This time it’s different….

It’s a classic risk management bromide to beware of the phrase “this time it’s different.” That’s good advice and the phrase should set off warning bells. Of course, the trouble is, this time, it really is different.

Engineers, like us, remember basic systems analysis. One of the first concepts is open systems versus closed systems. According to the International Council on Systems Engineering, “A closed system is a system that is completely isolated from its environment. An open system is a system that has flows of information, energy, and/or matter between the system and its environment” Clearly, investing is not a closed system.

But, investing is not even an open system. Why not? Unlike engineered systems, the rules are constantly changing. So what’s the point? Be very careful if you think you’ve figured out the ‘system’ and know the rules. Be even more careful if you use old data from 10, 20, 50 or 100 years ago.

Does that mean you should disregard “this time it’s different” as a warning? Hardly. The crux of the warning is that there are likely some fundamental rules to investing, which, if you violate, are likely to cause wailing and gnashing of teeth as you see your investment go bad.

At first this sounds like cognitive dissonance, believing two contrary things at the same time. It’s not quite as bad as that though. Let’s put it this way, “This time it’s different, except for (blank).” That’s probably pretty close to the truth and enables to believe both “this time it’s different” and its inverse. You just don’t know exactly what (blank) is and even if you do, it may be terribly difficult to quantify.

Now you have two risk management warning bells, “this time it’s different” and “this time it’s not different.” Each warning should raise a set of questions and enable you to examine risks from different perspectives. This is what the best investors do.

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