“A man’s errors are his portals of discovery.” – James Joyce
Last week, Google’s DeepMind project successfully defeated the world’s reigning champion at the ancient Chinese board game of Go. The game requires complex, strategic and abstract thinking and the achievement marked a new milestone for Artificial Intelligence capabilities and applications of Machine Learning techniques. Unlike the game of chess, in which potential moves can be quantified for their mathematical strength, Go moves require more subjectivity, forcing the computer to weigh infinitely more possible options and outcomes. The series of games played between Google’s computer, named AlphaGo and the human champion, Lee Se-dol resulted in a 4 – 1 victory for Google. Could something like Google’s DeepMind algorithm someday be applied to money management? Any algorithm that could consistently profit from the public equity market would certainly be a, “Holy Grail” in finance. But until that day arrives, investors must depend on their own original thinking. Computers might be better calculators today, but when it comes to making highly subjective business decisions with lots of variables and possible outcomes, humans still have the edge.
Edward B. Burger is a prolific author and mathematician, now serving as the president of Southwestern University. His highly acclaimed book, The 5 Elements for Effective Thinking, uses the fundamental elements of Earth, Fire, Water, and Air, with the additional fifth element of Change, as metaphors to explain to readers how and why it’s so important to invest in their thinking abilities. Thinking, is a meta-skill and when you improve your thinking via reading, weaving a latticework of mental models, practicing, or play, the benefits transfer to almost everything else you do. And because investing is one of those practices that requires so much time and critical thinking, becoming a more effective and deeper thinker can offer a value investor superior insights.
Burger’s first rule for effective thinking is to know your fundamentals. No matter if you’re playing chess or pouring over balance sheets, getting to the fundamental ideas of whatever you’re studying is essential not only for basic comprehension, but for truly meaningful understanding. Sure, having surface-level knowledge helps, and is still better than nothing, but it’s in the actual art of drilling deeper into subjects that Burger explains meaning is found:
“As you learn more, the fundamentals become at once simpler but also subtler, deeper, more nuanced, and more meaningful.
In a previous Latticework article on How to Make Better Decisions, we wrote about the importance of expanding your universe as a means to developing taste. As Silicon Valley investor, Paul Graham writes in Taste For Makers, “The recipe for great work is: very exacting taste, plus the ability to gratify it.” And the only way to obtain “very exacting taste” is by mastering the fundamentals. It was the philosopher Schopenhauer who said, “Talent hits a target no one else can hit; Genius hits a target no one else can see.” It’s precisely this ability to see beyond the average person that creates those subtle, superior, genius insights.
“In spite of the instant gratification that surrounds me, I’ve continued to invest the old-fashioned way. I own stocks where results depend on ancient fundamentals: a successful company enters new markets, its earnings rise, and the share price follows along. Or a flawed company turns itself around. The typical big winner in the Lynch portfolio (I continue to pick my share of losers, too!) generally takes three to ten years or more to play out.”
Peter’s not looking for some hot tip fresh off Wall Street. Intelligent investors like Peter Lynch know that this sort of speculation isn’t what’s going to create rational investment opportunities. Rather, it’s your proficiency, understanding, and application of business fundamentals that create insights. Peter does bring up another point worth mentioning however; which is, the concept of timing and patience and letting your winners run over three to ten years.
For many professional money managers, timing isn’t always a friend. In bear markets, client fear leads to calling in capital when market prices are actually most attractive. Additionally, given how long it takes to confirm if an investment is working, it’s easy to lose patience. But as value investor, François Rochon says, “You won’t get much of a garden, if you remove a tree after six months because it hasn’t grown fast enough”. To solve this problem, investors must find alternative methods for getting feedback. Which brings up the next point in Burger’s book: to achieve effective thinking, you need feedback loops.
The old saying goes, “Fool me once, shame on you. Fool me twice, shame on me.” Everyone, including Warren Buffett himself, makes mistakes. But ultimately, it’s your attitude, resiliency and ability to learn from those mistakes that matter more to your future success. As Stanford University psychologist, Carol Dweck shares in her book Mindset: The New Psychology of Success, your mindset has a massive effect on how you perceive failure. You can either grow from failure, or be crippled by it. Those with faster feedback loops gain more experience. Those with more experience, compound their wisdom quicker than those who lack feedback. While theoretical knowledge and cautionary water-cooler-tales are helpful, their benefits only stretch so far. It should be of interest for all investors who are early in their careers to gain as much direct experience as possible, as this is the highest quality feedback loop available.
In our interview with the investing titan, Howard Marks of Oaktree Capital, Howard discusses why he believes experience is so important, especially for young investors:
I think there are certain things that go with youth. First of all, you haven’t had much experience. Experience is very important. The extremeness of cycles and the way they can turn against you and the ease of doing things wrong in a cycle and because of the cycle, I think it’s a great help to have been through some. In the beginning, they’re terrifying. Hopefully, with time you realize that, “Oh, this is another of these cycles and now I know how to get through it.” 1) They lack experience. 2) One thing that is hard to have without experience is a strongly felt personal philosophy because I think that your philosophy comes from your experience.
For additional investing wisdom from Howard, consider supplementing this article with: Howard Marks on Self-Assessment, the Most Important and the Most Dangerous Things.
“We like to think of our champions and idols as superheroes who were born different from us. We don’t like to think of them as relatively ordinary people who made themselves extraordinary.” – Carol Dweck
The good news, is that with time, experience, the right attitude, and enough discipline, there aren’t many subjects that can’t be mastered to the depths of highly effective thinking. The remaining elements in Edward Burger’s book, contain more good recommendations; mainly, the importance of asking better questions, and adapting to changes as your thinking evolves. There’s a great quote by the writer, David Foster Wallace: “Good writing isn’t a science. It’s an art, and the horizon is infinite. You can always get better.” If you consider value investing an art, the same way that DFW viewed writing an art, then you can make the same analogy. Good investing is an art where the horizon is infinite. Learning to think more effectively will help you greatly on that journey. One of the pieces of advice that Charlie Munger offers young people is to, “Go to bed smarter than when you woke up.” It’s a simple and powerful idea, but if applied consistently, the miracle of compounding will take full effect. Superior insight must start with superior sight. It’s the targets that only you can see, that when you hit them, will make you a genius.