Last Updated on December 2, 2024
Overview – Book Smarts and Hands-on Smarts
When undergoing education or training for a certain job, many programs take a blended approach, which involves theoretical education (i.e., classroom-style teaching) and some work/field experience over a specified amount of time. The goal is that, upon completing their training, students have a balanced mix of theoretical and practical knowledge needed to succeed in the future.
Investing is a very broad field that covers dozens of topics. As investors progress in their careers and as their horizons expand, they will find themselves constantly needing to learn new things. Because of this, an investor’s theoretical knowledge will be ever-expanding.
Although theoretical knowledge is indispensable to investment education, it’s easy to overlook or underestimate the importance of gaining first-hand investment experience. Just like any other endeavour, some things in investing can only be learned through experience, for better or for worse.
Effective investment education encompasses both theoretical and practical knowledge, and this is a challenge all investors will need to address.
Theoretical Knowledge Is the Foundation of Investment Education
Whether they’re about to start for the first time or have been at it for several years, most investors rely on theoretical knowledge to familiarize themselves with key investment ideas, principles, concepts, and paradigms, among many other things.
As investors advance their careers and find themselves dealing with an ever-growing portfolio, they must ensure their analytical skills remain sharp and their decision-making stays effective. Arguably the most common way to do that is to constantly expand and update their theoretical knowledge.
For many investors, getting familiar with the theory before accumulating any sort of investment experience makes sense. The sequence of getting familiar with theory before gaining real-world experience is, for the most part, a logical one.
Going back to our earlier discussion of many education/training programs requiring a mix of classroom and hands-on experience, no respectable program makes their students perform their work/field experience without having a bit of classroom education first. Why? So that students can first familiarize themselves with what the job entails and are equipped with sufficient knowledge to succeed at it.
Similarly, trying to start an investment career without the slightest clue about how things work, even on a fundamental level, is a recipe for disaster since investors will have no idea (or, at best, have a slight idea) of what they’re doing.
Theoretical investment knowledge involves more than just learning about key investment topics, it also involves other important elements such as understanding the mistakes made by past investors or knowing how to effectively keep your emotions on a tight leash, among many other important things.
It’s often said that “Knowledge is power”, but in investing, knowledge also serves the additional role of being a layer of defence. Investors can reach incredible heights while avoiding dangerous pitfalls by being equipped with the right knowledge.
Some Lessons in Investment Education Can Only Be Learned Through Experience
While the importance of accumulating theoretical knowledge as part of investment education cannot be overstated, not everything can be learned by simply reading more books or watching more videos. Sometimes, certain lessons can only be taught by experiencing something first-hand.
Understanding how things work from a theoretical perspective and seeing how things work given the imperfections of reality can prove to be very different, yet very important. You may already know this from your own life.
When it comes to playing chess, getting familiar with key theoretical concepts such as openings, mid-game & end-game strategy, and positional tactics is key to playing well, especially at a high level. However, no matter how much theory they know, players will only get better by playing all kinds of opponents and witnessing how chess openings, strategies, and positioning work in real games.
Similarly, although understanding certain concepts and phenomena in investing from a theoretical perspective is important, knowing how these things work out in the field is invaluable. Anyone can read about how to navigate bouts of market volatility and think to themselves, “Wow, this is easy”, but navigating real periods of volatility while seeing your portfolio value fluctuate on a whim and constantly being inundated with bad news may not be as simple as originally thought.
Many active investors and investors-to-be understand the importance of being equipped with the right knowledge to succeed in their careers, but there’s only so much they can learn from theory alone.
Gaining real, hands-on investment experience is something that can never be replaced, and will continue to be an invaluable source of countless lessons and insights.
Investment Theory and Experience Complement One Another
Investment education requiring a mix of theory and experience may sound unnecessary, excessively time-consuming, and cumbersome. While some of these things may be true, both are required because of the special relationship they share.
How exactly does that relationship work? Simple: theory can help predict or anticipate what we will potentially experience, while experience can help validate (or invalidate) prevailing theory, thereby improving its predictive power.
Theory and practice are therefore linked by a common, positive feedback loop.
Back to our chess example from earlier, chess theory can help players prepare for and anticipate what sorts of moves or strategies their opponents will use. On the flip side, by gaining experience against various opponents, players can better understand which theoretical concepts are true, and which one may not be as effective in a real game.
This idea also applies to investing. Theoretical knowledge of investing can help investors understand what sort of things they’ll encounter and how to appropriately respond. Conversely, first-hand experience can help investors ascertain which theoretical aspects are valid and which ones may be suspect.
Although investment theory and experience are distinct elements, that doesn’t mean they are mutually exclusive.
Strength in One Cannot Entirely Make Up for Weakness in the Other
Now that we know about the close relationship between investment theory and experience, we can address the question “What happens if you’re strong in one but weak in the other?”
An imbalance of strength between theoretical knowledge and experience isn’t automatically a bad thing. The argument can even be made that for many investors this is the case for them.
Some investors may have extensive knowledge in investing and related fields while only having a few years of experience, while others may have decades-long careers and only study theory once in a while, mostly for the sake of learning about new concepts or developments. Such a relatively small imbalance isn’t much of an issue, as long as theory and experience are more or less equal.
Problems arise, however, when this imbalance becomes too extreme.
An investor can have all the knowledge in the world, but they still need to do some hands-on work to make their portfolio grow and understand how investing works in the real world. An investor with decades of experience but is completely unaware of the constant introduction of new investment instruments, changes in sensible investment strategy, and new theoretical developments may inadvertently harm their portfolio.
Of course, these represent extremes that very few investors will operate at, but the purpose here is to illustrate what could potentially happen at such extremes. Ultimately, investment education, and subsequent investment success, require roughly equal doses of strong investment knowledge and sufficient experience for it to be effective.
Wrapping Up
Success in many endeavours requires practitioners to have sufficient theoretical and practical knowledge to maximize their likelihood of success. Investing is no different.
Although theoretical investment knowledge has served and will continue to serve, as the foundation of investment education, theory can only teach so much; there are many lessons that can only be learned through real-world experience.
Combining theoretical and practical investment knowledge is so powerful because of the relationship they share: theory can help predict what sort of experiences will occur, while experience can help affirm the validity of theoretical concepts and ideas based on how they perform in real conditions.
The challenge investors face is having approximately equal measures of theory and experience. Skewing heavily towards one cannot entirely make up for weakness in the other.
