One Funeral at a Time
Karl Popper thought long and deep about theories in his lifelong study of scientific discovery. He warned us about the dangers of being overconfident about the accuracy of our theories and told us that “no theory should ever be relied upon as the final truth”. Theories simply cannot be verified.
While we cannot verify that a particular theory is true, we can compare two theories and determine which lies closer to the truth based on observations. If one theory says the earth is flat and the other says the earth is round, we are not sure which theory lies closer to the truth, until someone sails around the earth and ends up at the same place he started. We then know which theory comes closest to describing reality. We know the earth-is-round theory comes closer to the truth than the earth-is-flat theory because the latter has been “falsified”, to use Popper’s term, through the observation of some event that doesn’t fit the theory.
Falsification, according to Popper, is the way we make progress in better understanding our world. Ironically, we learn about our world not through the proof that an existing theory is right, but through the proof that an existing theory is wrong. When one theory is proven false, some clever person comes up with a new theory that better describes what has been observed. Progress comes through the falsification of one theory and the creation of a new one.
The curious thing about falsification is humans are wired in such a way that prevents us from falsifying our own theories. Rarely does a scientist create a theory about our physical world and then set out to falsify it. An economist doesn’t come up with a theory one day and then falsify it the next. It just doesn’t happen. Nearly every instance of progress in jumping from one theory to a better theory involves different people. One person creates a theory and defends it. Another person falsifies the theory and creates a new one.
One reason we don’t set out to falsify our own theories is we typically have spent a great deal of time, energy, emotion, and money developing the theory in the first place. We have made an investment and we work to protect that investment. A scientist publishes a theory for all to see. His reputation is on the line. Tenure could be at stake. His social network depends on whether his theory is right or wrong. Eventually, he might devote an entire career to defending his theory. He is not about to throw all that away based on one or two inconsistent observations.
The great German physicist Max Planck said that science advances one funeral at a time. The old generation must die off for a new generation to come in and adequately test a theory in an unbiased way. When it comes to jumping from one theory to the next, the power of inertia is overwhelming.
We also have cognitive biases that prevent us from falsifying our own theories. Our brains are wired to make us see and remember evidence that confirms our theories and discount and forget falsifying evidence of that same theory.
This is a very powerful force not unlike an optical illusion. We know with certainty that two lines are the same length because we have measured them. Yet, our brain tells us one line is longer than the other based on how they are presented. Our mind quite literally plays tricks on us.
Charles Darwin respected this force so much that he made himself write down falsifying observations the moment he saw them. He knew that if he didn’t write them down, his mind would set about discounting and forgetting the critical piece of evidence.
We are no Charles Darwin nor are we Karl Popper. Not many of us are. As investors, though, we do create theories. We create theories about companies. We create theories about people. We create theories about the economy. The closer our theories come to reality, the better our investment performance.
We know that falsifying our existing theories is a difficult yet crucial element of creating even better theories. As investors, we must be specific, diligent, and systematic about overcoming the twin forces of inertia and confirmation bias. We must proactively look for falsifying evidence. When we find it, we turn cognitive bias into competitive advantage.