Strange Magic

"So, does Extension offer any classes that can help me to understand how investments work?" the Astrophysicist asked me. "I've always found Finance to be rather intimidating."

I was rather surprised to hear it, and said as much. "The science of financial management is just a set of mathematical models based on a limited amount of data, and the mathematics in question are much simpler than the ones you are already studying," I told him. "Trust me; I took Physics for Non-Majors and Astrophysics for Non-Majors as an Undergraduate, and the basic Finance class during business school. The Physics was definitely harder.”

“It’s not the math,” the Astrophysicist told me. “It’s the assumptions. Every one of these calculations assumes that the Prime Rate will do something, or won’t; that the Cost of Capital will be something, or won’t; inflation, foreign trade, consumer spending patterns, who gets elected to national office – all of it is based on assumptions, and none of those assumptions is based on anything! How do you build on a foundation like that?”

I’ve often encountered this same attitude in people without training in business, especially those with degrees in the humanities (or no college at all). This was the first time a scholar from a math-oriented discipline had ever asked me that question, however. “Human behavior is one of the keys to understanding Finance,” I agreed. “And it probably helps to remember that this is a new science; even two centuries there was no such thing as High Finance. But, that said, we’re still trying to predict future events based on past experience, and trying to take into account all of the factors we know about.”

“But you can’t ever be sure of those assumptions,” he objected.

“Neither can you,” I replied. “Everything in the Universe is moving all the time, and you never know when a previously undetected object is going to throw off an orbit you though you had pegged.”

“Well, to some extent that’s true,” he conceded.

“The misconception that most people have about Finance is that it’s just one set of computations – that you can run one simple calculation and know what a market or a specific company is going to do in the future,” I went on. “Theoretically, if you know every force acting on a body, you could tell me where it is going to go, and when, and how fast, and so on, right?”

“Of course,” he agreed.

“But if your first set of parameters was off, you’d never just throw up your hands and walk away,” I suggested. “This is essentially the same situation; we don’t know what’s lurking around the next corner, and we can’t just get out a telescope and look for it. But we’re only dealing with the actions of a limited number of people on one small planet; there are finite limits on what CAN happen. If you can figure out most of the things that MIGHT happen, you can plan for a whole range of different outcomes.”

“You can?” he asked, puzzled.

“Sure you can,” I replied. “Diversification can help you avoid being hit by failures in any one industry or region; International investments can help you avoid problems with natural disasters or popular revolutions; the right mixture of equity investments (stocks), debt investments (bonds), metals and commodities, real estate, and other investments can help you smooth out the effects of national economic and political events. Strategy is strategy; the means are always changing, but the science remains the same.”

“So you think I can do it,” the Astrophysicist said, smiling for the first time.

“Of course you can,” I assured him. “The only question is how much of your life you want to devote to pouring over spreadsheets. If it turns out that the science of money delights you, my colleagues on the Finance side can teach you everything you’re going to need. We can even teach you how to complete the Certified Financial Planner exam and become a CFA yourself. But if you’re like most of us, you’ll probably just want to hire one…”