A quote I saw in a recent covered call article got me thinking. Rob Carrick quoted Eden Rahim, who was speaking about a particular Horizons covered call ETF product:
“If you’re a super bull and think the market is going to advance vertically, this product is not for you ... If you think the market is going to do something other than advance vertically, as it has in the past couple of years, then this is something to consider.”
This way of thinking about investing feeds two types of magical thinking. (And to be clear, I’m not accusing either Carrick or Rahim of magical thinking.) The first is more obviously silly when exposed: the market can only have one outcome at a time. It can’t “advance vertically” for me but do something else for other people. If two people have opposite market guesses, at least one will be wrong.
The second type of magical thinking is that we can somehow know what the market will do with certainty. The market will rise, drop, or stay the same with some probabilities. It’s conceivable that some people may have better insight into the probabilities, but nobody can rule out some of the outcomes with certainty.
This means that an investor who thinks the market will go up and makes a large bet on this guess without thinking of the consequences if he or she is wrong may be taking on undue risk. Investors should always be thinking about what will happen if the market moves against them.
This carries over into other areas as well. Homeowners would do well to consider how their finances will handle it if house prices triple or get cut in half over the next decade. We’re most likely to have an outcome in between, but we must consider the full range of possibilities.