The State of Long-Term Expectation

In practice we have tacitly agreed to fall back on a convention.

This convention assumes that the existing state of affairs will continue indefinitely, except when we have specific reasons to expect a change.

This does not mean that we really believe that the existing state of affairs will continue indefinitely.

The actual results of an investment over many years very seldom agree with the initial expectation.

Nor can we rationalise our behaviour by arguing that to a man in a state of ignorance errors in either direction are equally probable, so that there remains a mean actuarial expectation based on equi-probabilities.

The assumption of arithmetically equal probabilities based on a state of ignorance leads to absurdities.

In effect, we are assuming that the existing market valuation:

• is uniquely correct in relation to our existing knowledge of the facts which will influence the investment yield
• will only change in proportion to changes in this knowledge.

But philosophically, this cannot be uniquely correct since our existing knowledge does not provide a sufficient basis for a calculated mathematical expectation.

In fact, all sorts of considerations enter into the market valuation which are irrelevant to the prospective yield.

Nevertheless, the above method of calculation will be compatible with a considerable measure of continuity and stability in our affairs, so long as we can maintain the convention.

An investor can legitimately encourage himself that his only risk is that of a genuine change in the news in the near future. This will happen:

• if there exists organised investment markets
• if we can rely on the maintenance of the convention

A genuine short-term change in the news:

• is unlikely to be very large
• can let him to form his own judgment.

If the convention holds good, then it is only these changes which can affect the value of his investment.

He need not need to lose his sleep merely because he has not any notion what his investment will be worth 10 years from now.

Thus, investment becomes reasonably “safe” for the individual investor:

• over short periods, and
• over many successions of short periods

This is if he can rely that there is no breakdown in the convention. This will let him revise his judgment and change his investment before there has been time for much to happen.

Investments which are “fixed” for the community are thus made “liquid” for the individual.

It has been, I am sure, on the basis of some such procedure as this that our leading investment markets have been developed. But it is not surprising that a convention, in an absolute view of things so arbitrary, should have its weak points.

It is its precariousness which creates no small part of our contemporary problem of securing sufficient investment.