Common Sense on Mutual Funds: Fully Updated 10th Anniversary Edition

Chapter 2. On the Nature of Returns: Occam's Razor

The preacher Ecclesiastes said, "There is no remembrance of things past; neither shall there be remembrance of things to come." That philosophy is doubtless sound for investors concerned about the erratic, unpredictable, short-term volatility in the U.S. financial markets. But in developing a long-term investment strategy, remembering the past is essential, because it can help us to understand the forces that drive security prices. When we subject financial realities to reasoned analysis, we gain insights into the sources and patterns of the long-term returns produced by stocks and bonds in the past. Those insights can provide a sound basis for determining the nature of future returns. What is more, they can form the basis for rational discourse about investing in the years ahead.

Sir William of Occam, a fourteenth-century British philosopher, is responsible for the insight that the simpler the explanation, the more likely it is to be correct. This postulate has come to be known as Occam's Razor, and I have used it in the analytical methodology with which I approach the financial markets. Wielding Sir William's razor, I have shorn my methodology of all complication, paring the sources of investment return down to three essential components. This analysis takes into account my conviction both that the performance of individual securities is unpredictable, and that the performance of portfolios of securities is unpredictable on any ...