DO you feel that the harder you work to inject order into your life, the more chaotic things get? You’re not alone.
For more than half a century, a modern field of mathematics called Chaos Theory has been applied to better understand the behavioural patterns of weather, people and money.
In a book I keep by the side of my bed to dip into for recreational study before sleeping titled The Best Writing On Mathematics 2015, there is a chapter titled Chaos On The Billiard Table written by mathematician Marianne Freiberger.
Her opening sentences encapsulate a fundamental truth about this messy world we inhabit: “Even simple processes can lead to chaos. That’s why it’s so hard to predict the weather, the stock market, and all sorts of other processes we come across in everyday life.”
But know that what mathematicians research in Chaos Theory has nothing to do with our conventional perception that chaos reflects purely random behaviour.
Mathematical Chaos Theory is NOT random. Instead, it is deterministic: Cause and effect still rule.
In his voluminous book Wealth Management - The Financial Advisor’s Guide To Investing And Managing Client Assets, author and financial planner Harold Evensky wrote about a new breed of scientists called the chaologist.
Chaologists consider proper (neat) order to be the exception and their version of chaos (a new messy dynamic concept of order) to be the rule.
If you grasp this, you’ll better appreciate why “life is messy”.
Evensky, who turns 75 this September, is considered the dean of American financial planning.
I was fortunate to hear him speak and to meet him more than 15 years ago when I was starting out as a financial planner.
He spoke with compelling clarity on erudite concepts like heuristics (mental shortcuts) and how to reframe client perceptions.
In Wealth Management, Evensky does no less when outlining the three key attributes of mathematical chaos.
Briefly:
1. Nature is deterministic, meaning the past mechanically governs the future. That exact mathematical relationship between the future and the past means there is no randomness.
2. However, we have trouble perceiving the non-randomness at play because the mathematical relationships are non-linear. That means they aren’t related in directly proportional ways.
3. Finally, the process is dynamic and changes over time.
UNDERSTANDING CHAOS THEORY
The reason why Chaos Theory generates messy, unpredictable results is because in reality, most final outcomes are super sensitive to initial conditions.
Even a tiny decimal point difference in opening conditions can cause a huge difference in closing conditions. (For further study I suggest you Google two search terms: 1. Edward Norton Lorenz and 2. The Butterfly Effect, to appreciate the vast range of Chaos Theory.)
Chaos Theory started with an observation by a meteorologist at the Massachusetts Institute of Technology (MIT) in 1961; the weather watcher’s name was Edward Norton Lorenz. (About 22 years after Norton’s discovery, I applied for admission into MIT, while studying for my A Levels in London. Sadly, I failed to gain entry but if I had, I wouldn’t be writing this for you in Vibes!)
Moving from weather to money, when we try to understand what Chaos Theory has to do with the price trajectory of your favourite stock or the aggregate value of your portfolio of unit trust funds, for instance, you should realise that exact future investment values are unpredictable although they aren’t random.
Even a shallow or cursory understanding of Chaos Theory opens our eyes to why risk-on asset classes like equities and investment real estate, or a risk-on asset sector like commodities (within the broader asset class of alternative investments) are so volatile.
Opening conditions are always different; therefore, their precise future price paths are unpredictable. Nonetheless, the complex non-linear equations describing those price movements over time will trace out a defined range of patterns.
Consider a hypothetical system that has this number as its opening condition: 1.60345678. If it then runs through a complex series of non-linear equations, it may have an ending condition of, say, +5.0.
Well, in a chaotic system, if the fresh opening conditions are just marginally different, say, 1.60345888, then that array of complex non-linear equations may generate a very different number, say, -7.7.
Now imagine those two numbers represent possible predicted temperatures (in celsius) for noon next Thursday for a tiny Eskimo village.
Evensky writes:
“The most familiar example of a chaotic system is the weather. Although on a day-to-day basis the weather may seem random, it obviously has a certain predictability. No one is likely to get sunstroke in Syracuse in January. It is equally unlikely that it will snow in Miami in September.”
Similarly, if you — or your financial planner, or investment adviser — select high quality risk-on investments to be the engines of growth of your personal wealth, well then, first, be aware that price volatility is the order of the day. And second, realise that you can turn that unavoidable volatility into a profit generator through an investment strategy like DCA or dollar-cost averaging. (You may learn more about that in my free eReport Deciphering the DCA-VCA Code at www.freecoolarticles.com/giftcentre.htm)
Perhaps then over time, you can harness an intrinsic attribute of Chaos Theory — pattern volatility — to generate wealth and thus, ironically, inject order into your financial life!
© 2017 Rajen Devadason
Read his free articles at www.FreeCoolArticles.com.
Connect on rajen@rajendevadason.com, www.linkedin.com/in/rajendevadason and Twitter @RajenDevadason.