In Investing, Trust But Verify

May 11th, 2008 · No Comments · Subscribe to this feed

Often when speaking of relations with the Soviet Union, Ronald Reagan would toss out the phrase “trust, but verify“. Reagan reportedly repeated this old Russian proverb (Russian: Доверяй, но проверяй) at the signing of the INF treaty to which his counterpart Mikhail Gorbachev responded “you repeat this phrase every time we meet”. Not to be outdone, Reagan replied, “I like it.”

Trust, But Verify

This venerable phrase is just as applicable to investing as it is to international politics. Many people are prone to taking the advice of market experts when making investment decisions. “Diversify”, they tell you. “Value outperforms growth”, they’ll say. “Own your own home,” is especially popular. What none of these experts tell you is they have absolutely no idea what’s best for you. They know nothing about you. Their goals, risk tolerance, even definitions of success are likely to be far different from your own. Of course, it’s important to do your own homework to avoid being scammed, but it’s not even a matter of dishonesty or conflict of interest. Nobody knows your situation and needs as well as you. Who, then, should be able to advise you better than yourself?

Ignore Steve

Yes, I’m sure your coworker Steve is a great investor. I’m sure his 401K is up 40% last year while yours is up a paltry 3%. “He must be doing something right,” you tell yourself. Consequently, you latch onto his every word as he discusses his newest investment idea (pork belly futures!) over coffee in the break room. Convinced of the huge investment opportunity in dead pigs, you rush back to your desk to change your 401k contributions to reflect Steve’s brilliant investment tip. Big mistake. Pork belly futures promptly plummet and you lose 50% of your money within a month. The moral of this story is that Steve wasn’t good, he was just lucky. The correct course of action would have been for you to smile, nod along, and then thoroughly research the actual investment potential of pork belly futures yourself rather than relying on somebody else’s probably uninformed opinion. Don’t allow yourself to be convinced by somebody else: convince yourself.