Truepoint recently held its fourth Annual Client Meeting at the Cincinnati Art Museum. The event was well attended and featured noted journalist James Surowiecki as keynote speaker.
Mr. Surowiecki, the financial columnist for The New Yorker, is best known for authoring New York Times business bestseller The Wisdom of Crowds. His entertaining and informative presentation drew heavily on the core thesis of his book – specifically, that the collective intelligence of groups is greater than that of individuals, including experts. Or as the subtitle of his book puts it, “the many are smarter than the few.”
At its simplest level, the wisdom of crowds can be seen at work whenever groups of people are asked to guess the number of jellybeans in a jar. As attendees arrived at the Truepoint meeting, they encountered just such a jar and were asked to jot down their estimates before entering the auditorium. We explained that the official number would be revealed later to test our speaker’s theory. As countless classroom experiments have shown, the average estimate of the group is likely to be closer than any one individual guess.
As Mr. Surowiecki pointed out during his talk, the theory holds in many realms of life. For instance, in politics, various public electronic “markets” do a far better job in predicting the winners of elections than prominent pollsters and pundits. Similarly, in sports, after bookmakers set the initial point spread for an event, the odds fluctuate based on the inputs of crowds placing bets on either side of the line. The favorites and underdogs each win roughly half of the time, proving the crowd’s collective judgments to be impressively accurate.
Certainly the wisdom of crowds applies in investing as well, as our speaker highlighted. The superior performance of index funds and passive investment strategies as compared to active money managers demonstrates how even the smartest experts can’t consistently outperform the collective wisdom of all market participants.
Despite the consistent futility of “expert” forecasts, Mr. Surowiecki described the appeal of such prognostications as the “seer-sucker theory”: no matter how much evidence exists that seers do not exist, suckers will pay for the existence of seers. He went on to add, that even if these superior beings do exist, there is no way to identify them – distinguishing between those who are lucky and those who are genuinely good is a near-impossible task.
Investors do not need to be rational, and markets do not need to be perfect, for markets to still be excellent at problem solving. Or to put it differently, individual irrationality can add up to collective rationality.
Speaking of excellent problem solving, the average estimate of jelly beans in the jar at our meeting was 1,333 – precisely one jelly bean off the actual total of 1,332. The wisdom of crowds, indeed.
If you have any questions, please don’t hesitate to contact us. If you’re not currently a client, but would like to schedule an appointment, please contact Lisa Reynolds at (513) 792-6648 or firstname.lastname@example.org.