Prior to the 15th century, maps generally contained no empty spaces. Mapmakers simply left out unfamiliar areas, or filled them with imaginary monsters and wonders. This practice changed in Europe as the great age of exploration began. In Sapiens, Yuval Harari argues that leaving empty spaces on maps reflected a more scientific mindset, and was a key reason that Europeans were able to conquer and colonize other continents, in spite of starting with a technological and military disadvantage. Conquerors were curious, but the conquered were uninterested in the unknown. Amerigo Vespucci, after whom our home continent was named, was a strong advocate of leaving unknown spaces on maps blank. Explorers used these maps to move beyond the known, sailing into those empty spaces so they did not stay unmapped for long.
The same phenomenon occurs in business. In the Innovator’s Dilemma, Clayton Christensen shows why large established ostensibly well-run companies so frequently miss out on major waves of innovation. A key principle in the book is the difference between sustaining technologies, which merely improve the status quo, and disruptive technologies, which offer a new and unique value proposition. Large companies will frequently focus on sustaining technologies, and ignore disruptive technologies that serve fringe markets initially. Ultimately its disruptive technologies that define business history. Yet complacent companies don’t figure that out until its too late.
Companies whose investment processes demand quantification of market sizes and financial returns before they can enter a market get paralyzed or make serious mistakes when faced with disruptive technologies.
There are two parts to overcoming the innovator’s dilemma:
- Acknowledging that the market sizes and potential financial returns of a nascent market are unknowable and cannot be quantified (drawing the blank spaces on the maps) and;
- Entering the nascent market in the absence of quantifiable data- (travelling into the empty space)
Analogous ideas also apply to investing. In Investing in the Unknown and Unknowable, Richard Zeckhauser distinguishes between situations where the probability of future states is known, and when it is not. The former is the realm of academic finance and decision theory. The latter is the real world.
The real world of investing often ratchets the level of non-knowledge into still another dimension, where even the identity and nature of possible future states are not known. This is the world of ignorance. In it, there is no way that one can sensibly assign probabilities to the unknown states of the world. Just as traditional finance theory hits the wall when it encounters uncertainty, modern decision theory hits the wall when addressing the world of ignorance.
Human bias leads us into classic decision traps when confronted with the unknown and unknowable. Overconfidence and recollection bias are especially pernicious. Yet just because we are ignorant doesn’t mean we need to be nihilists. The essay has some key optimistic conclusions:
The first positive conclusion is that unknowable situations have been and will be associated with remarkably powerful investment returns. The second positive conclusion is that there are systematic ways to think about unknowable situations. If these ways are followed, they can provide a path to extraordinary expected investment returns. To be sure, some substantial losses are inevitable, and some will be blameworthy after the fact. But the net expected results, even after allowing for risk aversion, will be strongly positive.
Examples in the essay include David Ricardo buying British Sovereign bonds on the eve Battle of Waterloo, venture capital, frontier markets with high political risk, and some of Warren Buffet’s more non-standard insurance deals. Yet since even the industries that seem simple and steady can be disrupted, its critical to keep these ideas in mind at all times in order to avoid value traps.
The best returns are available to those willing to acknowledge ignorance, then systematically venture into blank spaces on maps and in markets.
Imagine if Warren Buffett of 1960 puts down the deadtree 10-K he got in the mail and time travels forward to 2019. Then he looks over the shoulder of an analyst at present day O’Shaughnessy Asset Management. He would find the scene unrecognizable.
Or, if the original Jesse Livermore time traveled from the 1920s stock exchange to the present day trading floor of DE Shaw or Renaissance. Again, completely unrecognizable.
Back in the day people went to the SEC office in the Washington DC to access annual reports faster. That was how one got a fundamental edge. Now people scrape filings the minute they come out. Or use satellites and credit card data to get an edge on information before it hits regulatory filings. People used to gauge momentum by looking at the facial expressions of other traders, now they use complex computer models. People mine market and fundamental data around the globe looking for a bit of an edge. New techniques, same thing.
Over time there is the change in the physical activities, and words we use to describe the process of identifying and exploiting market inefficiencies. Nonetheless the ecological function is the same. Investors are just looking for mispriced risk, and exploiting it till its no longer mispriced.
Around the world there are unfair coins waiting for someone to flip them. Arbitrageurs will need to use weirder and weirder methods to find and exploit them. Methods change, but the arb remains the same.
“To Destroy the Ego,
One Must First Find it”
-Wu Hsin, Aphorisms for Thirsty Fish
One ego suspension trick I find useful is to separate myself from my ideas. Once I think of and share an idea I mentally treat it as this thing that is different and separate from me.
So if someone says the idea sucks- I can view their feedback objectively. They’re not attacking me. The way forward is not a choice between “my” idea and someone elses idea. Its just a choice between ideas.
The same goes for actions already completed. If someone questions a move I made in backgammon, or someone I hired at my company, or a major life choice, I can view it objectively and potentially improve in the future.
Its kind indirect way to achieving the benefits of Kipling’s call to:
“… trust yourself when all men doubt you
But make allowance for their doubting too. “
I just make it easier by stepping outside and not being attached to the “you”. The criticism and criticized are in the distance.
Sometimes this leads to better insight. There is no need to preserve an identity that may be attached to a particular idea. Just find the idea that is better according to some criterion and go there.
This isn’t a perfect system. There is only human software operating here. But it helps. Its a cruder version of what many great thinkers in the past have known.
Around 200 BC Chinese strategist Zhuge Liang first used a sales trick still re purposed by consultants and lawyers today.
Zhuge Liang was an amateur meteorologist, and he used this fact to convince people that he could control the weather. His knowledge of meteorology was very basic, something any farmer who paid attention would have known. Nonetheless his enemies didn’t have this knowledge. So it was easy to bamboozle them.
During one battle , he realized that the wind was likely to switch direction in a manner that was highly favorable for his army.
He made sure the enemy saw him do an elaborate ceremony that looked like black magic. He kept at it until the wind changed direction. As a result his reputation as a fearsome indispensable strategist grew massively.
This was featured in the historical fiction Romance of the Three Kingdoms . The phrase “Borrow the East Wind (借东风) refers to this story. Its sometimes used to described taking advantage of a situation.
A bit of dancing, drumming and smoke. Zhuge Liang took basic observation skills and sold them as black magic.
Modern knowledge work
I think of this anytime I see a knowledge worker selling their work makes it look more complex than it really is.
Jargon, chartporn and powerpoint replaces dancing drumming and smoke. Or alternatively with legal and compliance work, fear of regulatory risk leads to a company paying high fees to avoid problems. Even if all that is needed is filing a simple form at the right time.
There is a risk of a similar phenomenon in any business where there is a huge knowledge gap between seller and customer. Will the seller take advantage of that gap in a way that harms the buyer?
It may seem like there is one fundamental problem with this comparison: Zhuge Liang was a diplomat/military strategist. A sales call isn’t a war. Its not supposed to be adversarial!
That might actually be the problem. An honest sales process is about helping the client see the value. The battle is against any misperception not against the client. A dishonest sales process is about taking as much from the client as possible.
Zhuge Liang’s life was on the line. And warfare (against sentient opponents) is all about deception. Deceiving competitors is justifiable. But deceiving customers is not. Some businesses may feel their life is on the line, but I bet they could make a good living by reducing complexity rather than playing it up. I know I’m willing to pay up for reduced complexity!
Dealing with this issue has proved to be a major challenge in dealing with lawyers, compliance consultants and technology contractors. I’ll ask around and get quoted absurdly large price ranges for the same set of work.
I’m getting better at asking the right questions in order to see what services are really worth.
I place great value on lawyers, consultants and developers who can cut through the bullshit.
The idea of having “morning routine” is a favorite topic on the interwebs these days. Its now at the point where I can barely tell apart parody from serious articles. I think Tim Ferriss started it all by asking every single one of his guests their morning routine. Most people couldn’t resist listening. I know I couldn’t.
When a “high performer” provides a detail on their morning routine, they are merely providing an example of a thing that works for a very specific set of circumstances. Nothing more nothing less. Just because it worked for them, doesn’t mean it will work for you.
Nonetheless it is still a useful data point. Weird low cost ideas are usually worth trying.
Eliminating decision fatigue
I view morning routines as constrained optimization problem that will have different solutions for different people. It might even have different answers on different days for the same person.
I’m generally skeptical of anything overly complicated. The key benefit of a morning routine is it reduces decision fatigue. The morning routine is a “default setting” . But if one is obsessed with following it, it becomes a burden and prevents serendipity.
Towards an antifragile morning routine
The ability to adapt to changing circumstances is more important than having a set routine. Some days you have to work late. Other days you may have an early meeting. Or maybe your child gets sick. What if your spouse or mistress needs your support? What do you do when you travel or are awoken by a phone call? What then?
It doesn’t make sense to rigidly expect the world to conform to your plan. A fragile morning routine is worse than no morning routine. A robust morning routine is better. An antifragile morning routine is best.
Personally I have a “default setting” to do when I’m home and nothing special is happening. I have a handful of different algorithms I can enact depending on other circumstances that come up. This gives me the comfort of a routine without rigidity. If I’m travelling I’ll usually explore the local area just a bit.
Sometimes an emergency leads to a new insight.
The secret is to make peace with walking around in a world where we recognize that we are not sure and that’s okay. As we learn more about how our brains operate, we recognize that we don’t perceive the world objectively. But our goal should be to try.
Annie duke’s “Thinking in Bets” is basically long essay with an extremely valuable message. Under a plethora of entertaining anecdotes about professional poker it contains a valuable framework for making decisions in this uncertain world. This requires accepting uncertainty, and being intellectually honest. Good decision making habits compound over time
Thinking in Bets is a slightly less nerdy and less nuanced compliment to pair with “Fortune’s Formula”. It also fits in well with some of the more important behavioral finance books, such as…. Misbehaving, and Hour Between wolf and dog, Kluge, etc.
I’ve organized some of my highlights and notes from Thinking in Bets below.
The implications of treating decisions as bets made it possible for me to find learning opportunities in uncertain environments. Treating decisions as bets, I discovered, helped me avoid common decision traps, learn from results in a more rational way, and keep emotions out of the process as much as possible.
Outcome quality vs decision quality
We can get better at separating outcome quality from decision quality, discover the power of saying, “I’m not sure,” learn strategies to map out the future, become less reactive decision-makers, build and sustain pods of fellow truthseekers to improve our decision process, and recruit our past and future selves to make fewer emotional decisions. I didn’t become an always-rational, emotion-free decision-maker from thinking in bets. I still made (and make) plenty of mistakes. Mistakes, emotions, losing—those things are all inevitable because we are human. The approach of thinking in bets moved me toward objectivity, accuracy, and open-mindedness. That movement compounds over time
Thinking in bets starts with recognizing that there are exactly two things that determine how our lives turn out: the quality of our decisions and luck. Learning to recognize the difference between the two is what thinking in bets is all about.
Why are we so bad at separating luck and skill? Why are we so uncomfortable knowing that results can be beyond our control? Why do we create such a strong connection between results and the quality of the decisions preceding them? How
Certainty is an illusion
Trying to force certainty onto an uncertain world is a recipe for poor decision making. To improve decision making, learn to accept uncertainty. You can always revise beliefs.
Seeking certainty helped keep us alive all this time, but it can wreak havoc on our decisions in an uncertain world. When we work backward from results to figure out why those things happened, we are susceptible to a variety of cognitive traps, like assuming causation when there is only a correlation, or cherry-picking data to confirm the narrative we prefer. We will pound a lot of square pegs into round holes to maintain the illusion of a tight relationship between our outcomes and our decisions.
There are many reasons why wrapping our arms around uncertainty and giving it a big hug will help us become better decision-makers. Here are two of them. First, “I’m not sure” is simply a more accurate representation of the world. Second, and related, when we accept that we can’t be sure, we are less likely to fall
Our lives are too short to collect enough data from our own experience to make it easy to dig down into decision quality from the small set of results we experience.
Incorporating uncertainty into the way we think about our beliefs comes with many benefits. By expressing our level of confidence in what we believe, we are shifting our approach to how we view the world. Acknowledging uncertainty is the first step in measuring and narrowing it. Incorporating uncertainty in the way we think about what we believe creates open-mindedness, moving us closer to a more objective stance toward information that disagrees with us. We are less likely to succumb to motivated reasoning since it feels better to make small adjustments in degrees of certainty instead of having to grossly downgrade from “right” to “wrong.” When confronted with new evidence, it is a very different narrative to say, “I was 58% but now I’m 46%.” That doesn’t feel nearly as bad as “I thought I was right but now I’m wrong.” Our narrative of being a knowledgeable, educated, intelligent person who holds quality opinions isn’t compromised when we use new information to calibrate our beliefs, compared with having to make a full-on reversal. This shifts us away from treating information that disagrees with us as a threat, as something we have to defend against, making us better able to truthseek. When we work toward belief calibration, we become less judgmental .
In an uncertain world, the key to improving is to revise, revise, revise.
Not much is ever certain. Samuel Arbesman’s The Half-Life of Facts is a great read about how practically every fact we’ve ever known has been subject to revision or reversal. We are in a perpetual state of learning, and that can make any prior fact obsolete. One of many examples he provides is about the extinction of the coelacanth, a fish from the Late Cretaceous period. A mass-extinction event (such as a large meteor striking the Earth, a series of volcanic eruptions, or a permanent climate shift) ended the Cretaceous period. That was the end of dinosaurs, coelacanths, and a lot of other species. In the late 1930s and independently in the mid-1950s, however, coelacanths were found alive and well. A species becoming “unextinct” is pretty common. Arbesman cites the work of a pair of biologists at the University of Queensland who made a list of all 187 species of mammals declared extinct in the last five hundred years.
Getting comfortable with this realignment, and all the good things that follow, starts with recognizing that you’ve been betting all along.
The danger of being too smart
The popular wisdom is that the smarter you are, the less susceptible you are to fake news or disinformation. After all, smart people are more likely to analyze and effectively evaluate where information is coming from, right? Part of being “smart” is being good at processing information, parsing the quality of an argument and the credibility of the source. So, intuitively, it feels like smart people should have the ability to spot motivated reasoning coming and should have more intellectual resources to fight it. Surprisingly, being smart can actually make bias worse. Let me give you a different intuitive frame: the smarter you are, the better you are at constructing a narrative .
… the more numerate people (whether pro- or anti-gun) made more mistakes interpreting the data on the emotionally charged topic than the less numerate subjects sharing those same beliefs. “This pattern of polarization . . . does not abate among high-Numeracy subjects.
It turns out the better you are with numbers, the better you are at spinning those numbers to conform to and support your beliefs. Unfortunately, this is just the way evolution built us. We are wired to protect our beliefs even when our goal is to truthseek. This is one of those instances where being smart and aware of our capacity for irrationality alone doesn’t help us refrain from biased reasoning. As with visual illusions, we can’t make our minds work differently than they do no matter how smart we are. Just as we can’t unsee an illusion, intellect or willpower alone can’t make us resist motivated reasoning.
The Learning Loop
Thinking rationally is a lot about revising, and refuting beliefs(link to reflexivity) By going through a learning loop faster we are able to get an advantage. This is similar to John Boyd’s concept of an OODA loop.
We have the opportunity to learn from the way the future unfolds to improve our beliefs and decisions going forward. The more evidence we get from experience, the less uncertainty we have about our beliefs and choices. Actively using outcomes to examine our beliefs and bets closes the feedback loop, reducing uncertainty. This is the heavy lifting of how we learn.
Chalk up an outcome to skill, and we take credit for the result. Chalk up an outcome to luck, and it wasn’t in our control. For any outcome, we are faced with this initial sorting decision. That decision is a bet on whether the outcome belongs in the “luck” bucket or the “skill” bucket. This is where Nick the Greek went wrong. We can update the learning loop to represent this like so: Think about this like we are an outfielder catching a fly ball with runners on base. Fielders have to make in-the-moment game decisions about where to throw the ball.
Key message: How poker players adjust their play from experience determines how much they succeed. This applies ot any competitive endeavor in an uncertain world.
The best players analyze their performance with extreme intellectual honesty. This means if they win, they may end up being more focused on erros they made, as told in this anecdote:
In 2004, my brother provided televised final-table commentary for a tournament in which Phil Ivey smoked a star-studded final table. After his win, the two of them went to a restaurant for dinner, during which Ivey deconstructed every potential playing error he thought he might have made on the way to victory, asking my brother’s opinion about each strategic decision. A more run-of-the-mill player might have spent the time talking about how great they played, relishing the victory. Not Ivey. For him, the opportunity to learn from his mistakes was much more important than treating that dinner as a self-satisfying celebration. He earned a half-million dollars and won a lengthy poker tournament over world-class competition, but all he wanted to do was discuss with a fellow pro where he might have made better decisions. I heard an identical story secondhand about Ivey at another otherwise celebratory dinner following one of his now ten World Series of Poker victories. Again, from what I understand, he spent the evening discussing in intricate detail with some other pros the points in hands where he could have made better decisions. Phil Ivey, clearly, has different habits than most poker players—and most people in any endeavor—in how he fields his outcomes. Habits operate in a neurological loop consisting of three parts: the cue, the routine, and the reward. A habit could involve eating cookies: the cue might be hunger, the routine going to the pantry and grabbing a cookie, and the reward a sugar high. Or, in poker, the cue might be winning a hand, the routine taking credit for it, the reward a boost to our ego. Charles Duhigg, in The Power of Habit, offers the golden rule of habit change….
Being in an environment where the challenge of a bet is always looming works to reduce motivated reasoning. Such an environment changes the frame through which we view disconfirming information, reinforcing the frame change that our truthseeking group rewards. Evidence that might contradict a belief we hold is no longer viewed through as hurtful a frame. Rather, it is viewed as helpful because it can improve our chances of making a better bet. And winning a bet triggers a reinforcing positive update.
Note: Intellectual Honesty thinking clearly= thinking in bets
Good decisions compound
One useful model is to view everything as one big long poker game. Therefore the result of individual games won’t upset you so much. Furthermore, good decision making habits compound over time. So the key is to always be developing good long term habits, even as you deal with the challenges of a specific game.
The best poker players develop practical ways to incorporate their long-term strategic goals into their in-the-moment decisions. The rest of this chapter is devoted to many of these strategies designed to recruit past- and future-us to help with all the execution decisions we have to make to reach our long-term goals. As with all the strategies in this book, we must recognize that no strategy can turn us into perfectly rational actors. In addition, we can make the best possible decisions and still not get the result we want. Improving decision quality is about increasing our chances of good outcomes, not guaranteeing them. Even when that effort makes a small difference—more rational thinking and fewer emotional decisions, translated into an increased probability of better outcomes—it can have a significant impact on how our lives turn out. Good results compound. Good processes become habits, and make possible future calibration and improvement.
At the very beginning of my poker career, I heard an aphorism from some of the legends of the profession: “It’s all just one long poker game.” That aphorism is a reminder to take the long view, especially when something big happened in the last half hour, or the previous hand—or when we get a flat tire. Once we learn specific ways to recruit past and future versions of us to remind ourselves of this, we can keep the most recent upticks and downticks in their proper perspective. When we take the long view, we’re going to think in a more rational way.
Life, like poker, is one long game, and there are going to be a lot of losses, even after making the best possible bets. We are going to do better, and be happier, if we start by recognizing that we’ll never be sure of the future. That changes our task from trying to be right every time, an impossible job, to navigating our way through the uncertainty by calibrating our beliefs to move toward, little by little, a more accurate and objective representation of the world. With strategic foresight and perspective, that’s manageable work. If we keep learning and calibrating, we might even get good at it.
To: Democrats, Republicans
CC: Anarchists, Communists, Independents
Re: Department of Unintended Consequences
I don’t talk politics around here much but…
One thing the government needs is a “Department of Unintended Consequences” , or Unintended Consequences Ministry. This department will be in charge of analyzing the potential unintended consequence of any proposed policy put forth by any government department. I suggest that it hire the best computer engineers to help build simulations using the most advanced AI /game techniques. Perhaps this Unintended Consequences Ministry will help the broader government avert misguided actions, avoid long term consequences, and identify prudent courses of action.
This critical department will start it out with a small budget. But funds are tight, so other departments may have to make a few small cuts.
This department may rise in importance to be come a fourth component of the balance of power in the American system. I volunteer to be head of this department, and will accept a market compensation package.
Paul C Wonk
How can one maximize mental performance? The Organized Mind- Thinking Straight in an Age of Information Overload by Daniel Levitin is a book that works towards an answer to this question. The book’s ideas on offloading things to external systems and organizational techniques are very similar to David Allen’s , Getting Things Done . However, The Organized Mind, provides much more historical and scientific background an context. Further, An Organized Mind avoids being overly prescriptive, and instead gives the reader ideas on how to best optimize for their own situation.
Some of my highlights on the key themes of the book:
Getting the mind into the right mode
One useful framework that the books develops is hte idea of the mind as functioning in different modes. An important component of high performance is the ability to use the right mode at the right time.
There are four components in the human attention system: the mind-wandering mode, the central executive mode, the attention filter, and the attention switch, which directs neural and metabolic resources among the mind-wandering, stay-on-task, or vigilance modes.
Remember that the mind-wandering mode and the central executive work in opposition and are mutually exclusive states; they’re like the little devil and angel standing on opposite shoulders, each trying to tempt you. While you’re working on one project, the mind-wandering devil starts thinking of all the other things going on in your life and tries to distract you. Such is the power of this task-negative network that those thoughts will churn around in your brain until you deal with them somehow. Writing them down gets them out of your head, clearing your brain of the clutter that is interfering with being able to focus on what you want to focus on. As Allen notes, “Your mind will remind you of all kinds of things when you can do.
The task-negative or mind-wandering mode is responsible for generating much useful information, but so much of it comes at the wrong time.
Creativity involves the skillful integration of this time-stopping daydreaming mode and the time-monitoring central executive mode.
Insights into how human memory works
The book delineates the nuances of human memory by comparing it to systems in the physical world.
Being able to access any memory regardless of where it is stored is what computer scientists call random access. DVDs and hard drives work this way; videotapes do not. You can jump to any spot in a movie on a DVD or hard drive by “pointing” at it. But to get to a particular point in a videotape, you need to go through every previous point first (sequential access). Our ability to randomly access our memory from multiple cues is especially powerful. Computer scientists call it relational memory. You may have heard of relational databases— that’s effectively what human memory is.
Having relational memory means that if I want to get you to think of a fire truck, I can induce the memory in many different ways. I might make the sound of a siren, or give you a verbal description (“ a large red truck with ladders on the side that typically responds to a certain kind of emergency”).
This feature can lead to either valuable insights or being overwhelmed, depending on how it is controlled:
If you are trying to retrieve a particular memory, the flood of activations can cause competition among different nodes, leaving you with a traffic jam of neural nodes trying to get through to consciousness, and you end up with nothing.
Categorization is key to mental functioning.
This ability to recognize diversity and organize it into categories is a biological reality that is absolutely essential to the organized human mind.”
Shift burdens to external systems
You might say categorizing and externalizing our memory enables us to balance the yin of our wandering thoughts with the yang of our focused execution.
Cal Newport defines Deep Work as activities performed in a state of distraction-free concentration that push cognitive capabilities to the limit. Deep Work is essential in order to quickly master new things quickly, and to produce at an elite level in terms of both quality and speed.
Cal Newport quotes A.G. Sertillanges, a Dominican friar and professor of moral philosophy who wrote in The Intellectual Life
Men of genius themselves were great only by bringing all their power to bear on the point on which they had decided to show their full measure.
Winifred Gallagher concludes in the book Rapt: Attention and the Focused Life that management of attention is the key to improving nearly every aspect of existence. Realizing this is the easy part. The hard part is figuring out how to fit Deep Work into a busy schedule. Newport outlines 4 applicable philosophies for fitting deep work into the demands of a modern schedule.
1) The Monastic Philosophy
This is available to a limited pool of people, mainly tenured professors, and successful authors. Examples include computer scientist Donald Knuth and science fiction writer Neal Stephenson, who both go to extreme lengths to eliminate shallow tasks and communication.
2) The Bimodal Philosophy
Practically speaking, this is about taking a proper holiday, or carefully blocking off certain days for different kinds of work. It need not be long. Carl Jung, on several key occasions in the 1920s retreated to a house in the woods in order to work on writing, but spent most of his time to living a very active social life in Zurich. Adam Grant, a famous business school professor is, is very active with university responsibilities most of the time, but when working on a book, he’ll cut himself off from most office communication for 2-4 day periods.
3) The Rhythmic Philosophy
This is perhaps the most practical method for most people. Basically, it means creating a simple regular habit of deep work. Combine a simple scheduling heuristic, and an easy way to keep track.
One suggested method is to get up 90 minutes earlier and spend the extra time on deep work(this happens to be the method used by yours truly to get more reading/writing/coding done )
4) The Journalistic Philosophy
This seems like it could be combined with the rhythmic philosophy. In essence it means getting deep work in whenever you can fit it. It does require strong attention discipline(but like muscles, this can be trained). Walter Isaacson managed to write his first 800+ page book while working full time as a journalist using this method. (us mere mortal can use noise cancelling headphones as an aid in applying the journalistic philosophy of deep work)
Newport also offers two suggestions for ramping up the amount of deep work one does.
- Beware of distractions and looping. This is when the brain wanders into unrelated issues when it should be focused on a critical task. Newport used the example of when his brain would rehash preliminary results over and over again when he was trying to work on a proof.
- Structure deep thinking. Identify relevant variables, define the specific next step questions, and once it is solved , consolidate the gains by reviewing the identified answer. Approach problem solving methodically.
In the The Art of War, Sun Tzu wrote that those who excel in warfare do so because they seek out battles that are easy to win. Similarly, Warren Buffett wrote that he likes to look for one foot hurdles to step over, rather than trying to jump over seven hurdles. Of course actually finding easy battles, and one foot hurdles is itself quite challenging. If it was easy market forces would ensure that it quickly becomes hard. With so much brain and computer power dedicated to financial markets, there are few areas of opportunity left worth exploiting. However, by developing a behavioral and structural edge, one can act on the rare opportunities, and perform better than those that theoretically have an analytical and informational edge.
How can one develop a behavioral edge? Cultivating the right habits in order to be physically and mentally healthy goes a long way. Considering carefully what media to read is important to avoid being overwhelmed by noise. Finding time to think requires excellent resource management. It requires discipline to be willing to work on a name for months, only to pass on it, or to wait for months or even years for the right business to become cheap enough. Some might not enjoy spending hours reading about obscure nanocaps or corporate transactions, while ignoring popular stocks in the news. Some people seem naturally more willing to be contrarian, but I doubt anyone finds it easy all the time, especially during drawdowns. Being fearful when others are greedy, and greedy when others are fearful is harder than it sounds. Checking oneself for cognitive biases before any major financial decision is important. This is not an easy process, since cognitive biases have biological roots. I like to take a “red cell” approach, and try to understand potential short arguments for any stock I own. The connection between action and consequence is usually delayed in markets. It requires a lot of discipline, double checking and introspection to make your way through the vicissitudes of investing.
The cultivation of a structural edge is also nuanced. If you have developed a behavioral edge, then you can probably manage your personal finances in a way that allows your personal accounts to be invested for the long term. This requires maintaining excess liquidity at most times. If you manage money for other people, you have to be really careful who you take on as a client. If a client has a shorter time horizon than you, or are likely to need to pull money suddenly, the impact can be devastating. This is a difficult tradeoff, especially for small funds, since more AUM means more fees right away. With the right clients a capital markets disruption is a major opportunity, with the wrong clients it is a disaster. Whether in a personal account or a fund, simply having a long time horizon and a liquidity cushion can be a major source of long term alpha.
If one chooses to look at what other’s don’t one may actually end up with an analytical and informational edge in areas with less competition. I like to invest in things that are uninvestable for most investors with better resources, whether due to “headline” risk, illiquidity, or other institutional constraints. For example liquidations, delistings, and anything nanocap are fertile grounds for bargains. There are also interesting opportunities in distressed debt, and bankruptcies. I also like to look for situations where statistical services(Bloomberg, YCharts, Yahoo Finance, etc) are likely to have misleading or incomplete data, and companies that don’t fit in a comfortable category. Sometimes consolidated financials can be deceptive because of accounting rules, especially if a company has made acquisitions, holds real estate and/or holds a portfolio of securities. I also always make sure to adjust for material events that occurred after the 10-Q or 10-K date in determining a valuation. Judging by occasional market behavior I don’t think everyone does this. In any case there is always a gap between accounting reality and economic reality. The financial statements are just a starting point.
An ideal long term holding is a business that has a major competitive advantage and can easily earn a high return on capital over the long term, even if management screws up. These businesses are hard to find, and they’re sometimes hidden in a group of weak businesses that screened poorly, or attached to an old business that didn’t work. Thrift conversions are ignored by many, and easy to understand. Although the upside for thrift conversions is rarely large, the risk/reward tradeoff is phenomenal. Key information is often found on the OCC and FDIC websites, rather than in Edgar. Most OTC securities are ignored by sophisticated and large investors(plus the messiness of sorting through hundreds means you aren’t competing as much against computers). Sometimes I can get an informational edge by actually bothering to go to the company’s website and/or buying a token share and calling the company to ask for financials, which one has a legal right to access as a shareholder.
Whatever the investment, I’m only interested in buying if a lot can go wrong before I lose, and just a little going right provides a nice gain. Finding the right security is hard, but it should be easy to win once its in the portfolio. “Sifting through the debris of financial wreckage, out-of-favor securities and asset classes in which there is limited competition”, as Seth Klarman has called it does requires intense discipline and dedication, but provides ample rewards.
The extraordinary delusions and madness of crowds also serves up huge bargains from time to time, but the analysis is much harder. In all transactions, one must ask, why is someone willing to take the other side? I suspect there is more benefit to carefully analyzing my own psychology than to trying to outsmart others. I’d rather buy from a “non-economic” seller, when possible. Funds with industry or market cap mandates sell spinoffs indiscriminately. Funds that manage to an index dump companies kicked out indiscriminately. Delistings and liquidations are also sometimes forbidden by investment mandates regardless of the actual condition of the business or quality of the assets. I like to look at the portfolios of large concentrated funds that are facing massive redemption or shutting down, or from investors otherwise desperate for liquidity(oops did I say that out loud?). Sometimes people sell securities for reasons that make sense from the perspective of their job security, but are actually unrelated to the merits of the security being sold. Of course it takes a lot of searching to find where the right sellers are.
Charlie Munger told Howard Marks: “its not supposed to be easy, anyone who thinks its easy is stupid.” Indeed, finding easy things is hard.