Investment Maxims: Used and Abused

We love maxims because they are punchy, easy to use, easy to remember and they leave an impression. But they often contradict and get us into all sorts of trouble. Take the Citigroup stock priced at 99 cents just a few days ago, do you "strike will the iron is hot"? Or do you "look before you leap"? Now that you've considered both, the answer is much less clear.

In fact, there is a textbook written on the law of equity that boils the subject down into just twenty-five maxims. Imagine that, if you could apply just twenty-five maxims, you were proficient in the law of equity.

Much easier said than done.

“Here is certainly a remarkable difference of opinion. The truth is that there are maxims and maxims; some of great value, some worse than worthless. And the really valuable maxims are peculiarly liable to be put to a wrong use. A proposition, in order to gain currency as a maxim, must be tersely expressed. But the brevity which gives it currency, also in many instances, gives rise to misconception as to its meaning and application. A phrase intended to point out an exception may be mistaken for the enunciation of a general rule. An expression originally used only to state a truth may be mistaken for a statement of all truth…” --"The Use of Maxims In Jurisprudence", Jeremiah Smith. Harvard Law Review, 1895

Don’t you just love legal reasoning? This paragraph intended for legal jurisprudence was written over a century ago but rings no less true in the world of investing till this very day. You’ll find maxims thrown about by everyone ranging from hedge fund managers to relatives dispensing well-meaning but ill-informed advice over the kitchen table. That said, Maxims are a double-edged sword which are more often than not, “put to a wrong use”, and even worse, abused by some to pull a fast one over another.

Bad Maxims include:

- “You have to love a falling market.” This is a license to get investors to buy blindly every time the market falls. Here’s the counter-maxim, “Trying to catch a falling market is like trying to catch a falling knife.”

- "You have to be in it to win it." This applies to the lottery and it's frightening how gambling wisdom has creeped into the field of investing. Sure, you need exposure to the stock market to make gains, but does that mean you should be in every asset class which appreciates?

Good Maxims abused include:

- “There’s no such thing as a free lunch.” It’s largely true but I've also see this misapplied by a banker responding to a client’s request to reduce fees because they were uncompetitive. The client wasn’t asking for a free lunch, he was simply asking the banker to match the rates of his competition. If the client was asking for a free lunch, which he wasn't, he would have been asking for something unreasonable. The client was acting well within his rights.

That's not to say Maxims should be avoided entirely, we can use them if we always keep one thing in mind, "A little bit of knowledge is a dangerous thing."

There are many good ones that escape me at this time of writing. If you can think of any, please comment.

SOURCE
The Use of Maxims in Jurisprudence
Jeremiah Smith
Harvard Law Review, Vol. 9, No. 1 (Apr. 25, 1895), pp. 13-26 (article consists of 14 pages)
Published by: The Harvard Law Review Association