More reaping, less sewing

By Stephen Kelly, Investment Analyst, Maitland

It is astonishing to observe the level of inter-relatedness in the world.

Next time you accidentally drop a box of sewing needles all over your kitchen floor (which I appreciate may not be for quite some time), consider that this happy accident can be used to estimate the value of pi in mathematics (assuming the sewing needles are all the same length and your kitchen floor is made up of equally-spaced, parallel-striped panels – this is a consequence of a problem called Buffon’s Needle).

Or next time you’re trying to construct a 17-sided polygon using just a straight edge and compass (as one often does), you will be relieved to know that this is in fact possible, and the proof of this fact is equivalent to showing that the cosine of pi over 17 can be expressed using just the four field operations (plus, minus, multiply and divide) and the square root function – which by the way is no mean feat; it looks like this:

formula

 

There are a seemingly endless number of similar, arguably abstract, examples of inter-relatedness in mathematics which are unlikely to affect us, but there are a similarly large number in the world of investing, which undoubtedly will. One only need consider all those factors which affect the emotions of anyone that buys or sells stock in a company to believe that the list of occurrences ofinter-relatedness which affect a company’s share price is endless.

Since a country’s stock market index is simply the aggregation of all of the companies within its index (typically weighted by market capitalisation), factors which cause a movement in an individual company’s price will no doubt have an effect on the level of the country index. But the impact of the majority of these infinite number of instances of inter-relatedness likely affect the long-term trajectory of a stock market index to the same extent that the average person’s life has been affect by the problem of Buffon’s Needle – not a great deal.

So whilst perfect investing (in the sense of capturing every single up-tick and avoiding or shorting every single down-tick) would require us to be experts in all areas of every subject, and have a complete knowledge of all of those potential instances of inter-relatedness, successful investing does not. Successful investing requires an expertise of those key factors which affect the long-term value of a portfolio and the ability to maintain composure whilst the insignificant instances of inter-relatedness move short-term prices.

In today’s world more than ever, there are a seemingly greater number of potential occurrences of inter-relatedness being distributed to us at lightening speeds, requiring us to assess the difference, for example, between significant regulatory changes which can permanently affect the profitability of a business or sector,and a headline-grabbing but likely unenforceable Tweet. This makes it even more crucial not just to maintain composure and a long-term focus in the face of short-term volatility, but also to recognise when short-term price movements have moved out of sync with long-term value and present an opportunity to pick up a bargain.

Distinguishing between key instances of inter-relatedness which affect the long-term value of investments and those which merely affect the short-term price allows investors tofocus research efforts towards the long-term growth of wealth, whilst ignoring or taking advantage of those occurrences which are nothing more than the noise of needles hitting the kitchen floor.

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