“What has gone wrong with the development of economics as a science? Answer: There was a bunch of intelligent people who felt compelled to use mathematics just to tell themselves that they were rigorous in their thinking, that theirs was a science. Someone in a great rush decided to introduce mathematical modeling techniques … without considering the fact that either the class of mathematics they were using was too restrictive for the class of problems they were dealing with, or that perhaps they should be aware that the precision of the language of mathematics could lead people to believe that they had solutions when in fact they had none … Indeed the mathematics they dealt with did not work in the real world, possibly because we needed richer classes of processes—and they refused to accept the fact that no mathematics at all was probably better.” —Fooled by Randomness
A few months back, Warren Buffett warned, “Beware of geeks bearing formulas.” It’s a fair warning given the role quantitative finance played on Wall Street during the last few years. While “quants” don’t bear sole responsibility for the recent economic turmoil, the financial industry allowed itself to be sucked in to the notion that a mathematical formula was the solution to investing uncertainty. But what if the formulas were based on faulty data or were designed to fit a desired scenario versus the reality?
Quants play a valuable role in economic theory, but as Paul Wilmott, a respected and influential quant in his own right, said, “What banks really need are quants who can translate theoretical math and tell them how it applies,” … “Because what good is being fluent in geek if you can’t apply it? You might as well stay in university.” (link)
How does this apply to the individual investor? Ask yourself if your advisor can translate his or her investing recommendations so you understand what your choices mean. Does the “formula” your advisor suggests take into account your reality? A relationship with a trusted advisor should extend beyond the numbers. It must extend to having the tough conversations about risk and goals.
