I regularly read and share number of opinions from a wide variety of sources on twitter and in my weekend email newsletter. I also regularly receive replies to this effect: ‘Why would you even read so-and-so when he’s been wrong for so long?’ or ‘What do you think of so-and-so? He’s been so right for so long.’
I understand where this comes from but investors, more than anyone, should understand that ‘past performance is no guarantee.’ In fact, I believe that this sort of bias may be one of the most dangerous mistakes investors can make.
It’s called “genetic fallacy” and it simply means accepting or rejecting an idea solely because of its source rather than on its own merits. And here’s why it’s so dangerous.
Everyone remembers the story of the ‘Boy Who Cried Wolf.’ Using this sort of thinking, you ignore or dismiss the boy even when the wolf is standing right in front of you simply because he has been wrong for the past few days.
On the flip side, it also means trusting Alan Greenspan when, in 2004, he says the explosion in the use of derivatives is not problematic simply because he has been right on this front for long period of time, even decades. And it means ignoring the mountain of evidence suggesting he’s wrong.
It also means trusting Ben Bernanke when he says, in 2005, there is no real estate bubble simply because he has been right in asserting for a time that residential real estate has never seen a year-over-year price decline nationwide in our country’s history. And it means ignoring the mountain of evidence suggesting he’s wrong.
Another way to think about genetic fallacy is it’s just another form of performance chasing. It’s no different than buying the fund manager who has done the best over the past several years and pulling money from the one that’s done poorly. Or buying the most popular stocks in the market and selling the least popular.
These buy high/sell low approaches, in both investing and in thinking, can be very dangerous to your wealth. The only real way to effectively assess various opinions and strategies is on their own logical merits, regardless of their source.