The problem is that this adage is often used as a justification when people accept a principle in theory but then violate it. I come across this adage frequently in discussions about investment decisions. Today, many mutual fund investors are well versed in best investment practices. The problem is that their investment portfolios often read like a catalog of exceptions to those practices, each justified with the infamous “exception that proves the rule” story.
Remember one principle of investing: never invest in an equity fund all at once. The prudent approach is to invest through SIPs, whose benefits are well known. However, the portfolios of investors who understand this principle are full of exceptions, all accompanied by a seemingly sound rationale.
You may hear explanations like, “I have a large sum of money available and someone alerted me to this fantastic opportunity, so I invested it all at once.” Or perhaps, “I know sector-specific funds are not recommended, but it’s clear that the infrastructure sector is poised for growth, so I made a large investment in this great infrastructure fund.” Another common refrain is, “Given the volatility of the equity markets, I decided to invest in a 10-year fixed deposit.” These scenarios repeat themselves, with slight variations, in numerous portfolios. They all fall into the category of “exceptions to the rule,” whereby investors consciously choose to deviate from investment principles they know to be correct. They have convinced themselves of this, often with the help of a persuasive salesperson.
Most of us think of investment rules as general guidelines or well-intentioned advice that can be ignored for once. This attitude is wrong. An unusual source provides an interesting perspective on this topic. I came across a NASA document that, although focused on software development, offers relevant insights for investors. The document, titled “The Power of Ten,” describes 10 rules for developing safety-critical software and was written by Gerard Holzmann, a NASA computer scientist. Holzmann’s research is particularly relevant to our discussion.
Holzmann found that rules must be treated as laws, not guidelines, to be effective. Many organizations have numerous policies, but in practice their employees become experts at justifying exceptions. Instead, Holzmann found that fewer but sacrosanct rules led to better results. He advocated eliminating any process for assessing the legality of exceptions. And most importantly, even if an exception was justified in a particular case, the overall outcome improved if exceptions were never allowed. This worked because by foregoing some justified exceptions, many frivolous exceptions were eliminated without the need for case-by-case evaluation. For individual investors, there is no external enforcer of rules, so self-discipline is key. Understanding the logic behind this advice can be invaluable. There may be situations where deviating from the basic principles of sound investing could have led to better returns. But these exceptions are rare and can usually only be identified with certainty in hindsight. Therefore, it is much better to consider these guidelines as sacrosanct and to resist the temptation to fall for the myth that “exceptions prove the rule”.
Treating investment principles as inviolable laws rather than flexible guidelines will produce better results. Sometimes you might miss out on a lucrative option, but more often it will protect you from making frequent exceptions due to short-term market conditions, savvy salespeople, or your own bias.
(The author is CEO, VALUE RESEARCH)
