When it comes to investing, people always make the same mistakes. In the last twenty centuries, we can see the patterns of error and delusion emerge once and again. There is little change except in the fashions of the day.
In Ancient Rome, aristocrats would speculate in agriculture, mining, real estate, and shipping ventures. In the Middle Ages, I would consider textiles and dying the principal areas of financial speculation. In the Renaissance, it was mostly spices and bank lending.
Fortunes were made from time to time, but historians do not often write about the fortunes that were lost. Many aristocratic families ruined themselves in failed speculations. Industrialists came and went, especially in emerging industries such as textiles and publishing. Nonetheless, those who went bankrupt would rarely recover.
What can we learn from the financial devastation in history? That human nature does not change. Incentives, if not checked properly, can drive people to make wrong decisions. Ambition can easily turn into blind greed, prompting individuals to take disproportionate risks.
There is a remedy against those maladies, but the remedy is philosophical, not financial. In order to resist the large appeal of unlikely gains, we need a solid philosophical framework. In order to ensure that we keep our feet on the ground, we need a mental barrier against financial balloons.
A great skill to have
In the 6th century BC, Lao-Tzu already witnessed the human willingness to gamble away the future. In retrospect, it is easy to see that those promises would never come through, but in the heat of the fray, it is hard to withstand the illusion of overnight enrichment.
Fortunately, the Taoist mindset helps us remain realistic in every situation. Chapter 46 of the Tao Te Ching enunciates the key principle in this respect, namely, that it’s a great blessing to know when to stop. It is a great skill to know when enough is enough.
Lao-Tzu, Yang-Tzu and Chuang-Tzu didn’t have to face the complexity of today’s financial world, but they knew that trees seldom keep growing beyond the average size of their species. The same principle applies to all other entities and events.
Exceptions are statistically rare, and for that reason, they are to be discarded as investment propositions. An unlikely gain is not worth pursuing at the cost of a practically assured loss. The lesson from history cannot be misunderstood.
Only fools are willing to believe that a certain tree will keep growing without limit, and that he has gained access to special information that enables him to identify rare opportunities.
I dare say that we are all fools at some time in our lives, and that’s why philosophy is so important. Without the insights of a first-rate thinker like Lao-Tzu, we risk falling prey to delusions and losing grip of our emotions.
There is compelling proof that I am not exaggerating. Look at the financial crises in recent history. At the height of a crisis, people are willing to convince themselves that asset valuations will continue to grow without limit. It is the modern equivalent of trees that keep growing up to the sky until the moment when market participants wake up and must face the facts.
Many centuries have passed since the ancient Taoists came up with their insights. It was difficult for their contemporaries to learn the lessons and history illustrates that those lessons are periodically forgotten. That’s why people in Ancient Rome, in the Middle Ages and in the Renaissance committed the same financial errors.
Nowadays, we have an immense advantage compared to our ancestors. If they wanted to learn the insights of ancient times, they had to procure the works of Lao-Tzu, Yang-Tzu, Chuang-Tzu and other thinkers. Or they had to gain access to a library where they could read those works and take notes by hand.
Our advantage is the internet, which enables us immediate access to their works and to historical demonstrations of their validity. We can go beyond the warnings of Chapter 46 of the Tao Te Ching, and see how often those warnings have proven true in history.
Chuang Tzu on facing losses
Nonetheless, it is fair to ask if history does not also provide examples of opportunities that lead to extraordinary gains. If a tree grows up to the sky once in a while, how do we know that we are not missing out on that rare investment opportunity? Those rare occasions, one could argue, represent the only way for the average person to make oversized profits.
Indeed, how do we know that we are not facing the once-in-a-lifetime opportunity that will break all historical precedents? Is it not better to err on the side of optimism instead of taking for granted that no tree will ever be able to grow up to the sky?
Let me reply to that question by means of an ancient Taoist story. Chuang-Tzu wrote a story in which a farmer suffered an array of setbacks, but on each occasion, he refused to throw up his arms, lament his bad luck, and fall prey to depression.
His best horse ran away, causing him a heavy loss, but then the horse returned bringing a second horse along, and made the farmer wealthier. By all accounts, that was a positive surprise.
Then his son fell from the horse and broke a leg, preventing him from working in the fields. For the farm, the son’s broken leg was very bad news because it jeopardised the harvest, but a day later, the farmer was happy that his son was able to escape military conscription thanks to the broken leg.
Who knows if the son might have died in the war. His fall from the horse and his broken leg also proved to be a positive development in a way that the farmer had not foreseen. Does it not mean that, in life, we can also have positive surprises?
I hate to disappoint readers but unwarranted expectations is not the message that Chuang-Tzu was trying to convey; he was not arguing that, in life, we can make all sorts of mistakes and then hope that problems will sort themselves out and losses will magically turn into gains.
We should interpret Chuang-Tzu’s stories in the light of the Tao Te Ching, not in the light of wishful thinking. Chapter 46 of the Tao Te Ching exhorts readers to accept inevitable losses and understand that they are part of natural law. The Tao gives and takes, sometimes in a cryptic manner, but that’s just life.
Chuang-Tzu is inviting readers to look beyond short-term consequences, and accept the ups and downs of life as part of the game. However, Chuang-Tzu is not encouraging us to incur disproportionate risks and blow away our savings.
What did the farmer in Chuang-Tzu’s story do? He accepted setbacks stoically and remained alert for new opportunities. He was happy to see his best horse return, bringing along a second horse, but he viewed the whole thing as a lucky occurrence. He also was happy to see that his son’s broken log proved good for something, instead of constituting a pure loss.
Chuang-Tzu’s farmer had not provoked the negative events himself; he had not left the barn door open the whole night and then found that his best horse had escaped; nor had he caused his son’s fall from the horse and the broken leg. Those setbacks had been fortuitous and, at first sight, purely detrimental.
Taoist wisdom calls for moderation and steadiness in every aspect of our lives, including business and investment. It pays to work diligently every day, hoping for the best, but calmly accepting the vicissitudes of life. Only fools expect everything to run smoothly without experiencing any disruptions.
Wisdom entails logic and reasonable expectations. Let’s not bet our savings on exaggerated, unlikely promises of trees that grow up to the sky. Let’s not distort the story of Chuang-Tzu or the warnings from the Tao Te Ching. They remind us to stay real and keep our feet on the ground precisely when everybody else is falling prey to delusions.
If you are interested in putting effective strategies into practice in all sorts of situations, I recommend my book “The Philosophy of Builders.”