Picking a Formula for Investing
To James Case, winning games from chess to investing isn't an art form but a science. In his new book, Competition, Case, a management consultant with a Ph.D. in mathematics, sets out to show how it's just a numbers game. He elevates the idea of competition into a science that can be used to understand everything from warfare to evolution. Associate Editor Renuka Rayasam spoke with Case about how investors can use the science of competition in their own strategy.
Why is the subtitle of this book "The Birth of a New Science"?
This book is about science and competition, but people don't usually think of those two things together. There are all sorts of competitions out there—baseball, investing, and climbing the corporate ladder. They have been studied individually, but there are certain universal factors that can be studied all at once. Just about everything science has been able to learn about competition contradicts almost everything economists have been saying about it for 300 years.
So economists have it all wrong?
They say markets are efficient, and every time we try to interfere we screw things up. That just isn't true. There's a famous line from Adam Smith, about when a man pursues his own self-interest, he is doing the best thing he can do. But one of the few things that science is sure about is we have these tragedies of the commons that arise when people pursue their own interest. [Before property rights], common land in England was overgrazed and ruined.
People have to be reminded what a weak sister economics is to other sciences. When you look at an issue like increasing the minimum wage, economists say it will hurt people it should be helping by getting them all fired. If economics was anything like a science, they would be able to say there's nothing to these scare stories, but they can't. Half line up on one side of the debate, and half on the other.
Aren't stock markets by definition supposed to be efficient?
In investing there is something called the efficient market hypothesis, the idea that markets price everything correctly. The standard methods of portfolio selection are based on that hypothesis, and they don't perform all that well. Then there's Fortune's Formula that both in theory and practice outperforms traditional selection strategies. Markets work well on their own but can be made to perform better with judicious intervention.
What is Fortune's Formula?
That's a technical formula that uses geometric means, rather traditional arithmetic means, to calculate averages. The idea is you pick the portfolio that has a large rate of return and small amount of variance. Those are things you have to calculate. Both rate of return and variance are averages. Fortune's Formula weighs that information differently and is the fastest way to increase your wealth. It is portfolio selection that ignores everything but how the stock is appreciating in price and its volatility. It uses those two and ignores all other pieces of information, and it works rather well.
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