Jelly Bean Investing

"Facts are meaningless. You could use facts to prove anything that's even remotely true!" says Homer Simpson, one of our favorite sages. Rarely has such wisdom come from one so yellow and two-dimensional.

Nowhere are facts more deviously misused than in investing. Data abounds for investors—cheap as free. We can check pretty much any assertion, but we generally don't. Seem harsh? Then why our obsession with the price of oil and its impact on stocks? Daily news stories hammer the ill effects of higher oil prices on stocks, yet there's no meaningful statistical correlation.

Behavioral finance has many explanations—confirmation bias, illusion of validity. It boils down to our brain's evolution—or lack thereof. Our hunter-gatherer ancestors didn't do statistics, so we don't either, not instinctively. Reformed media hypester John Stossel illustrates our statistical defects thusly:

Bird flu was called the No. 1 threat to the world. But bird flu has killed no one in America, while regular flu -- the boring kind -- kills tens of thousands. New York City internist Marc Siegel says that after the media hype, his patients didn't want to hear that.

"I say, 'You need a flu shot.' You know the regular flu is killing 36,000 per year. They say, 'Don't talk to me about regular flu. What about bird flu?'"

A couple hundred chicken farmers dead in Asia, and suddenly, we're in a dead panic. Bird flu seems scary, but if you don't share close quarters with chickens in Kazakhstan, odds are you'll die of something else. We promise. (Even if bird flu hits America, we don't think it'd hurt the market much. See our commentary "A Pandemic of Fear.")

But our brains don't want to think something the experts warn us about is no big deal. Who are we to questions experts? They're on TV! We're not on TV. They have facts! And statistics! And pictures of dead chickens with scary sound effects!

Daniel Huff wrote an excellent cautionary tale, How to Lie with Statistics, that should be required reading for any investor. (For just one example of a brilliant statistical lie, check our weekly financial term archive for "average return.") Currently, a media darling is the bursting housing bubble—which will bring recession and market ruin. They have negative year-over-year housing growth statistics to prove it. Our brains hate negative numbers.

Statistics are funny. Looking at the raw numbers, housing prices are still near all time highs. Home prices haven't dropped precipitously—but anyone with an agenda can make the case with a clever statistical construct. The numbers are right there! Why are we so fooled?

Stossel shares an experiment he did on 20/20. They offered $1 per red jellybean blindfolded participants could fish out of one of two plates holding red and white jellybeans.

Here's the catch: While one plate held 20 jellybeans and the other 100, the plate with 20 beans had a higher percentage of red ones. We put up signs that told people this clearly: "10 percent red" of the small plate and just "7 percent red" of the big plate.

Surprisingly, even with the percentage signs in front of them, a third of the people picked the plate with 100 beans.

Why? It said right there—"Hey! Better odds over here!" Investing is much like the jelly bean experiment. We rationally understand the odds, but our brains go haywire when presented with a bigger plate of jelly beans. Who doesn't like more jelly beans? Mmmm . . . jelly beans . . .

We're stricken, but not doomed. Our evolutionary defects are easily overcome by rational analysis and a healthy dose of skepticism. Every fact, particularly those we think beyond reproach, should be investigated. Ask, "What do I believe that could be wrong?" Homer Simpson would be proud.

See more of Stossel's article, "Worry About the Right Things," here - https://www.realclearpolitics.com/articles/2007/04/worry_about_the_right_things.html.