The Problem of Induction.

September 7, 2015

Simplicity is to the simple mind what mother's milk is to the rooting babe. Comforting. Its own reward. A precursor to a much-needed nap.
Though it does not come easy, we do, as a species, appreciate simplicity. Brief effort followed by a quick reward.
So, it is no surprise that human beings tend to quickly draw conclusions. Thinking through an issue requires time and energy. We have too much to do. So, we tend to infer or deduct.
Inductive reasoning involves a series of observations and the inference of a new claim based upon those observations.
I wake up when the day begins. The day begins with morning. The sun comes up in the morning. When the sun comes up, the day begins.
Assuming these premises to be true and logical, one derives conclusions from these seemingly logical assumptions. Following, we begin to act upon these seemingly logical conclusions. Which where the trouble begins.
You see, while we are quick to infer, deduce, or determine the likely consequences of a chain of events, we are apt to infer incorrectly. Though we often don't realize the error in our ways until we're well into the rabbit hole. Which got Alice into big trouble.
Wars have been waged. Battles fought. Men killed. Fortunes lost. Families, towns and nations torn asunder. All because of our innate willingness to draw and act upon incorrect conclusions.
Other animal species? Not so much. They do not infer, deduce or induct. They are instinctual, and respond in the exact same way to the same stimuli every time.
Philosophers have long recognized this very human problem.
David Hume, uniquely associated with induction, pondered the discovery of causal relations, and the idea that these relations are oft discovered by induction, as opposed to reason. Hume realized that causal relations in the future may not always resemble those causal relations of the past.
If matters of fact are based on causal relations, and causal relations are found by induction, then induction must be valid.
If this, then that. And, if others are like this, then that too.
The problem of induction is concerned not only with the uncertainty of conclusions derived by induction, but doubts the very principle through which those uncertain conclusions are derived.
Scientific philosopher Karl Popper argued that science does not use induction, and that induction is a myth. Knowledge, Popper stated, is created by conjecture and criticism. The main role of observation and experiments in science, Popper argued, is in attempting to criticize and refute existing theories. So tested, these theories stand the test of time.
Yet, most men would mistake a Bunsen burner for a beer stein. And so we are quick to deduce and infer, based upon past (usually recent) experiences. Here the problems begin.
Concerning the problem of induction, investors rank among the biggest casualties.
I have often said that investing is equal parts history, math and psychology. Yet, the average investor bases decisions upon such pragmatic underpinnings as the carnival barking of a close friend, who happens to be a bar tender, who got a tip from a customer, who read it online.
When things are good, investors are bullish. Courageous. Wise and bold. Yet when things go bad, and positions decline, investors run for the exits, swatting at themselves as if covered by spiders and screaming for their mommies.
To be a successful investor, you have to be able to avoid the natural human tendencies of improper deduction, illogical reasoning and the desire to follow the herd.
When markets rise, everyone wants to buy. When they fall, everyone wants to sell. We should, in fact, do the opposite. Buying as everyone else runs for the exits, and selling as the lines to get in bend around the block.
Everyone's a contrarian, until they find themselves standing alone. In the dark. At which point they become the bundled up little brother from the movie, "Christmas Story," chasing after Ralphie and his friends, "Guys, wait up, please, guys!"
According to renowned investor William Ackman, there are some specific keys to the psychology of investing. They include:
1. Be financially secure. That is, don't invest what you need to live on.
2. Don't get spooked by short-term fluctuations.
3. Do your own research. Don't accept the premises of others.
4. Invest at a reasonable price. In other words, make sure the price you're paying is reasonable relative to the company's earnings.
Remember, speculation and investing are counter to human nature. They tend to bring out survival instincts that were more effective for outrunning angry sabertooths than preserving capital.
What's more, people tend to avoid process and methodology. And when it comes to investing, a lack of methodology is like skydiving without a checklist. It may work out the first time, but the best of intentions is no substitute for a parachute.

Securities offered through Dempsey Lord Smith LLC – Dempsey Lord Smith LLC, Rome, GA Member FINRA / SIPC / MSRB.

Advisory Services offered through Dempsey Lord Smith, LLC, an SEC Registered Investment Advisor. Clearing through and accounts held at Charles Schwab & Co., Inc.

Dempsey Lord Smith, LLC nor Hyde Park Wealth Advisors LLC provides tax or legal advice and you should consult your accountant and/or attorney if considering an investment of this type. Hyde Park Wealth Advisors LLC is not controlled by or a subsidiary of Dempsey Lord Smith LLC. Investing in Alternative Investments come with a variety of risks that could result in a complete loss of principal investment.

Alternative Investments offered as private placement securities are offered only to qualified accredited investors via confidential private placement memorandum. Income and returns are not guaranteed and there are no assurances investments will meet their stated objectives.

© 2024 Hyde Park Wealth Advisors. All Rights Reserved