Chris Carney and I have been speaking at seminars and events together for over 20 years. At times he's given me reason to think he's crazy, but he's always told a good story to convey an insight. I asked him if I could use one of those for this blog, and I'm happy to say that he agreed.
The "Allegory of the Cave" is a very famous excerpt from one of Plato's most famous works, The Republic. It was likely recorded some twenty-four centuries ago - right around 375 B.C., and ever since. It has been interpreted by philosophers in various ways- politically - educationally - and, for the purposes of this post - financially. Now, I'm no philosopher (nor is Chris!), but I think there are some really cool takeaways from this story that can help us all in a variety of ways. As a bonus, you'll be able to impress your kids (if they aren't teenagers) by citing Plato around the breakfast table!
First, let us quickly review the allegory as Plato wrote it, cast as a dialogue between his brother Glaucon and Socrates. The story has three major parts, Imprisonment, Departure, and Return, each of which is important to reflect upon as we try to use the allegory to grow and change as investors. Please allow me a little literary license during this review; while I won't directly quote The Republic, I do hope to do justice to the original work.
The story is set in a cave in which a large group of prisoners are chained to a wall and can only stare at another wall, which is directly in front of them. They are in total darkness, except for the shadows cast on that wall from the outside world. On a sunny day, or when there is a fire burning behind them, they can see the shadows of the people walking along outside, of birds flying, and of other animals passing between the light and the cave. The imaginary prisoners have been chained to this wall since they were young, so they know only this reality. Imagine the excitement if an elephant or some exotic creature's shadow appeared on the wall! You can also imagine the cruelty of the jailers (if you didn't already think them cruel enough) should they be play tricks or manipulate the shadow view before the prisoners. This is how the Dutch painter Jan Saenredam imagined the scene in 1604.
In addition to the shadows, we can imagine the prisoners' frustration at hearing noises that they can't fully understand. Voices, partial words or snatches of sentences as people walk by, or the sounds of rainfall, wind, animals, and so on. All shrouded in mystery. Plato posits that as insane and crazy as this scene seems, for the prisoners, it would in fact be their "reality." They would know nothing else.
The second part of the story is really hard to imagine. Just imagine living in that crazy, murky, deceptive prison for your entire life, and suddenly the jailer walked in and released you! As you walked out of the darkness and into the light you would almost be blinded by the reality around you. The sun would hurt your eyes. The colors would dazzle your senses and confuse your mind. If that imaginary elephant walked by, you wouldn't be able to comprehend what it was, and you would probably in no way connect it to its shadow, seen in the past. It would be totally disorienting. Now throw in full-throated and complete conversations. All of your senses would suddenly come alive. But would it be pleasant? Imagine the shock. What is really real? As a released prisoner attempts to comprehend the world around him or her, all kinds of new possibilities open up.
This is where the allegory gets really interesting to me. Imagine that the former prisoner, after having enjoyed (?) "reality" for a while, is taken back to the prison and re-chained to the wall, able once more to only view shadows. How would that feel? The first readjustment would have to be to the realities of the cave. Darkness, unclear shadows, and confusion. I can imagine the prisoner talking to his fellow inmates with excitement! Trying to explain colors - animals - light - everything! It would be so exciting and amazing, but what would the other prisoners think? Imagine how difficult it would be to explain the three dimensional, noisy world you had just experienced to someone who has never experienced any of those things. How do you describe colors to people who have only seen shadows? How do you explain the sun… or my imaginary elephant, with all of its smells, sounds, and textures thrown on top of its appearance? It would be really difficult, and the other prisoners would no doubt struggle to believe anything you said. In fact, they would probably become frustrated with you for trying to change the reality that they have always understood. If as a returned prisoner, you started encouraging others to try to escape to this amazing reality, there might in fact be trouble. Plato actually suggests that the other prisoners might kill the returned prisoner if he tried to force them to escape. Comfortable with what they know, they don't want change, and besides they don't believe what they hear.
How does this insight help us in investing?
One of the really cool things that Chris and I have seen over the last 20 years is that an investment version of "the Cave" is for many a reality, in real-time, all over the country. The course we teach is wonderful and painful because we teach people about the real-life elephants. It's painful and many people really struggle, but after three days they can finally see that the shadows of yield, duration, and spread (along with many other investing shadows) are not reality.
The struggle is real. Yield is a formula. Duration is a formula. Just like the shadows that the prisoners in Plato's allegory were "real" shadows of items interrupting light rays, they do not represent the true risk-reward of a security. Virtually every attendee at one of our teaching programs previously thought that they were a "true" reality. When we pull the numbers out into the light, what we find is an amazing 3-D picture. As I have been posting about here over the past six months, when we incorporate counting the money, over time, across multiple scenarios, we are then able to see all of the colors and comprehend a true image of each investment. Does that mean that sometimes the shadows are always misleading? By no means. Sometimes you can actually identify an elephant by its shadow…but sometimes you can't. Sometimes it's a hippo; sometimes it's a cardboard cut-out.
I think Chris's commentary on this says it better than I can:
"Every day the problem re-presents itself when the phone rings… the brokers call and show bonds based on yield, spread etc. Inadvertently the broker's traders, by extension through the sales rep, are foisting their short-term paradigm onto the investor - getting the investor to make a long-term decision based on the traders' short-term paradigm. A long-term investor making decisions using short-term metrics (like yield, OAS, spread, convexity, etc.) makes suboptimal decisions, the cumulative impact of which, when measured over a long period of time, quite sizable.
"These metrics are effective for a small group of people in the bond world, but this group wields tremendous influence because they are at epicenter of execution: traders. Traders are buying and selling on a short term basis while portfolio managers must buy with the intent of holding positions for a long period of time. Traders have inventory that they'd like to unload by the end of the day. Investors have portfolios that they intend to hold for many years. Therefore, portfolio managers have to consider additional factors that traders do not - TIME, MONEY and INTEREST RATE CHANGES."
What we find is that after spending an intense few days in "the light" of learning about the many problems with conventional wisdom during one of our courses, many attendees are really excited to get back to their institutions. They are like the prisoner who had been released, and then returns the cave-like prison of conventional wisdom, and their colleagues have never left. Many make a valiant attempt to "educate" their peers about all of the new knowledge and all of the cool three-dimensional knowledge they have acquired…
…and then, just as Plato portrayed this interaction 2,400 years ago - they are metaphorically "murdered" by their still benighted colleagues.
They are attempting to describe the color blue, or an Elephant, to people that have only seen the shadows of conventional wisdom. Conventional wisdom feels so comfortable, and since "everyone else is doing it,, it can't be wrong, right? Unfortunately, it is a very difficult mission, and so many now-enlightened messengers eventually fail to convince anyone back at their institutions. But unlike in The Republic, some eventually succeed!
They do this by not giving up. Some do it by getting more of their colleagues the opportunity to experience the light at a program. Many must persevere through "metaphorical" social "murder" in ALCO once or twice, first. And some ask for help, bringing the light into the cave with demonstration, proof, and sometimes our direct, personal assistance. These people change their world.
My hope is that we can break many more conventional wisdom prisoners out from the shadow world. How? I have been beating this drum for years, but I think it's simple. Count the money, over time, across multiple scenarios. That is the equivalent of carrying a torch, and then the color blue, and maybe even an elephant, into the Cave, so that our fellow prisoners can come to want to escape.
Final, final thought: This will sound weird, but I actually kind of miss snack boxes on airplanes.
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University and Pacific Coast Banking School, please reach out to Chris directly.