INFORMATION VS UNDERSTANDING.

Dumb Money Still Buying? One of my recent blog entries (January 18) discussed hedge funds and their vast research materials including computer programs designed to screen for investment opportunities. One reasons small investors are often considered at a huge disadvantage is that they lack access to these sophisticated tools to manage their investments. Sounds pretty hopeless for the little guy doesn't it? Fortunately, as I said in that post, I am not convinced that is the case.

One Problem With The Information Age. The main problem with the information age is that we think we need vast amounts of information to make any kind of decision. When I completed a commercial real estate certification 25 years ago, I learned to carry out all kinds of calculations to evaluate real estate investments. We did everything from discounted cash flow analysis to sensitivity risk analyses. I was enthusiastic about trying these. I had high hopes that I could add them to determination of cap rate, GRM, expense ratios, and a whole host of other information I had previously learned how to collect. One place I hoped to use this was with a good friend from Germany who had developed a million + net worth in real estate. Using one of the first property acquisition candidates we located, I went back to my office and spent an afternoon applying all my new techniques. The next day I met with my client and showed him all these new analyses. He didn't compliment me on my thorough analyses, he just sort of ignored it.

The Same Thing Happened Again. The information was difficult to understand and few clients paid a lot of attention to it. Since my attempts to use this to communicate with with clients were unsuccessful, I decided to develop the information for myself in order to become a better consultant. After a year of using this information, I decided it had limited use. Why was that the case? 1. Most experienced investor clients made their decision relying heavily on intuition. While, many academics and consultants make fun of intuition, many clients have relied on it for some time and become very successful using it. 2. There are already dozens of quantitative tools to evaluate real estate investment. These can be done in minutes instead of hours and tell you 95% of what you need to know to make a successful investment. The more sophisticated tools involved making assumptions and projections about the future. Even if the more complex calculations can be carried out successfully, the assumptions you make about the long-term future are subject to wide variation and are unlikely to be accurate over longer periods.

Blink. This is the title of a book on this subject by Malcolm Gladwell, a writer for The New Yorker magazine. He studied several situations where it turned out that gathering too much sophisticated information did more harm than good. One of these was an east coast hospital emergency room. Whenever they had a patient come in with chest pains, they had a set of tests designed to determine whether or not it was a cardiac event. The series of tests was quite reliable; however, the time required to conduct all these tests was time that treatment had to be delayed. A statistical analysis of all the tests showed that they could cut the number of tests by 75% and do almost as well as with the full battery. The new, abbreviated test scheme saved money and lives. Gladwell cites several other examples in his book. Fortunately, this example could be statistically validated. Some of the other examples were totally based on intuition. Intuition that could not be taught because the person using it didn't really know how he was doing it. An example of this came from a tennis fan who could predict with amazing accuracy whenever the server was going to double fault. His results were statistically validated over a long period but the predictor couldn't tell you any observation that allowed him to make such a prediction. One of the main observations in Gladwell's book is that often we don't need more information, what we need is understanding. I believe this is an area that we need to think about in the information age when we can be so busy collecting and organizing information that we don't stop and look at what we are collecting in a critical fashion. The term "paralysis by analysis" comes to mind.

Still In Colorado. Learning some things here as I try to tackle a couple of problems using the same principles I have talked about here. Call my cell phone 303-902-3940 if you have any questions or comments.