The Uncertainty Principle, Applied to One Aspect of Financial Health

Tuesday, June 8, 2010 at 9am
By John Friedman

Following on the heels of yesterday’s post about the imagery of portfolio planning, today’s post is about some other language I’ve been using, with varying degrees of success.

Today, then, we leave behind the simple world of airplanes that definitely fly, and charge into the world of quantum mechanics generally, and of Heisenberg‘s Uncertainty Principle specifically — a world in which airplanes might, or might not, fly, depending on . . . how you look at it.

Now I’ll be the first to admit that this stuff can be hard. In fact, reading about quantum mechanics can leave your head hurting — kind of like what happens when I think about negative interest rates — because the thoughts of Heisenberg and Schrodinger, involving eigenstates and maybe-dead cats and the like, are all so very much removed from our everyday experience that they can be bewilderingly confusing.

But that confusion can ultimately leave things, perhaps, just a little more illuminated, so it’s off, into the world of uncertainty, we go!

*  *  *

As a result of the difficult-for-most-everybody nature inherent in quantum mechanics, lay versions of its basic concepts abound.

The lay version I want to focus on is, thankfully, straightforward enough. Here the idea is that, even though our eyes and minds tell us that a given object has certain characteristics (the chair is red, for example or, more in keeping with the topic, the subatomic particle is located on a certain part of the red chair), it’s entirely within the realm of possibility that the object has displayed many different characteristics (the chair has also been black, and the subatomic particle has also been located on a different part of the chair), but that when we looked, the object just so happened to be that way (black or red, but not both, and here or there, but not both).

Or, if you want to hurt your head further, you can think of it instead of as the object simultaneously having all those characteristics — the chair is both red all over and black all over, and the subatomic particle is in various places on both the red-all-over and black-all-over chair — and that the very act of observing the object delineated those characteristics down to the single characteristic we observed.

To lay it down even further, you can say that the very act of observing an object takes the probabilities swirling around that object down to a single actuality. More picturesquely, you can think of the object as existing as a probability cloud of differing existences which, when observed, condensates down to a single solitary existence.

*  *  *

You can look on Wikipedia for something that sets this idea out, nicely and simply, but nothing is spot on, because physicists are not lay people, and because quantum mechanics and the uncertainty principle are mathematically-derived ideas which, thus far, have proven to be stupendously and insanely accurate, so physicists are loathe to mooshy up their beautiful theory to make it understandable for those using Wikipedia. Can you blame ’em?

The articles coming closest to the lay version I’m using here are the articles on wave function collapse and the observer effect (sound about right, n’est ce pas?), the latter of which states in part as follows:

In physics, the term observer effect refers to changes that the act of observation will make on the phenomenon being observed. This is often the result of instruments that, by necessity, alter the state of what they measure in some manner. A commonplace example is checking the pressure in an automobile tire; this is difficult to do without letting out some of the air, thus changing the pressure.

So: you look at it, you change it.

*  *  *

Now, given that we are all lay people in here, let’s just say that there are some things in this world that seem to have more to do with probabilities than with actualities, and that, with some input from us, we can make them actualities.

The future clearly works like this. For example, there are all sorts of probabilities about what you will be doing precisely 24 hours from now. The passage of time, though, will make those probabilities collapse, slowly but surely, so that 20 hours from now fewer possibilities remain extant, while 23 hours from now even fewer will still be in the running, and then at one minute shy of the appointed hour the possibilities will be quite limited indeed, until at that very moment 24 hours from now there will be but one actuality. At that point, time plus you will have conspired to make that moment what it is, and what it is not.

*  *  *

The present can work like this as well. And here is where we loop back into financial health. Can you think of anything in your current financial life, right at this very moment in time, that is something more akin to a probability than a reality?

Hmmm . . .

There are lots.

In here, though, let’s focus in on the number showing up as the balance on your most recent end-of-month investment account statement. Surely that number changes not just daily, but, with respect to stocks, infinitesimal-moment-to-infinitesimal-moment, at least during stock market hours (which are mostly from 6:30 am to 1 pm West Coast time, Monday through Friday).

And surely, even if you don’t look at that account often, you have a general idea about what it might be worth — what the probabilities are — because, for example, if it was worth $100 one month ago, you know with some degree of probability that it could be worth, say, $99 or $101 today (or $90 if you have been paying attention to this blog), while you also know that it is extremely unlikely that is is worth, say, $200, while $2,000 is even more unlikely and $2,000,000 is for all intents and purposes impossible.

The same thing is true even if you do look at that account often. If it is worth $100 now, you know that it might be worth $99 or $101 at the close of the market today, or even $97 (last week) or $102. But $200, $2,000 and $2,000,000 are still unlikely. Observation in this context, then, doesn’t make any difference, other than you knowing more about the portfolio (by way of more recent information) and therefore being able to reduce the probabilities some.

Seen this way, the number on your end-of-month statement is just one big probability cloud, artificially frozen in time, at the end of the last hour of the last market day of the last completed month — like a strobe light catching a frenetic dancer in some contorted position, suspended in mid air.

This, then, is the key to this entire linguistic/imagery-istic exercise: the only thing that stops that number from moving about and being uncertain — the only thing that takes that number from a possibility to an actuality — is converting it into something that does not change value, ever. And what might that be?

How about cash (and, yes, I am ignoring currency devaluations and broken bucks courtesy of The Reserve Fund and the like)?

Cash has no probability cloud; it’s an actuality, not a possibility. You want certainty? Then go to cash. Absent that, then please say hello to my little friend uncertainty.

*  * *

So please think of an investment, if you can (it can be difficult . . . ), as a probability cloud, because, at any given moment, it is never, ever worth the number shown on a brokerage statement. Instead, that investment has only one value: that value is in the future, and it is the number of dollars, as of the very moment when you, through the sheer force of your effects on the universe and on the particular chunk of it that this particular investment represents, exert your will and convert that investment of yours into cash hard cash (also known as selling the investment).

Until then, any number that you or someone else places on the investment is a mere probability inside of a substantial probability cloud.

So when your portfolio goes down 10% (like it has recently), think of it as a shift of the probability cloud. That 10% difference is not cash; it’s not real. And when your portfolio goes up 10% (like it often does during a year’s time), think of it as a shift of the probability cloud. That 10% difference is not cash; it’s not real. True, an up probability cloud is more fun than a down probability cloud, but all of it is mere information — mere probabilities, amid major uncertainties — rather than an actuality.

As it turns out, then, when it comes to investments (and here we can include real estate, because it’s been mighty uncertain the past handful of years, yes?) there’s no there there until you bring the investment into the world in which we live, which is a world in which our economic needs are met via cash, not via probability clouds.

Until then, it’s all naught but a maybe-dead cat.

‘Til tomorrow then, here’s to your financial health, and may it continuously improve.

1,061 words

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