Understanding economics, particularly Austrian economics, can help us in our investing. Austrian economics teaches us that the study of economics is really the study of human action. While charts and formulas can be helpful, predicting economic trends is really trying to predict human behavior.
This is also why it is so tough to time investments. There were some people that called the housing bubble back in 2003 and 2004, a few years before the actual peak. There were a few that called the tech bubble in the 1990’s years before the actual peak. So while they were right in their predictions of the bubbles popping, their timing wasn’t right.
Keynes did get something right during his lifetime. He said that the market can stay irrational longer than you can stay solvent. This really is a great statement. It is why it is so tough to play the futures/ options market. It is also why you should never go “all in” (to borrow a poker phrase) and put all of your money in one basket.
Let’s say that you think the price of gold is going to go to the moon. The current price is just over $1,400 per ounce. Let’s say you think it will double and go to $2,800 in the next year. If you put all of your money into gold and it does as you think, then you will double your money. But what if that doesn’t happen? What if it goes down over the next year to $1,000 before actually going to $2,800 the following year? In that scenario, you lost the opportunity to buy it at an even lower price and make even more money, but at least you still doubled your money. It just took longer than you thought.
Of course, there is the possibility that you could have been totally wrong and lost money. Someone could have predicted in 1981 that gold would surpass $1,000 per ounce and they would have been right if they were willing to wait over 25 years.
The point is that even if you can make some accurate predictions as to what will happen in the economy and with certain investments, you should still remain somewhat conservative. You should speculate with money that you can afford to lose and you should always keep some cash. You may think that you see the investment of a lifetime, but what if something even better comes along in another 6 months? You would be better off keeping some cash on the side. In the case of the gold example, if you thought it was a great buy now because you think it will go to $2,800 per ounce, then what if the price drops over the next few weeks? Wouldn’t it be nice to have some extra money to buy more gold at $1,000 instead of the $1,400 price?
This is not to say that you should wait on things either. I am a believer in the permanent portfolio as described by Harry Browne in his book Fail Safe Investing. I believe everyone should put a majority of their investments in something similar and do it immediately. But if you are going to take some big risks with some play money, I would still suggest that you not bet it all at once. Leave some money aside so that you can play another hand later on. After all, you may be right in your prediction but wrong on your timing.
Don’t become insolvent while the market stays irrational. You may think that something should happen now, but the billions of people that make up the market may not act that way right now.