By ROBIN POWELL
He’s now regarded as one of the most influential mathematicians of all time, but it was his interest in astronomy that inspired Pierre-Simon Laplace to produce his most famous work.
Laplace was fascinated by the movements of planets and stars. He initially shared the scientific consensus at the time that celestial mechanics could be described deterministically. That view was based on the work of Isaac Newton, which suggested that, given the required information, it was possible to predict the future positions of celestial bodies with accuracy.
But Laplace gradually changed his mind. Uncertainty and lack of information, he realised, made it very hard to make precise predictions with any consistency. The movement of celestial bodies, he argued, was best understood in terms of probabilities. It was that realisation which led Laplace to lay the groundwork for modern probability theory in his work Théorie Analytique des Probabilités, first published in 1812.
Now you may be wondering, what have celestial mechanics and probability theory got to do with investing? In fact, there are significant parallels.
The financial markets are highly complex
The investing universe, just like the actual universe, is hugely complex. It’s very difficult to explain why, on a daily basis, the prices of individual assets move up and down as they do. But that doesn’t stop financial professionals and commentators making market forecasts. The problem they face is that, unlike astronomers, they don’t have any fundamental laws they can refer to. There are no systematic ways of telling, in advance, which assets are going to rise or fall, when it will happen, or how significant those losses or gains will be.
Unfortunately, the overwhelming evidence is that those experts are misguided. As another French mathematician, Louis Bachelier, demonstrated in his 1900 thesis Théorie de la Speculation, that the price of a stock or bond follows a random path, influenced by countless tiny, unpredictable factors. What this means for investors is that speculating as to which assets will perform best in the future is a waste of effort, time and money. The best thing to do is diversify across different asset classes, countries and economic sectors, and simply stay invested.
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This article is based on the book Index Funds: The 12-Step Program for Active Investors. The issues it raises are addressed in Step 8:
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