investing is that there are no indisputable laws, nor is there one correct way to go about it. Furthermore, within the vast array of different investing styles and strategies, two opposite approaches may both be successful at the same time.

One explanation for the appearance of contradictions in investing is that economics and finance are social (or soft) sciences. In a hard science, like physics or chemistry, there are precise measurements and well-defined laws that can be replicated and demonstrated time and time again in experiments. In a social science, it's impossible to "prove" anything. People can develop theories and models of how the economy works, but they can't put an economy into a lab and perform experiments on it.

In fact, humans, the main subject of the study of the social sciences are unreliable and unpredictable by nature. Just as it is difficult for a psychologist to predict with 100% certainty how a single human mind will react to a particular circumstance, it is difficult for a financial analyst to predict with 100% certainty how the market (a large group of humans) will react to certain news about a company. Humans are emotional, and as much as we'd like to think we are rational, much of the time our actions prove otherwise.

Economists, academics, research analysts, fund managers and individual investors often have different and even conflicting theories about why the market works the way it does. Keep in mind that these theories are really nothing more than opinions. Some opinions might be better thought out than others, but at the end of the day, they are still just opinions.

Take the following example of how contradictions play out in the markets:

Kofi believes that the key to investing is to buy small companies that are poised to grow at extremely high rates. Kofi is therefore always watching for the newest and ambitious financial companies, which are just making some profits. Kofi doesn't mind because these companies have huge potential.

Akua isn't ready to go spending her hard-earned dollars on what she sees as an unproven concept. She likes to see firms that have a solid track record and she believes that the key to investing is to buy good companies that are selling at "cheap" prices. The ideal investment for Akua is a mature company that pays out a large dividend, which she feels has high-quality management that will continue to deliver excellent returns to shareholders year after year.

So, which investor is superior?

The answer is neither. Kofi and Akua have totally different investing strategies, but there is no reason why they can't both be successful. There are plenty of stable companies out there for Akua, just as there are always entrepreneurs creating new companies that would attract Kofi. The approaches I described here are those of the two most common investing strategies. In investing lingo, Kofi is a growth investor and Akau is a value investor.

Although these theories appear to contradict one another, each strategy has its merits and may have aspects that are suitable for certain investors. Your goal is to be informed enough to understand and analyze what you hear. Then you can decide which theories fit with your investing personality.



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