Investing Isn’t Physics

This is my favorite quote from The Four Pillars of Investing by William Bernstein.

Finance is not a hard science like physics or engineering; rather, it’s a social science. The difference is this: a bridge, electrical circuit, or aircraft will always respond in exactly the same way to a given set of circumstances, while the financial markets do not.

That really resonated with me. Before I was a financial planner, I wrote software for a living. I studied mathematics and computer science, and I spent more than a decade in a world where systems behaved almost exactly as they were designed to behave. The same input produced the same output, every time, always. When a program did something surprising, that was a bug, and with enough time & coffee you could find it.

Then I changed careers into a field that looks like that same world, but most definitely is not. Bernstein's bridge always holds because a bridge doesn't have opinions or feelings. But markets aren’t made of stone and steel; they’re made of people. And people react to the last thing that happened, to each other, and even to rumors about the future. Just imagine if bridges behaved like that.

The bug that isn't a bug

In engineering, a surprise means something is broken. In markets, surprise is the normal operating condition.

The deeper reason is one of my favorite ideas in all of finance: studying a bridge doesn't change the bridge. Studying a market changes the market. Publish a (seemingly) reliable pattern, a signal that beats the odds, a strategy that "always works," and money floods toward it until the advantage is gone. The act of understanding the system alters the system. Nothing in physics behaves this way, and nearly everything in markets does.

This is why yesterday's “sure thing” keeps turning into tomorrow's cautionary tale, and why anyone selling you certainty about what markets will do next is selling something that the structure of markets cannot produce.

Which brings up the question I'm asked more than any other. A friend, or sometimes a client, wants to know what I think the market is about to do, and I never seem to have a good answer. "I have no idea" is honest but unsatisfying. "It can only do one of three things: up, down, or sideways" is my standard attempt at a complete answer mixed with a little humor, but sadly nobody ever laughs.

So here's the truthful version, the one I actually believe. I know I'm not the smartest participant in the market. But I am smart enough to know that I don't know what the stock or bond market will do next. Bernstein's point is that this isn't modesty. In a system made of people reacting to each other and to the forecasts themselves, “what’s coming next” is not a computable quantity, for me or for anyone.

The seduction of false precision

Spreadsheets deserve some blame here. Project a portfolio into the future and the software will cheerfully hand you an answer to four decimal places. The decimals are real, but the certainty is absolutely not. This is because beneath the arithmetic are mathematic “guesses” about how millions of people will feel about risk, the economy, or the stock market in years that haven't happened yet.

This often trips up professionals from genuinely precise fields. Engineers, physicians, and software developers. People trained to trust software, models, and data. Because in their world, models have earned the right to it. The hardest habit to unlearn is treating a financial projection like a load bearing calculation for a bridge. In finance, a projection is more analogous to a weather forecast: useful, directionally informative, updated often, and a poor thing to bet on to the decimal.

The one part that actually is physics

One corner of investing really does behave like engineering: costs.

Markets won't respond identically to identical circumstances, but a 1% annual fee subtracts 1% every year with the reliability of gravity. A tax bill you didn't need to trigger is gone with the same certainty. Expenses are the closest thing to a deterministic variable in the whole machine of finance, which is exactly why they get the engineering treatment from me. Nobody controls what the market returns. Everyone controls a surprising amount of what they keep.

That's the real reason the portfolios I build are boring on purpose: broadly diversified, low cost, tax-aware, and simple enough to explain in a single paragraph. I wrote more about that approach in the case for portfolio simplicity. Precision goes where precision actually works. Humility goes everywhere else.

Building for a social system

If markets were physics, the right portfolio would be a solved equation, fully optimized, no slack required. Because they're social, even human. The right portfolio is the one that survives contact with people, including you. It carries diversification, which is humility expressed as an allocation. It carries margin for error, because forecasts age like bread, not wine. And it gets revisited on purpose, not because the plan was wrong, but because plans are forecasts and the planning is the durable part.

There's one more difference. In a hard science, the system doesn't care how you feel. In this one, how you feel is part of the system. Panic is a market force. So is euphoria. Which is why the unglamorous skill of staying invested through uncomfortable stretches has historically mattered more to real-world outcomes than squeezing out the last clever basis point.

Bernstein's book is the one I recommend possibly more than any other, especially to high-achieving engineer type people. It's old enough to have survived several markets that were supposed to break it, and it keeps getting handed to new readers because the core insight doesn't age: the math of investing is easy, and the humans are hard.

Referenced: William Bernstein, The Four Pillars of Investing (McGraw Hill).