“To Know, is to know that you know nothing. That is the meaning of true knowledge.”  – Socrates

I always get amazed by the news stories running every day after market hours stating 5 reasons why market moved the way it did, very rarely they will do a news about how the markets are going to move today because of these 5 reasons. This is simply because they will fail miserably, it is not that they don’t know the variables (causes) which affect the market, but they just fail to know implications of all variables. Last week, I stumbled upon a very famous but very old essay written almost 200 years back by Pierre-Simon Laplace¹, a French scholar. He wrote in his essay that the events, which we ignore, assuming they are insignificant and do not seem to affect may be the main causes, but it is too difficult for us humans to understand at present. With the advancements of human knowledge, we can interpret the variables and forecast the outcome, but this is still limited to our knowledge base.

The uncertainty around the cause of an event is termed as The Butterfly effect. A scientist posed the question during 1972, ‘Does the flap of a butterfly’s wings in Brazil set off a Tornado in Texas?’ Which is now termed as the Butterfly effect and makes the foundation to Chaos theory. The idea can be interpreted in two manners; One is that you will never know what hit you until it hits you or Second that when you trace the actual cause of the effect, it can be something very insignificant which you always ignored.

I do not know the answer, What I do know that in world of finance you never know what hit you. Some recent examples being, people were worried when RBI Governor resigned but market cheered up next day and When in US one company revised its earning guidance, for the next few days global markets suffered the significant loss.

The point I am trying to make is that the world we live in is quite complex and the best of the strategist, economist or portfolio managers can not interpret the future path consistently. With the growing knowledge, in a short run as well as in a long run, they can assign the probabilities to possible outcomes and plan accordingly. Unless any Black Swan event happens, they stay on track and grow at a moderate pace. Still we (Common Investors) want to live by the tips; during school & college we asked the important topics/ sections to read for exam, and for investments, we want to know the best fund to get maximum return at the lower risk. I constantly get quizzed by people to suggest them the best investment returning funds or investment options. If we can not interpret the right investment avenue, then How should we accumulate wealth.

Below are my three cardinal rules:

1. Focus on the wealth growth & overall growth vs the returns on investment: In my decade plus experience of wealth growth most of the growth came by additional savings each year vs investment returns. Live below your means.
2. Always follow an asset allocation: Dynamic or Static will depend on your own aptitude and dedication/ time allocated to manage your portfolio, but you should always have a right balance of assets in your portfolio to minimize the risk to your portfolio returns.
3. Have reasonable return expectations: Warren Buffet at the age of 52 had $250mm and today he has $81bn at age of 88 years this compounds to ~17% return assuming he never added/ withdraw a single penny. So, expecting 20% returns YoY is not a very wise expectation.

¹If you do not know him, just ask any of your engineer friend or a mathematics student about Laplace’s equation or second order partial differential equation. This will result in lot of funny emotions in their memories as it finds the applications in physics, economics, EMFT as well as probabilities etc.