The Signals and Noise
Ending February 20, 2026
The Members Message
A physicist, a chemist, and an economist are stranded on a deserted island, with nothing to eat but a single can of soup that washed ashore.
- The physicist says, "Let’s smash the can open with a rock."
- The chemist says, "No, let’s build a fire and heat the can until it bursts."
- The economist interrupts and says, "You’re both making it too complicated. Let's assume we have a can opener".
When we approach a subject for study, we generally have to make some assumptions and in many cases they go unnoticed. These assumptions are created to make the theory coherent, otherwise the hypothesis or theory falls apart. So academics spend a lot of time making sure their theories are nice, tidy and logical. The maths is always clean and there is very little doubt or uncertainty.
Finance folks especially academic finance folks love to study markets and try to detect patterns which can lead to a theory of how the real world works. When things get messy, we can make an assumption and that allows the theory to continue.
In finance the dominant theory, which we have discussed on prior podcast is called the Efficient Market Theory (EMT) or Efficient Market Hypothesis (EMH).
Academic finance is very different from the realities of investing. For one, it is heavily based on many assumptions which we don't hear about. Among other assumptions, the EMH states that all investors are rational, meaning we don't have emotions and have access to the same information at the same time.
Now before looking deeper into the theory, ask yourself whether that applies to you and other investors. I suspect the answer is no, it doesn't. And if that is the answer, then why do we persist in trying to wave away these critical aspects? Because if we don't assume, the world becomes a messy place where academics can't propose theories!
Now we can look at an alternative that better reflects realities. The Kelly Criterion says people have different utilities, invest money over time not all at once and can have knowledge that gives them an edge over other investors.
So what does a solid investment proces look like?
- You must have an 'edge' - investing is a zero sum game. I win, you lose. It's that simple. If you know what you are doing and have a plan, then you stand a much higher probability of winning over the long term.
- Invest according to valuation. Don't get seduced by the daily movements of the squiggly line. Use valaution asyour guide and buy undervalued assets (that's your edge).
- Make sure the strategy is simple and easy to understand. Explain it in a 3 minute video. Then ask a friend to watch it. Do they understand it?
- Don't risk it all. Never be fully invested. Sh*t happens and none of us are smart enough to know whan that stuff hits the fan. The secret is you will also make more money in the longer term thanks to an ability to understand and take advanatge of volatility.
- Think about the range of returns. Look at the CAPE ratio. It is currently 40. Ask yourself - has there ever been a 10 year period where investors has beaten average returns when the CAPE is 40?
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